Sudan
Staff Report for the 2012 Article IV Consultation
Author:
International Monetary Fund. Middle East and Central Asia Dept.
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Publication Date:
05 Nov 2012
eISBN:
9781475548341
Language:
English
Keywords:
ISCR; CR; exchange rate; Sudan; government; authority; debt; debt relief; financial support; debt service; trade balance; excess reserves; Oil exports
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Staff Report for the 2012 Article IV consultation, prepared by a staff team of the IMF, following discussions that ended on July 23, 2012, with the officials of Sudan on economic developments and policies. Based on information available at the time of these discussions, the staff report was completed on September 7, 2012. The views expressed in the staff report are those of the staff team and do not necessarily reflect the views of the Executive Board of the IMF.

Abstract

Staff Report for the 2012 Article IV consultation, prepared by a staff team of the IMF, following discussions that ended on July 23, 2012, with the officials of Sudan on economic developments and policies. Based on information available at the time of these discussions, the staff report was completed on September 7, 2012. The views expressed in the staff report are those of the staff team and do not necessarily reflect the views of the Executive Board of the IMF.

Introduction

1. Deep-seated security issues have for years posed serious challenges to Sudan’s economic prosperity. Sudan has experienced an alternation of civilian and military governments and two protracted North-South wars that took a heavy toll on human life and economic resources. The Comprehensive Peace Agreement (CPA), signed on January 9, 2005 by the government of Sudan and the Sudan People’s Liberation Movement/Army (SPLM/A) and the secession of South Sudan in 2011, have created a window of opportunity for peace and stability. However, further efforts are needed to address ongoing conflicts in bordering states.

2. The 2012 Article IV consultation is taking place at a unique juncture in the history of Sudan, following South Sudan’s secession in July 2011. The secession resulted in Sudan losing some three-quarters of its oil production, half of its fiscal revenues, and about two-thirds of its international payment capacity (Figures 1 and 2, and Box 1). Adjusting to a permanent shock of such magnitude is a daunting challenge and requires a strong policy response at a time when international financial support is very limited (Figure 6). Sudan’s unstable security situation adds to this challenge.

Figure 1.
Figure 1.

Sudan: Oil Sector Contribution to GDP

Citation: IMF Staff Country Reports 2012, 298; 10.5089/9781475548341.002.A001

Sources: Sudanese authorities; and staff calculations.
Figure 2.
Figure 2.

Sudan: Oil Production and Revenues

Citation: IMF Staff Country Reports 2012, 298; 10.5089/9781475548341.002.A001

Sources: Soudanese authorities; and staff estimates and projections.

Impact of the Secession of South Sudan

The secession of South Sudan is having a significant impact on the Sudanese economy. While Sudan’s economy is relatively diversified and open, it has developed since 1999 a marked dependency on the oil sector that has substantially increased its vulnerability to external and fiscal shocks. The oil sector’s contribution to GDP has been modest, hovering around 15 percent. However, it provided sizeable budget revenues and contributed a major share of the country’s foreign exchange receipts. The economic and financial losses related to South Sudan’s secession are substantial and have affected all the sectors of the economy.

Main Impacts of the Secession on Sudan’s Economy

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Sources: Authorities; and staff calculations and estimates.

  • Real sector: The loss of output is concentrated in the oil sector and estimated at 75 percent, compared with 5–10 percent in the rest of the economy. In terms of value-added, the overall loss is about SDG 50 billion (26¼ percent of 2012 GDP), of which about 19 percent of GDP in the oil sector.

  • Fiscal sector: The revenue loss for the government is estimated at SDG 12 billion (6¼ percent of GDP), corresponding to the foregone oil revenues net of the transfers to South Sudan and the savings on wages of South Sudanese civil servants.

  • External sector: The main impact is related to the loss of oil exports estimated at about US$6.6 billion (12.9 percent of GDP) in 2012.

  • Monetary sector: The July 2011 data indicate that the secession led to a downward adjustment of Sudan’s official reserves by 17 percent (US$0.5 billion), and that of the stock of bank credit to the private sector by 7 percent (0.9 of GDP) corresponding to the amount of credit outstanding provided by the southern branches of Sudanese banks.

Figure 3.
Figure 3.

Sudan: Credit to the Government; Inflation; and Reserve Money, 2009–12

(Change in percent)

Citation: IMF Staff Country Reports 2012, 298; 10.5089/9781475548341.002.A001

Source: Sudanese authorities.
Figure 4.
Figure 4.

Sudan: Official and Parallel Exchange Rates, 2007–12

(SDG per U.S. dollars)

Citation: IMF Staff Country Reports 2012, 298; 10.5089/9781475548341.002.A001

Source: Sudaneseauthorities.
Figure 5.
Figure 5.

Sudan: Selected Economic Indicators, 2005–12

Citation: IMF Staff Country Reports 2012, 298; 10.5089/9781475548341.002.A001

Sources: Authorities; and staff estimates and projections.
Figure 6.
Figure 6.

Sudan: Comparison 2012 and 2010 Article IV Staff Reports

Citation: IMF Staff Country Reports 2012, 298; 10.5089/9781475548341.002.A001

Sources: Sudanese authorities; and staff estimates and projections.

3. After a year of uncertainty, the authorities approved in late June 2012 a comprehensive reform program to address the deterioration of the country’s economic and financial situation. The program—which builds on the authorities’ Three-Year Emergency Program1—includes an exchange rate devaluation of about 66 percent, an increase in key taxes, a sharp reduction in fuel subsidies, cuts in non-priority spending, and a strengthening of the social safety nets.

4. The response to past IMF advice has been broadly satisfactory. Sudan implemented reforms under a series of 13 Staff-Monitored Programs (SMPs) between 1997 and 2011. Notable achievements include progress in restoring macroeconomic stability, liberalizing the economy, and improving economic management capacity. However, weaknesses persist in financial management, revenue mobilization, and monetary management. The Fund continues to support the authorities reform efforts through technical assistance and policy advice (Box 2).

