Sudan: Selected Issues Paper
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International Monetary Fund. Middle East and Central Asia Dept.
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Publication Date:
05 Nov 2012
eISBN:
9781616355722
Language:
English
Keywords:
ISCR; CR; price; government; state government; policy reform; exchange rate regime; monetary policy; surveillance indicator; price competitiveness; Real effective exchange rates; Exchange rate arrangements; Exports; curb rate
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This selected issues paper on Sudan was prepared by a staff team of the International Monetary Fund as background documentation for the periodic consultation with the member country. It is based on the information available at the time it was completed on September 7, 2012. The views expressed in this document are those of the staff team and do not necessarily reflect the views of the government of Sudan or the Executive Board of the IMF.

Abstract

This selected issues paper on Sudan was prepared by a staff team of the International Monetary Fund as background documentation for the periodic consultation with the member country. It is based on the information available at the time it was completed on September 7, 2012. The views expressed in this document are those of the staff team and do not necessarily reflect the views of the government of Sudan or the Executive Board of the IMF.

III. Assessing Sudan’s External Competitiveness1

While acknowledging data caveats and uncertainties surrounding the secession of South Sudan in July 2011, this analysis finds some vulnerabilities and secession-induced permanent adjustment needs that could undermine Sudan’s near- and medium-term external competitiveness and stability:

  • External sector performance crucially depends on natural resources (oil and now also gold), raising concerns over Sudan’s competitiveness (of traditional exports) and increasing the vulnerability to external shocks.

  • Price competitiveness has long been undermined by an overvalued real effective exchange rate (REER), partly remedied by the reforms adopted at end-June 2012.

  • Non-price competitiveness suffers from significant structural and institutional bottlenecks, making the case for substantial structural reforms to improve the business climate.

A. Background

1. Until recently, Sudan was an oil-exporting low-income country (LIC) with a history of mixed macroeconomic performance. In the mid-1990s, the predominantly agricultural economy with a large and inefficient public secor was in economic distress. The narrow revenue and export base was insufficient to finance large fiscal expenditure and balance of payments (BOP) needs. Large fiscal deficits were monetized by the CBOS, while external arrears were building up. Inflation reached triple digits and the premium on the dollar on the curb market was in the double digits. Supported by Fund re-engagement in 1997, the authorities’ decisive reform efforts and the coming on stream of oil production in 1999 helped restore macroeconomic stability. For more than a decade, real growth was strong and non-oil growth robust (Figure III.1.a), almost quintupling per capita GDP by 2010 (Figure III.1.b). Oil production remained modest in the real sector (accounting for about 16 percent of total GDP in 2010), but crucial in the financing of the budget and the BOP (covering about 50 percent of current spending and imports of goods and services in 2010, respectively).2 Thanks to curtailed fiscal deficits and tightened monetary policy, average annual inflation remained contained at around 10 percent until the food and fuel price shocks in 2008 (Figure III.1.c). The exhange rate was gradually depreciated and the current account deficit returned to single digits (Figure III.1.d).

Figure III.1.
Figure III.1.

Key Macroeconomic Developments

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A003

Sources: Sudanese authorities, WEO, and IMF staff calculations.

2. The secession of South Sudan in July 2011 resulted in a major permanent external shock to Sudan, leading to a deterioration in economic condition similar to that of the early 1990s. The loss of about three quarters of the country’s oil production hit the real sector as well as the fiscal and external sectors (Figure III.1.a): it left Sudan with roughly half of its previous fiscal revenues and a third of export proceeds. Macroeconomic fundamentals deteriorated, putting severe pressures on the fiscal position and the exchange rate. As in the mid-1990s, the authorities resorted to monetizing the fiscal deficit, driving up inflation and widening the spread between the official and the curb exchange rates. Continued uncertainties as to future relations with South Sudan have further aggravated the situation.

3. At end-June 2012, the Sudanese authorities embarked on a reform path, aiming at addressing the macroeconomic imbalances resulting from the secession of South Sudan. The key measures adopted are: (i) a devaluation of the Sudanese pound and the reform of the exchange rate regime; (ii) an increase in taxes; (iii) a reduction of fuel subsidies and non-priority spending; and (iv) an expansion of social safety nets. While these measures will help reduce near-term pressures and improve the economic outlook, over the medium term there is a need to continue these reforms in order to restore domestic and external stability.

B. External Competitiveness

External Sector Performance

4. Sudan’s historically narrow and undiversified export and FDI bases raise concerns over its external competitiveness and stability. After the coming on stream of oil in the late 1990s, the expanding oil production had been driving export (Figure III.2) and FDI dynamics (Figure III.3.c) until the secession in July 2011. Nonetheless, persistently narrow export and FDI bases, mainly built on dwindling natural resources, hint at the lack of competitiveness in other exports and indicate vulnerability to external (especially terms of trade) shocks.