The Fund’s Role in Sudan Since South Sudan Secession

Since the secession of South Sudan, Fund support to Sudan has consisted of the following:

  • Intensive economic advice and technical assistance on policies to address the impact of the South’s secession.

  • Co-chairing with the World Bank the Technical Working Group on Sudan’s external debt (see paragraph 49).

  • Providing economic advice to the African Union High Implementation Panel (AUHIP) in charge of mediating between Sudan and South Sudan.

  • Setting-up of an inter-departmental working group to ramp-up the Fund’s work on Sudan prior to the secession of South Sudan.

Performance Under SMPs, 1997–2011

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Sources: Sudanese authorities; and staff estimates.

Starting in 1999.

5. The political situation remains fragile owing to persisting, albeit low intensity, protests following the announcement of government reforms, and the volatile security environment. Since South Sudan’s secession, tensions and military skirmishes between the two countries have persisted. African Union–sponsored negotiations have recently led to a tentative agreement on oil-related issues. Implementation of this agreement is, however, contingent on reaching an agreement on borders security issues (Box 3).

Oil-Revenue Agreement Between Sudan and South Sudan

Sudan and South Sudan reached in early August 2012 a preliminary agreement on oil-revenue sharing. Implementation of this agreement is, however, contingent on reaching an agreement on borders and other security issues. The agreement covers a period of 3 ½ years, starting from the resumption of oil production in South Sudan. It includes both a transitional financial arrangement (TFA)—a transfer from South Sudan—and pipeline-related fees. Under the agreement South Sudan will:

  • Provide a TFA payment that totals US$3.028 billion over 3½ year period. The TFA payment is expressed in per barrel terms, as US$15/bl, based on the South Sudan’s projection of an average of 150,000 bl/day of oil production. If production is higher, payments will be made at the rate of US$15/bl until cumulative payments reach US$3.028 billion.

  • Pay pipeline-related fees averaging US$9.7/bl. These fees were also negotiated for this 3½ year period. Although—unlike the TFA payments—these will continue after the 3 ½ year period, after being renegotiated.

In addition, it was agreed that Sudan and South Sudan would initiate a joint outreach campaign to the international community, with four objectives:

  • mobilize financing to compensate for Sudan’s loss of oil revenue;

  • garner support for debt relief for the two Sudans, in the context of the Zero Option (see paragraph 50);

  • encourage financing for South Sudan’s development needs; and

  • lifting of sanctions on Sudan

Recent Development, Outlook and Risks

A. Developments in 2011 and the First Half of 2012

6. Sudan’s economic conditions deteriorated considerably in 2011 in the aftermath of South Sudan secession. Nonoil real GDP growth decelerated to 3.4 percent and inflation picked up at about 18.5 percent (Figure 5 and Table 1). The overall fiscal deficit reached 1.3 percent of GDP (Table 3) and was mostly financed by the banking system, which resulted in reserve money growing 28 percent; credit to the economy was subdued at 8 percent (Tables 4 and 5). There was a contraction in the balance of payments with exports declining by 13 percent, reflecting the drop in oil exports which was only partially offset by the increase in gold exports. Imports declined by about 8 percent. This restructuring of the trade balance resulted in a current account deficit of about 0.5 percent of GDP (Table 2).

Table 1.

Sudan: Selected Economic Indicators, 2008-13

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Sources: Sudanese authorities; and staff estimates and projections.

In the calculation of the growth rates: 2010 aggregates are related to unified Sudan; 2011 aggregates include South Sudan for the first half of the year; and 2012 aggregartes are related to post-secession Sudan.

Table 2.

Sudan: Balance of Payments, 2008–17

(In Millions of US Dollars)

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Sources: Sudanese authorities; and staff estimates and projections.
Table 3.

Sudan: Government Operations, 2008–17

(In Millions of SDGs)

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Sources: Sudanese authorities; and staff estimates and projections.

Nonoil balances exclude oil revenues, grants, transfers to South, oil related transfers to Northern states and pipelines fees paid by the government.

Table 4.

Sudan: Monetary Survey, 2008–13

(In Millions of SDGs)

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Sources: Sudanese authorities; and staff estimates and projections.
Table 5.

Sudan: Summary Accounts of the Monetary Authorities, 2008–13

(In Millions of SDG)

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Sources: Sudanese authorities; and staff estimates and projections.

7. Economic conditions continued to deteriorate in the first half of 2012. The fiscal position weakened as revenue under-performed by some 30 percent,2 compared to an execution rate of over 95 percent for spending. Reserve money and broad money grew 24 percent and 25 percent, respectively, much higher than in the first half of 2011 (Figure 3).3 Relative to the first half of 2011, exports contracted considerably (-40 percent), which resulted in a widening of the trade deficit to an estimated $2.7 billion, compared to a surplus of about $2.2 billion in the first half of 2011. By end-July, 12-month inflation reached 41 percent.

8. In order to stop the erosion of the country’s international reserves, the authorities introduced in 2011 some administrative restrictions. These include rationing foreign exchange, imposing restrictions on banks’ excess reserves in foreign currency and on bank deposits in foreign currency. By year-end, official reserves stabilized at about US$1.3 billion (1.8 months of imports).4

9. Pressures on the Sudanese pound intensified pushing the premium on the US dollar to above 100 percent, and induced the authorities to devalue the exchange rate of the pound (Figure 4). At end-June, gross official reserves stood at about 2.7 months of imports, following the receipt by the central bank of Sudan (CBOS) of external support (Table 2).

10. Sudan’s monetary system is characterized by moderate dollarization, with a dynamic curb foreign exchange market. Last year, foreign currency deposits as a ratio to broad money (M2) were on a downward trend from a peak of 16.5 percent in the first half of 2011 to reach a low 14 percent by end-May 2012, just before the step devaluation of the pound. The share of loans in foreign currency in total bank credit was about 10–15 percent. As a result of the devaluation, the balance sheets of the central bank and the commercial banks inflated by about 40 percent and 20 percent, respectively, and the share of loans in foreign currency rose to about 23 percent.

11. Financial sector indicators were mixed in the last two years. While the capital adequacy ratio rose from 10 percent in 2010 to 11 percent in March 2012, nonperforming loans (NPLs) remained high at 14 percent (Table 8). Also:

Table 6.

Sudan: Summary Accounts of the Commercial Banks, 2008–13

(In Millions of SDG)

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Sources: Sudanese authorities; and staff estimates and projections.
Table 7.

Sudan: Medium-Term Macroeconomic Outlook, 2010–17

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Sources: Sudanese authorities; and staff estimates and projections.

Staff estimates and projections

Sudanese oil blends. Projections are based on the latest WEO assumptions (based on future prices).

Table 8.

Sudan: Financial Soundness Indicators for the Banking Sector, 2006–12

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Source: Central Bank of Sudan.

Data for December 2006 refer only to 27 of the 30 existing banks (exclude Sudanese Argiculture Bank, Capital Bank, and Industrial Development Bank).

  • Banks’ liquidity remained high (37 percent).

  • Commercial banks’ profitability was adversely affected by the high share of NPLs and the holding of large unremunerated excess reserves; the less liquid banks suffered also from the rising reserve requirements.

  • Banks maintained large interest rate spreads and prudent lending reflecting rising risk aversion exacerbated by deteriorating economic conditions.

  • Between December 2010 and March 2012, the return on assets dropped from 3.9 percent to 1.4 percent and the return on equity from 26½ percent to 8.1 percent.

12. The devaluation of the Sudanese pound is expected to have a notable impact on the banking system. Staff’s preliminary estimates show that the capital adequacy ratio could fall below 10 percent and the NPLs ratio could exceed 15 percent. The NPLs ratio could deteriorate further during the next 12 months when the bulk of banks’ loan portfolio in foreign currency reaches maturity.

B. Outlook and Risks

A fragile path to recovery

13. The economic situation is expected to continue to be difficult during the next 18 months (2012–13), clouded by the impact of South Sudan’s secession and tight financing constraints:

  • Non-oil GDP is expected to decline slightly in real terms, mostly reflecting a reduction in domestic absorption consistent with the fiscal adjustment, and the absence of offsetting gains on non-resource exports. The authorities expect an overall GDP growth of 2 percent in 2012 driven by a strong performance in the agriculture and gold sectors.

  • As a result of the gradual fiscal consolidation, inflation is expected to average about 30 percent in 2012, before easing to 17 percent in 2013.

  • The overall fiscal balance is expected to reach 3.7 percent of GDP in 2012 before narrowing to 3.2 percent of GDP in 2013, reflecting an improved non-oil primary balance.

  • The current account deficit is expected to average 6.9 percent of GDP in 2012–13, with imports contracting by a cumulative 20 percent, and capital inflows, including FDI, dropping by an estimated 50 percent.

Medium-term outlook slightly positive, but with risks

14. The authorities’ reform package of June 2012 is an important step toward restoring macroeconomic stability and reducing the economy’s dependence on oil (Box 3). They would allow macroeconomic conditions to improve gradually starting in 2014, with non-oil growth picking up to about 4.5 percent, inflation declining to single digits, and the fiscal deficit dropping to about 1.5 percent of GDP.

15. Risks to the outlook are tilted to the downside. Increased tensions along the borders with South Sudan could lead to an increase in military spending, which would add pressure on the budget. Additional risk relates to a reform slowdown resulting either from a pickup in oil and gold production or social resistance to further reforms (Box 4). On the upside, the implementation of the recent tentative agreement with South Sudan on oil related issues or commitment from the international community to provide Sudan debt relief would lessen the country’s fiscal and external constraints and facilitate the adjustment process.

Authorities’ Views

16. The authorities broadly agreed with staff’s assessment of the economic outlook and risks. While emphasizing the difficulty of the recently adopted reforms, they thought that these policies were needed to address the prevailing imbalances. They also acknowledged the need to sustain the reform process over the medium term.

Risk Assessment Matrix

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Policy Discussions

Policy discussions took place in the context of difficult social, political and security conditions, and focused on the scope of the government’s policies to address the impact of South Sudan’s secession and their ability to stabilize the economy and support economic recovery.

17. Adjusting to the large economic shock incurred by Sudan is highly challenging. It requires the implementation of a two-tier reform strategy centered on: (i) short-term adjustment measures to mitigate the deterioration of economic conditions, and (ii) a medium-term reform program to refocus the economy on its non-resource sector.

18. Sudan’s reform program aims to address the near-term challenges. Its underlying policy mix combines fiscal adjustment, increased exchange rate flexibility and a tightening of the monetary stance. Restoring macroeconomic stability and reinforcing economic conditions would require however strong and determined implementation of the reforms. Also, the severity of the fiscal and external shock compounded by the country’s limited access to external financing will require additional efforts over the medium term in order to restore fiscal sustainability and improve international payment capacity.

Authorities’ Views

19. The authorities agreed with the two-tier reform strategy to address their economic imbalances. They, however, noted some positive factors that could ease the country’s financial constraints, including higher gold exports, a gradual pickup in oil production, and financial assistance from friendly countries.

Key Measures Adopted in June 2012

Fiscal policy:

Revenue measures

  • Increase the VAT from 15 to 17 percent

  • Increase the development tax from 10 to 13 percent

  • Increase the Business profit tax on the banking sector from 15 to 30 percent

  • Increase stamp duties on financial transactions and international flights

  • Repeal the negative list used to limit imports and impose instead import tariffs

  • Enhance revenue collection and lift discretional tax exemptions

Expenditure measures

  • Phase out fuel subsidies and strengthen social safety nets

  • Liberalize the price of sugar

  • Consolidate ministries at all levels of government

Social spending

  • Raise the salary of civil servants and pensioners by 100 SDG per month (about 40 percent of minimum wage)

  • More than doubling spending on social benefits

  • Lower custom duties on main staples and exempt medicine

Monetary policy:

Exchange rate reform: The new foreign exchange regime is centered on four rates:

  • A central rate of SDG 4.42 per US dollar that applies also to the importation of fuel products, the payment of government obligations, and valuation assessment at customs;

  • A subsidized rate for wheat of SDG 2.9 per US dollar;

  • A gold exchange rate used by the central bank in its gold transactions; and

  • A commercial banks rate that applies to all other transactions and has three components: (i) an indicative rate;1 (ii) a variable incentive premium set by the central bank (currently 15 percent); and (iii) a flexibility factor that allows banks to deviate from the sum of the indicative rate and the incentive by a range of ±4 percent.