  • Relative to its peers,3 Sudan’s share of world total exports had steadily increased, while its share of world non-oil exports had decreased (Figure III.3.a and b). After the secession of South Sudan, total exports dropped with the loss of oil, masking a pickup in non-oil exports thanks to stronger gold proceeds. Meanwhile, for more than a decade, non-oil-non-gold exports have remained chronically low at less than 10 percent of total exports (Figure III.4). At the same time, while Sudan’s total FDI inflows seem to outperform those of its peers, only 10 percent of total FDI went to the non-oil sector.

  • The normalized Herfindahl-Hirschman Index (HHI) not only confirms a relatively high export concentration across commodity groups, but also across destination countries (Figure III.5).4 China had become the main export destination (accounting for nearly 70 percent of total exports in 2010). Preliminary data hint at the net impact of the loss of oil and increase in gold as slightly reducing export product concentration, whilst tilting export destination concentration toward Gulf countries.

Figure III.2.
Figure III.2.

Trade Volumes and Terms of Trade

(Index, 2000=100)

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A003

Sources: Sudanese authorities, WEO, and IMF staff calculations.
Figure III.3.
Figure III.3.

Cross-Country Comparison of Exports and FDI

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A003

Figure III.4.
Figure III.4.

Export Structure

(In Billions of USD)

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A003

Source: Sudanese authorities, and IMF staff calculations.
Figure III.5.
Figure III.5.

Export Concentration

(Index, 1=high and 0=low)

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A003

Source: UN Comtrade, and IMF staff calculations.

C. Price Competitiveness

Exchange Rate Regime and Developments

5. After the de facto peg to the USD for most of the recent past, the measures introduced at end-June 2012 effectively reinstate Sudan’s official managed floating exchange rate regime.5 Notwithstanding the authorities’ stated objective, the monetary policy framework was until recently a de facto exchange rate anchor of the Sudanese guinea (SDG) vis-à-vis the USD.6 The official exchange rate was last depreciated by 0.06 USD to 2.67 to the USD in April 2011. Yet, the secession of South Sudan weakened the CBOS ability to manage the de facto peg. Furthermore, the introduction of administrative measures and exchange restrictions during 2011 fostered the expansion of the parallel foreign exchange market. This finally led the authorities to devalue the Sudanese pound and reform the exchange rate regime (Box III.1).

Current Exchange Rate Regime

On June 25, 2012, the Sudanese authorities step-devalued the central rate and centered the exchange rate system on the following four rates:

  • the central rate was CBOS’ only official rate previously and applies to its foreign exchange purchases. It was devalued by 66 percent from SDG 2.67 to 4.42 per USD and now also applies to the settlement of government obligations, import of fuel products, and valuation assessment at customs;

  • a newly introduced subsidized rate for wheat of SDG 2.9 per USD;

  • a newly introduced gold rate used by CBOS to purchase gold, which is close to the curb rate; and

  • the commercial banks rate which is no longer set equal to the CBOS rate plus a premium determined by the central bank,1/ but instead is allowed to follow an iterative crawling peg to achieve some floating. It is calculated as: (i) the indicative rate (which equals the weighted average of the previous day’s central rate and average commercial banks rate excluding the premium), (ii) plus the premium set by the central bank (currently 15 percent), and (iii) a flexibility factor of +/-4 percent allowing banks to deviate from the sum of the indicative rate and the incentive premium.

1/ In November 2010, CBOS introduced an exchange subsidy by authorizing banks and foreign exchange bureaus to buy foreign exchange at a premium above their buying rates. CBOS determines the premium, which was gradually revised downwards from, initially, about 19 percent to 4.77 percent in May 2011.

6. After a decade of widespread tamed exchange rate fluctuations, the SDG’s bilateral exchange rates vis-à-vis major trading partners depreciated again (Figure III.6). The SDG experienced a temporary appreciation trend after the Comprehensive Peace Agreement was signed in 2005. Nonetheless, depreciation pressures resumed with increased inflation during the 2008 food and fuel price crisis, and amidst increased uncertainties about the future of the country starting in 2010, finally culminating in the referendum over South Sudan’s secession in January 2011. During the 12 months prior to the June 2012 devaluation, the SDG has roughly kept its value against most trading partners’ currencies, while sizably appreciating against the Euro and the Indian rupee(Table III.1). In 2011, the main trading partner was China (with a trade share of 46 percent), followed by Japan, the Euro Area, India, Saudi Arabia, the United Arab Emirates and Egypt (with trade shares ranging between 3 and 8 percent, respectively, for the last two).7

Figure III.6.
Figure III.6.