Monetary policy: Increase the reserve requirement ratio from 15 percent to 18 percent and roll back CBOS deposits in commercial banks.

1 The indicative rate is the weighted average of the previous day central rate and the average commercial banks rate excluding the incentive premium.

A. Containing the Deterioration of Economic Conditions

The revised 2012 budget goes a long way toward reducing near-term fiscal imbalances; however, reaching fiscal sustainability will require a determined continuation of the reform momentum.

20. Fiscal policy is confronted in the near term with the major challenge of adjusting to the loss of about 50 percent of government revenues. In view of Sudan’s limited access to external financing and the need to contain monetary financing, achieving this objective requires bold action on both the revenue and expenditure sides.

21. The authorities’ efforts to enhance revenue collection are encouraging. Given the pressing budgetary needs, the moderate tax increases are likely to be the most feasible course, although a concerted effort to expand the tax base through tax policy and administration measures is needed to raise revenues on a more sustainable basis. Staff is of the view that a diligent implementation of the revenue measures could yield additional revenues of about 1 percent of GDP higher than envisaged in the revised budget. It encouraged the authorities to provide the tax and customs directorates with adequate resources, while enhancing tax and customs administration in line with Fund technical assistance recommendations.

Tax Revenue

(In percent of Non-oil GDP)

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Sources: Country authorities; and staff estimates.

22. Staff stressed the need to rationalize the taxation of the expanding gold sector.5 Government gold revenues are currently small and limited to the payment by the gold trading companies of a 15 percent business profit tax on their commission. While gold producers currently pay a 7 percent royalty, staff recommended subjecting them to the business profit tax.

23. Staff welcomed the replacement of the negative list by import tariffs, which will boost revenues. Over the medium term, it recommends a gradual reduction in the tariffs to reinforce the openness of the economy.

24. The authorities’ reduction in fuel subsidies and the strengthening of social safety nets are important reforms.6 The reduction in subsidies will create space for additional priority spending. Staff underscored, however, that the budgeted increase in social safety nets is not targeted, which could limit their efficiency, whereas the general wage increase in the civil service could be inflationary, due to its contagion effects on the rest of the economy. Finally, staff advised limiting transfers to states to 30 percent of total revenues, in line with constitutional provisions.

25. Staff encouraged the authorities to strengthen the government development budget. This budget has been reduced by 17 percent in nominal terms, which entails a large drop in real terms. Staff recommended: (i) a comprehensive appraisal of the investment budget, including procedures and project selection, to ascertain that priority projects are correctly funded; and (ii) the establishment of quarterly monitoring to improve the efficiency of execution.

Authorities’ Views

26. The authorities broadly agreed with staff’s assessment. They considered their revenue projections to be realistic in light of the limited scope for raising revenue and in order to avoid undue spending pressure from other ministries. On gold taxation, they argued that taxing producers would be counterproductive as it would reenergize smuggling. They expressed their determination to phase out the fuel subsidy by end-2014 (SIP, Chapter 1). They also expressed their intention to streamline exemptions granted by law, and to gradually reduce transfers to states while developing better revenue collection at lower levels of government.

Monetary policy

27. In recent years, monetary conditions in Sudan have been mostly determined by the fiscal stance and market exchange rate developments (SIP, Chapter 2). This situation has been exacerbated by the adverse effects of the secession of South Sudan: the abrupt rise in government financing needs, the loss in oil export proceeds, which affected the central bank’s foreign reserves accumulation, and the marked erosion of the domestic currency in the curb market.

28. The deterioration of Sudan’s external and fiscal accounts has affected the work of the banking system and weakened CBOS’s independence. Monetary developments since South Sudan’s secession were mostly driven by the need to accommodate the government financing requirements. The increased monetization of a fast growing fiscal deficit has adversely affected the ability of the central bank to contain inflation, resulting in core inflation rising by 44 percent in the 12-month period through July. The decision by the CBOS to reschedule about SDG 4 billion (about 2.3 percent of GDP) of its temporary advances to the government over a 100-year period has given more space to deficit monetization and circumvented existing laws.7 At the same time, credit to the economy was hampered by the segmentation of the foreign exchange market, and by an increased risk aversion by banks, which prefer to lend to state owned enterprises, or invest in government securities whose interest rate although negative in real terms remains well above the level charged by banks and are in high demand.

29. The CBOS has taken steps in an attempt to lessen pressure on the exchange rate and safeguard external reserves. It has increased the required reserve ratio from 10 percent to 18 percent since the beginning of the year, and put in place administrative measures to tighten controls on banks and accommodate the government’s financing requirements. All these measures have proven inefficient and counter-productive.

30. Staff underscored the importance of enhancing monetary management by the CBOS given the large bank excess liquidity.8 Excess liquidity weakens the monetary transmission mechanism and undermines the use of monetary policy for stabilization purposes. Accordingly, staff recommended that the authorities:

  • Tighten the monetary stance by: (i) containing credit to the government, (ii) unwinding the CBOS deposits with commercial banks, and (iii) refrain from providing credit to the economy;

  • Use reserve money rather than the exchange rate as an anchor to keep inflation under control;

  • Refrain from raising the reserve requirements to stabilize the exchange rate. This measure increases taxes on banks and adversely affects their profitability. Also, in Sudan’s context it has limited effects on exchange rate movements, which have their root in the expansionary fiscal policy and the increasing monetization of the deficit.

  • Restore the monetary transmission mechanism by giving to commercial banks the appropriate opportunities to recycle their unused deposit liabilities. This could be achieved through the organization of a competitive auction system of CBOS securities and the reactivation of the interbank market as a first step toward the development of open market operations.

31. Financial stability remains key in ensuring the success of the government’s economic and financial reforms. In that respect, staff recommended a comprehensive assessment of Sudan’s banking system to determine the short and medium term effects of the financial and economic implications of South Sudan’s secession on banks’ balance sheets and vulnerability. Such assessment would help identify the reforms that are needed to improve the sector’s competitiveness, efficiency and resilience, and enhance its development.

32. The CBOS’s current role in the gold market is a burdensome distraction from its core and demanding responsibility of maintaining price stability. Prior to the CBOS’ intervention in the gold market in early 2011, a significant part of the gold was smuggled abroad and sold at sub-value. The CBOS is the sole exporter of gold and has recently built a gold refinery to increase the value added of gold and boost its international reserves. Staff urged the CBOS to gradually withdraw from this activity.

Authorities’ Views

33. The authorities concurred with staff on the need to tighten the monetary stance. They indicated that they will gradually reduce the monetization of the deficit as the government revenue base improves. With respect to gold, they argued that the CBOS will continue to play an active role until this industry is well established and the mining industry’s regulatory framework finalized.

Exchange rate policy

34. In recent years, the curb market exchange rate has gradually become very important. Following South Sudan’s secession and the subsequent drop in the oil revenues, this role became preponderant, heavily influencing overall economic conditions, including external trade flows and the domestic inflation dynamics. This also resulted in the depreciation of the equilibrium real exchange rate. Based on available data up to June 2012, various indicators suggest that the exchange rate is overvalued, though the magnitude of the overvaluation remains uncertain (Box 6).9

35. In this context, the recent large devaluation of the official exchange rate reveals the strong determination of the monetary authorities to move to a more flexible exchange rate regime and bridge the gap with the curb market.10 While staff’s preliminary qualitative assessment, conducted prior to the recent devaluation, has found major vulnerabilities that threaten external stability and competitiveness, staff strongly recommended unifying the official market by eliminating the other three rates (central rate, subsidized rate, and gold rate), a measure which would likely facilitate convergence with the curb market rate (SIP, Chapter 3). Such an option is consistent with the authorities’ strong preference for a managed float regime and could be envisaged provided the commercial banks rate is kept flexible enough to remain in line with economic fundamentals; such increased flexibility is warranted, as evidenced by the end-July increase in the gap between the two rates to about 10–15 percent, after narrowing considerably when the new regime was introduced in late June. Staff pointed that the exchange regime and administrative restrictions could give rise to multiple currency practices and exchange restrictions under Article VIII.

Authorities’ Views

36. The authorities agreed with staff’s assessment and the need for greater exchange rate flexibility. They indicated that they will continue to monitor market conditions to ensure that convergence with the curb rate is achieved. They justified the existence of special rates by the need to limit the burden of the devaluation on the government’s obligations. With respect to the special rate for gold, they indicated that they will gradually bring it in line with the commercial banks rate.

External Stability Assessment

Staff’s assessment finds major vulnerabilities and secession-induced permanent adjustment needs that threaten external stability and competitiveness.

The secession of South Sudan resulted in a structural shift in the balance of payments dynamics. Over the past decade, the current account was driven by developments in the oil sector—both exports and FDI. For the medium-term, the BoP is expected to shrink as a result of the drop in oil exports and limited alternative source of financing. Accordingly, the current account will depend on Sudan’s ability to develop its non-oil export base.

Based on available data up to June 2012, several indicators suggest that the exchange rate is overvalued, though the magnitude of the overvaluation remains uncertain:

  • current account dynamics have worsened permanently;

  • the curb rate has become the main denominator and its gap to the official rate had widened (Box Figure 1);

  • the REER and NEER were on an appreciating trend, leaving them way above historical levels as well as above the steadily depreciating REER and NEER based on the curb rate (Box Figure 2);

  • reserves had suffered of protracted exchange market interventions in one direction (see Box Figure 3); and

  • growing external arrears add to an already unsustainable external public debt burden.

Box Figure 1.
Box Figure 1.

Average Monthly Exchange

Rate (2007M01-2012M07)

Citation: IMF Staff Country Reports 2012, 298; 10.5089/9781475548341.002.A001

Box Figure 2.
Box Figure 2.

REER and NEER

(2000M01-2012M06)

Citation: IMF Staff Country Reports 2012, 298; 10.5089/9781475548341.002.A001

Box Figure 3.
Box Figure 3.

Average Monthly Reserve Levels

(2006M01-2012M06)

Citation: IMF Staff Country Reports 2012, 298; 10.5089/9781475548341.002.A001

Against this background, on June 25, the authorities have allowed for a corrective outright exchange rate depreciation of the CBOS indicative rate from 2.67 to 4.42 SDG/USD and of the commercial banks rate from 2.88 to 5.45 SDG/USD. This reduced the gap to the curb rate from over 100 to 23 and 93 to 3 percent (Box Figure 1) and undid a major part of the REER overvaluation (Box Figure 2). Until end-July, however, the gap has widened again to 40 and 15 percent, respectively, making the case for continued exchange rate flexibility to assure that the official rate goes in line with fundamentals.

Second, qualitative competitiveness indicators point to significant structural and institutional bottlenecks, calling for substantial structural reforms to improve the business climate –especially facilitating cross-border trading, accelerating financial sector development, investing in infrastructure to reduce production and distribution costs, and improving governance, political stability and overall security.

Finally, reserve levels are too low as judged by traditional rules of thumb and a new methodology for assessing the adequacy of reserve holdings. The latter makes the case for a coverage of more than 4 months of 2011 imports.

B. Economic Transformation

Medium-term reforms should aim to refocus the economy on its non-resource sector by strengthening economic fundamentals and improving the business environment and growth inclusiveness.

37. The authorities’ development strategy outlined in the three-year economic plan projects a relatively fast economic recovery. The plan identifies potential sources of growth and assumes a timely implementation of comprehensive reforms that would significantly enhance economic performance.