SDG Bilateral Exchange Rates Against Major Trading Partners’ Currencies

(Period averages, 2000M1–2012M7)

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A003

Sources: IFTS; and IMF staff calculations.
Table III.1.

Trade Shares and Year-on-Year SDG Value Change Against Major Trading Partners’ Currencies

(In percent)

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Sources: IFTS; and IMF staff calculations.

Exchange Rate Assessment

7. The exchange rate assessment for Sudan suggests an overvaluation of the SDG. With conceptual and methodological obstacles preventing a formal empirical analysis based on the Consultative Group on Exchange Rates (CGER) approach,8 the assessment relies on available exchange rate surveillance indicators. Those point to the value of the SDG having already been out of line with its medium-term economic fundamentals for a sustained period. Even though recent reforms significantly helped reduce the overvaluation, it appears to linger as indicated by: (1) unsustainable BOP dynamics; (2) persistent exchange rate overvaluation; (3) low reserves resulting from protracted large-scale exchange market interventions in one direction; (4) imposition of administrative measures and restrictions of access to foreign exchange to ease pressures on the SDG value and on international reserves; and (5) growing external arrears adding to an already unsustainable external public debt burden.

8. Indicator 1—unsustainable BOP dynamics. Over the past decade, the current account deficit (including official grants) has averaged some 5 percent of GDP. It was mainly financed by FDI (of which 90 percent went to the oil sector) and accumulation of arrears, and less by aid. This has intensified the strain on already low reserves and increased pressure on the exchange rate (Figure III.7 and Table III.2), BOP dynamics have worsened with the South Sudan secession-induced drop in oil exports and FDI, which was only partly compensated by a recent pickup in gold exports. Meanwhile, imports have been holding up, indicating the impact of an exchange rate overvaluation. Although the recent exchange rate depreciation will to some extent help rebalance the BOP and ease pressures on reserves, adequate exchange rate flexibility is warranted over the medium term to help restore external sustainability.9

Figure III.7.
Figure III.7.

BOP Dynamics

(In percent of GDP)

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A003

Sources: Sudanese authorities; and IMF staff calculations.
Table III.2.

Selected Balance of Payments Indicators

(In percent of GDP)

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Sources: Sudanese authorities; and IMF staff calculations.

9. Indicator 2—persistent exchange rate overvaluation, as indicated by relative price measures: (i) curb market rate premium, (ii) REER, and (iii) internal terms of trade.

(i) After steady increases to about 100 hundred percent, the June 2012 devaluation substantially reduced, though it did not eliminate, the SDG/USD premium on the curb market (Figure III.8): in July 2012, it remained at 37 percent of the CBOS’s central rate and 13 percent of the commercial banks’ rate. This put some degree of a halt to the rise of the curb market, which had slowly started with the divergence of the central and curb market rate in early 2008 and accelerated sharply in April 2011. With CBOS unable to meet the country’s foreign exchange demand, the curb market was booming, reinforcing the role of the curb rate as the economy’s leading rate, which had depreciated sharply, reflecting the loss of oil export proceeds and mounting uncertainties about Sudan’s economic prospects. Available data suggest that domestic prices (of both tradables and nontradables) also tended to move with the curb rate rather than with the central rate (Figure III.9); this movement has prevented an overshooting of the curb rate in the aftermath of the depreciation on June 25, 2012 (Figure III.10).

Figure III.8.
Figure III.8.

SDG/USD Exchange Rates

(Monthly Average 2007M1–2012M7)

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A003

Sources: Sudanese authorities; and IMF staff calculations.
Figure III.9.
Figure III.9.

Domestic Price and Exchange Rate Changes

(Percent, 2007M1–2012M6)

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A003

Sources: Sudanese authorities; and IMF staff calculations.
Figure III.10.
Figure III.10.

SDG/USD Exchange Rates

(Daily June 2–August 28, 2012)

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A003

Sources: Sudanese authorities; and IMF staff calculations.

(ii) The June 2012 depreciation also significantly reduced, but most likely did not fully eliminate, the double-digit overvaluation of the REER. Since 1999, the purchasing power parity (CPI)-based REER had been on an appreciating trend, and the nominal effective exchange rate (NEER) on a depreciating trend (Figure III.11). These trends reflect improved macroeconomic fundamentals around the coming on stream of oil and the stabilized exchange rate in the presence of high inflation relative to trading partners. However, with economic fundamentals worsening after the secession of South Sudan, the REER up to the last available observation in June 2012 (just predating the exchange rate reforms) seemed increasingly overvalued:

  • The June 2012 REER ranged some 21 to 65 percent above historical averages. After some depreciation starting in mid-2010, the official SDG rate had seen an appreciation in nominal and real effective terms again, for the most part even more than in other oil-exporting LICs (except for Angola; see Figure III.11 b). At end-2011, the REER had almost reached its historical peak in November 2010 again, while the NEER stood at an all-time low. This left the June 2012 REER well above any historical averages and NEER below most of them (see text Table). As this REER appreciation did not correspond to gains in productivity, but was rather driven by chronically high inflation, the appreciation has eroded external price competitiveness. The June 2012 depreciation will likely have corrected for the bulk of the overvaluation. However, the macroeconomic outlook relative to trading partners (see the persistent inflation differential in Figure III.1.c) suggests that some overvaluation pressures will persist, requiring nominal depreciation.