38. In staff’s view, Sudan’s medium-term challenge is to regenerate most of the lost economic and financial potential while minimizing the adjustment cost on the economy. This would require a gradual transformation of the economy into a more competitive economy that could generate the foreign exchange it needs to cover its imports requirements and expand, and to deliver the tax revenues that the government needs to operate.

The required policies

39. Fiscal reform should continue in the context of a medium-term budgetary framework, anchored on a fiscal deficit target of 2 percent of GDP that would ensure steady progress toward a long-term primary surplus via continued structural consolidation, while boosting potential growth through increased infrastructure investment. This strategy would limit inflationary financing in the short- and medium-term, while keeping the non-oil primary deficit at about 5 percent of GDP, and ensure progress toward fiscal sustainability in the long-term. The fiscal reforms should be centered on: (i) a revision of the government revenue model; (ii) a rationalization of public spending and a streamlining of the civil service; and (iii) the overhaul of state finances (SIP, Chapter 4).

  • The new government revenue model could be achieved through gradually eliminating tax exemptions and improving taxpayer compliance management. Also, the implementation of an ambitious privatization program could generate some additional transitory resources that could be used to finance the needed increase in government investment;

  • Improving the efficiency and quality of public spending, including developing a well-targeted safety net system. In particular, the subsidy reform momentum should be maintained in the context of the 2013 budget and the related savings should be used to strengthen the social safety nets and the investment program.11 Also, subjecting public enterprises to hard budget constraints would require a comprehensive restructuring of the public sector, and streamlining the civil service will necessitate the organization of a census to identify the reforms that are needed to rationalize government services.

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Source: World Bank 2012 Doing Business Report

  • Overhauling and reforming state finances in order to reduce the states’ dependence on central transfers remains the key component of the fiscal reform. It will necessitate shifting to a model that improves revenue collection capacity and rationalizes expenditure control at the state level while rebalancing federal transfers toward capital spending and the delivery of basic social services.

40. The monetary and banking sector should be enhanced by an increased reliance on indirect monetary management and a comprehensive restructuring of the banking system. In the monetary area, the directed credit allocations should be terminated, and central bank securities should be used to manage liquidity, reactivate the interbank money market and develop open market operations. Also, the CBOS should strengthen its monetary policy committee by increasing its economic monitoring capabilities. In the banking area, a comprehensive evaluation of the banking system should be undertaken to enhance the legal, regulatory, and institutional framework in line with international practice, and remove impediments to financial deepening. Also, banking supervision should be strengthened, including through enhanced training of supervisory staff.

A01ufig01

Sudan: Human Development Indicators Trends 1980-2010

Citation: IMF Staff Country Reports 2012, 298; 10.5089/9781475548341.002.A001

Source: UNDP, 2011.

Authorities’ Views

41. The authorities agreed with staff on the importance of continuing fiscal consolidation and structural reforms to ensure the economy will move to a sustainable growth path.

C. Promoting Competitiveness and Inclusive Growth

Promoting competitiveness and inclusive growth will require reforms on a number of fronts while simultaneously continuing to safeguard macroeconomic stability.

42. The business environment needs to be more conducive to private sector development (Figures 7 and 8). According to the World Bank’s Doing Business Report, regulations governing investment and banking in Sudan are opaque and subject to frequent change, discouraging entrepreneurial activity. In order to boost the economy and ensure sustained and inclusive growth, government policies need to remove impediments to private sector investments and promote a wage policy linking wages to the economy’s productivity. Also, encouraging exports would contribute to rebalance the country’s external accounts. While active internal demand management policies would help increase the country’s export potential, they would need to be accompanied by supporting policies, including provision of advice and services to exporters that could be provided by specialized agencies and banks.

Figure 7.
Figure 7.

Sudan: Selected Political and Social Indicators

Citation: IMF Staff Country Reports 2012, 298; 10.5089/9781475548341.002.A001

Sources: Worldwide Governance Indicators; Global Competitiveness Indicators; UNDP Human Development Indicators; World Bank Development Indicators; and Business Monitor International.
Figure 8.
Figure 8.

Sudan: Selected Economic and Financial Indicators

Citation: IMF Staff Country Reports 2012, 298; 10.5089/9781475548341.002.A001

Sources: Worldwide Governance Indicators; Business Monitor International; Sudanese authorities; and staff estimates.

43. Staff emphasized the importance of strengthening small- and medium-size enterprises (SMEs) and opening up the economy. SMEs could be a key driver in promoting economic diversification. Opening up the economy to foreign investors would: (i) attract external resources to finance badly needed investments that would increase employment and the country’s economic potential; and (ii) enhance the local know-how, the best recipe for private sector development. To support these actions, the government should focus on developing the physical infrastructure and human capital, and improving basic public services. These actions would generate over time productivity gains, reduce policy uncertainty and bolster investor confidence.

44. Unemployment remains high (above 20 percent, mostly affecting youth and women) and poverty is widespread. The UNDP estimates that currently, about 47 percent of Sudan’s population lives below the poverty line of less than one U.S. dollar a day. While Sudan has made progress in each of the Human Development Indicators, it remains classified amongst the bottom of developing countries and lags behind in achieving the Millennium Development Goals. Staff urged the authorities to begin to address labor supply issues by: (i) conducting a skills assessment aimed at identifying market needs; and (ii) reforming technical and vocational training programs and enhancing the quality of general and technical education (SIP, Chapter 5).

45. Sudan’s membership in the Common Market for Eastern and Southern Africa and the Greater Arab Free Trade Area has been beneficial and is an important step towards its integration into the world economy. Also, a greater economic integration with South Sudan in the form of a common market would boost trade and economic productivity of the two countries. Such project would require however a close coordination at the policy and institutional levels including the harmonization of economic policies, and the integration of the countries’ transportation infrastructure and network.

Authorities’ Views

46. The authorities agreed with the staff’s assessment. They noted that their current strategy aims to accelerate structural reforms in order to create new sources of growth and income to compensate for the loss of oil revenues. In addition to revitalizing the agriculture sector, which remains the backbone of Sudan’s economy, they are placing greater emphasis on the large untapped potential of the mining sector as evidenced by the sharp increase in gold production.12 They also believe that oil production could increase over the medium-term through enhanced recovery of existing oil wells and the discovery of new ones.

Debt Issues

47. Sudan is in debt distress with the bulk of its external debt in arrears. A debt sustainability analysis (DSA) based on the joint IMF-WB LIC debt sustainability framework and discussed with the authorities indicates that at end-2011, all debt indicators exceeded their thresholds (Annex 1).13 Arrears clearance and debt relief will be needed to bring Sudan’s external debt to a sustainable level and gain access to external financing. Staff strongly recommended to: (i) establish broad support for debt relief under the Enhanced HIPC Initiative, which requires enhancing its dialogue with creditors and donors; (ii) continue to cooperate with the IMF on economic policies; and (iii) limit borrowing on non-concessional terms as much as possible.

48. Sudan’s arrears to the Fund totaled SDR 983.3 million at end-July. Staff welcomed the payments made so far in 2012 totaling US$6.7 million against obligations falling due of SDR 2.49 million (or US$3.85 million). Staff strongly encourages the authorities to continue making payments to the Fund, to make them on a regular basis, and to increase them as their payment capacity improves.

49. The technical group on Sudan’s external debt (TWG) co-chaired by the Fund and the Bank was created in late 2010 to advance the technical work on debt relief. Since then it met five times. It facilitated the reconciliation of debt data between Sudan and its creditors,14 made presentations on arrears clearance and the debt relief process, and developed debt relief scenarios.

Authorities’ Views

50. The authorities agreed with staff’s assessment and advice. However, they expressed frustration that the debt relief remains an elusive goal, and feel subject to unfair treatment by the international financial community. They stressed that as a result of the slow progress of negotiations with South Sudan, they may consider the fallback debt option of apportioning the debt between the two countries.15

Other Issues

51. Since the 2010 Article IV consultation, Sudan has introduced measures that may be inconsistent with its obligations under Article VIII of the IMF’s Articles of Agreement. These measures include the new exchange regime, as well as other distortionary measures that inhibit current account convertibility.16 Staff is currently assessing these measures to determine whether they give rise to multiple currency practices (MCPs) or exchange rate restrictions under Article VIII.

52. Staff welcomed the progress achieved on the Interim-Poverty Reduction Strategy Paper (I-PRSP), which was adopted by the Parliament in late June 2012. The government is preparing to share it soon with the IMF and the World Bank.

53. Sudan’s current statistical database is broadly adequate for surveillance and program monitoring, but needs further improvements. Staff urged the authorities to enhance the status and resources of the Central Bureau of Statistics, giving the Bureau the authority to produce and disseminate official statistics and coordinate the national statistical work program.

54. The authorities expressed an interest in a successor SMP. Staff pointed out that the recent economic measures could form the basis for initiating discussions on a SMP. These discussions could start later this year.

Staff Appraisal

55. Against the backdrop of internal tensions and conflicts, Sudan managed in the past 15 years to promote economic growth and improve economic conditions. The 2011 Assessment of Engagement Under the SMPs confirmed Sudan’s satisfactory macroeconomic performance and its progress on key structural reforms under successive SMPs.

56. The secession of South Sudan has translated into a severe economic shock that resulted in the loss of a sizeable portion of the country’s economic potential and international payment capacity. To deal appropriately with this shock, staff encourages the authorities to: (i) stabilize the macroeconomy in the near term; and (ii) over the medium term recalibrate the economy in line with the country’s reduced economic and financial potential. In view of Sudan’s limited access to international markets, this strategy will need to rely mainly on domestic resources.

57. The authorities’ reform program and the underlying policy mix is a positive step towards consolidating economic conditions and curbing inflation. Over the medium-term, the challenge remains to sustain these adjustment efforts in order to regenerate most of the lost economic potential by gradually building a more competitive and self-reliant economy.

58. Staff welcomes the policies underlying the revised 2012 budget. It commends the authorities’ decision to substantially reduce fuel subsidies, and strongly supports the reinforcement of the social safety nets and the marked reduction in non-priority spending. On the revenue side, staff considers the increase in tax rates as appropriate given the pressing need to mobilize revenues, but urges the authorities to step up efforts to widen the tax base.

59. Staff urges the authorities to develop a medium-term budget framework, to strengthen budgetary execution and control, and to overhaul and reform state finances. Staff recommends enhancing tax policy and revenue administration by reducing tax exemptions and improving tax compliance. Given the government’s leading role as the wage setter in the economy, it advises linking the average wage in the civil service to the nonoil economy’s productivity, a measure that would gradually boost competitiveness and improve the external trade balance. Staff also encourages the authorities to pursue the phasing-out of subsidies and develop a well targeted safety net system. It also recommends imposing a profit tax on gold producers as the sector develops.

60. Enhancing the effectiveness of monetary policy necessitates a better coordination between the monetary and fiscal authorities. Bringing inflation under control will require greater de facto central bank independence in order to contain and gradually reduce the monetization of the fiscal deficit.

61. Staff underscores the importance of enhancing monetary management at the CBOS. Staff recommends using reserve money as an anchor to tighten credit to the government and ensure sufficient credit to the private sector, eventually bringing inflation under control. Noting the systemic nature of bank excess liquidity, it recommends refraining from raising the reserve requirements ratio as the latter is largely ineffective, and could only adversely affect banking intermediation and profitability. To restore the monetary transmission mechanism, staff advises the CBOS to provide the commercial banks with the appropriate opportunities to recycle their unused deposit liabilities, which could be achieved through the organization of a competitive auction system of CBOS own securities.

62. The authorities’ step devaluation of the official exchange rate is welcome. staff notes that the commercial banks rate is less overvalued than other official rates and is thus closer to market conditions. Staff strongly recommends to unify the existing four official rates and to extend the commercial banks rate to all transactions. Staff advises, however, that greater exchange rate flexibility will be an important element in facilitating the required adjustment and safeguarding foreign exchange reserves. It encourages the authorities to end the use of the premium incentive practice and gradually repeal all the existing administrative restrictions.

63. Stepping up structural reforms will help address the underlying structural challenges facing the economy. Key reforms include: (i) a comprehensive civil service reform, (ii) banking sector restructuring, (iii) ambitious privatization program, and (iv) improving governance.

64. Sudan is in debt distress and its arrears continue to constrain access to external financing. The authorities should continue to contain the contracting or guaranteeing of non concessional external borrowing, and reach out to donors to garner support for debt relief. Staff encourages the authorities to continue to strengthen their cooperation with the Fund on policies and payments.

65. The support of the international community is critical to the success of Sudan’s reform strategy. Its absence could jeopardize the maturing of the economy, cap its growth potential, and worsen its poverty profile. Staff strongly encourages the authorities to enhance their dialogue with creditors and donors. Also, the authorities’ implementation of sound macroeconomic policies would be critical in catalyzing much needed support by assuring donors that their resources are being put to effective use.

66. It is recommended that the next Article IV Consultation with Sudan takes place on the standard 12-month cycle.

Table 9.

Sudan: Millennium Development Goals

article image
Source: World Development Indicators, 2011.
Table 10.

Sudan: Payment Indicators, 2007–12

(In millions of SDRs; unless otherwise indicated)

article image
Source: Fund staff estimates and projections.

The change in stocks of overdue financial obligations may differ from obligations falling due net of payments made to the Fund. Payments made to the Fund do not reflect adjustments resulting from burden-shared refunds, SCA-1 and SCA-2 refunds, retroactive reductions in rates of charge, and end-year balance in Sudan’s SDR account.

Current account receipts, excluding oil earnings not accruing to the government.

Domestic fiscal revenue, net of transfers to the states.

Includes the payment of US$21.1 million (equivalent to SDR 14 million) received on January 2, 2007.

Includes the payment of US$8.5 million (equivalent to SDR 5.4 million) received on January 2, 2008.

Includes the payment of US$5.5 million (equivalent to SDR 3.54 million) received on January 4, 2011.

1

In mid-2011, the authorities adopted a Three-Year Emergency Program for 2012–14, which outlines a comprehensive strategy to address the economic and social challenges posed by the secession. Its objectives are to maintain fiscal and external sustainability, boost inclusive growth, and gradually reduce unemployment.

2

This is mainly due to the fact that no agreement could be reached with South Sudan on oil transit fees, which represented almost 30 percent of total revenues in the original budget.

3

The increase is mainly due to the effects of the devaluation of the official exchange rate on the monetary aggregates. Excluding this effect, both reserve money and broad money would have grown by about 13 percent.

4

Gross official reserves were recently revised to correct for a misclassification that involved the inclusion on the assets side of liability items corresponding to short-term external commitments. The new classification is consistent with the recommendations of the 2012 IMF multisector statistics technical assistance mission.

5

Gold exports amounted to some 29 tons (about US$1.4 billion) in 2011 and are projected at 50 tons in 2012 (about US$2.5 billion).

6

The price increases are 47 percent for gasoline, 23 percent for diesel, 15 percent for LPG, while the price for jet fuel has been fully liberalized.

7

The existing Public Finance Law sets the central bank financing of the fiscal deficit at a maximum of SDG 1.5 billion.

8

Excess liquidity in Sudan is a systemic problem that dates back to 1996 at the beginning of the exploitation of oil and has been persistent since then. It is the direct result of the oil-related fiscal expansion combined with the country’s low financial deepening.

9

Data problems related to the secession of South Sudan prevent a meaningful application of quantitative methods, including CGER procedures.

10

While the devaluation of the central bank’s indicative rate is about 66 percent, the effective devaluation of the commercial banks rate is about 88 percent.

11

The subsidy reform is expected to generate savings of more than 0.6 percent of GDP during H2-2012.

12

Gold production has increased nearly seven fold, from 4 tons in 2008 to 29 tons in 2011, and is projected to further increase to 50 tons in 2012.

13

See Sudan—Staff Report for the 2012 Consultation—DSA.

14

As of end-July 2012, more than 92 percent of Sudan’s external debt has been reconciled.

15

Prior to South Sudan’s secession, the two countries had reached an agreement on the so-called “zero option,” under which Sudan would retain all the external liabilities after the secession of South Sudan, provided that: (i) South Sudan joined Sudan in outreach efforts for debt relief for Sudan, and (ii) the international community gave firm commitments to the delivery of debt relief within two years. Absent such a commitment by July 2013, Sudan’s debt would be apportioned between the two countries.

16

These include rationing foreign exchange and earmarking it to selected sectors, and introducing restrictions on banks’ excess reserves in foreign currency with the central bank and on bank deposits in foreign currency.

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Cover IMF Staff Country Reports
Sudan: Staff Report for the 2012 Article IV Consultation
Author:
International Monetary Fund. Middle East and Central Asia Dept.
Volume/Issue:
Volume 2012: Issue 298
Publisher:
International Monetary Fund
ISBN:
9781475548341
ISSN:
1934-7685
Pages:
77
DOI:
https://doi.org/10.5089/9781475548341.002
Figure 1.

Sudan: Oil Sector Contribution to GDP
Figure 2.

Sudan: Oil Production and Revenues
Figure 3.

Sudan: Credit to the Government; Inflation; and Reserve Money, 2009–12

(Change in percent)
Figure 4.

Sudan: Official and Parallel Exchange Rates, 2007–12

(SDG per U.S. dollars)
Figure 5.

Sudan: Selected Economic Indicators, 2005–12
Figure 6.

Sudan: Comparison 2012 and 2010 Article IV Staff Reports
Box Figure 1.

Average Monthly Exchange

Rate (2007M01-2012M07)
Box Figure 2.

REER and NEER

(2000M01-2012M06)
Box Figure 3.

Average Monthly Reserve Levels

(2006M01-2012M06)

Sudan: Human Development Indicators Trends 1980-2010
Figure 7.

Sudan: Selected Political and Social Indicators
Figure 8.

Sudan: Selected Economic and Financial Indicators