  • Besides, the June 2012 REER also ranged 110 percent above the real exchange rate calculated based on the curb exchange rate (henceforth labeled REER*). The reason is that in contrast to the REER, the REER* had been on a depreciation trend since early 2008 (Figure III.11a), reflecting the depreciating curb rate in line with deteriorating fundamentals. The June 2012 REER* remained well below historical averages. The evolution of the REER* suggests that, if left to operate freely, market forces would have already restored external price competitiveness by reversing the REER overvaluation.

  • Finally, the June 2012 REER had some 32 percent to depreciate as suggested by a cross-country comparison accounting for Balassa-Samuelson effects (Figure III.12). Based on 2011 data, Sudan’s real exchange rate (proxied by the market exchange rate relative to the PPP exchange rate) was 32 percent higher than the level suggested by its relative productivity (proxied by relative income).10 Based on 2010 data, the difference was 30 percent. This suggests that given its relative income level, Sudan has been suffering from a too-high overall price level. With the price level of tradables being commonly determined by world market prices, this points to Sudan’s price level of nontradables being too high relative to that of other countries’.

    (iii) Deteriorating internal terms of trade (ITT).11 ITT dynamics go opposite to the REER’s, but in line with the REER*’s (Figure III.13 versus Figure III.11), providing further evidence for the longstanding leading role of the curb rate. In fact, despite administered and thereby contained petroleum product prices, the overall price index of tradables has been increasing in a stronger and more volatile way than the price index of nontradables (Figure III.9)—an increase of 21 and 16 percent in 2011, respectively and of 27 and 13 percent, respectively over the 12 months preceding the June 2012 depreciation.

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Figure III.11.
Figure III.11.

Real Exchange Rate Developments (2000M1–2012M6)

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A003

Sources: EER; INS; and IMF staff calculations.
Figure III.12.
Figure III.12.

Exchange Rate and Per Capita GDP

(2011, cross-country comparison)

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A003

Sources: WEO; Sudanese authorities; and IMF staff calculations.
Figure III.13.
Figure III.13.

Internal Terms of Trade Index

(2007=100, 2007M1–2012M6)

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A003

Sources: Sudanese authorities; and IMF staff calculations.

10. Indicator 3—chronically low international reserve levels owing to protracted large-scale exchange market interventions in one direction. For decades, reluctance to allow sufficient exchange rate flexibility—and consequent need to support the official exchange rate—has kept reserves well below both the minimum of three months of prospective imports (Figure III.14) and the current optimal level of more than four months of 2011 imports (depending on the opportunity cost of capital).12 Reserves sharply started out toward new lows shortly before the secession and later with the oil-related loss of the bulk of the foreign exchange accumulation base, in turn further constraining CBOS’ ability to manage the official rate and deteriorating resilience to exogenous shocks.13 Reserves only very recently somewhat stabilized, reflecting the exchange rate policy reforms introduced at end-June and the receipt of significant bilateral BOP support (Figure III.15). Nevertheless, even in the presence of sufficient exchange rate flexibility, rebuilding reserves from own means will remain challenging.

Figure III.14.
Figure III.14.

Annual Stock of Usable Reserve Assets

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A003

Sources: Sudanese authorities: and IMF staff calculations.
Figure III.15.
Figure III.15.

Monthly Stock of Usable Reserve Assets (2006M1–2012M6)

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A003

Sources: Sudanese authorities; and IMF staff calculations.

11. Indicator 4—imposition of administrative restriction of access to foreign exchange for current account transactions. Aiming at stabilizing the currency and limiting the depletion of official reserves, the authorities have been imposing exchange restrictions.14, 15 These first include, for instance, a limit on foreign exchange for travel purposes and the imposition of a 100 percent cash margin for letters of credit on most imports, rationing of foreign exchange and its earmarking to selected sectors, controls on the repatriation of profits of foreign-owned companies operating in Sudan, and restrictions on banks’ excess reserves in foreign currency with CBOS. In the context of the recent reforms, the authorities have abolished some restrictions. Gradually phasing out remaining and newly instated restrictions will, however, be key to restoring the efficient functioning of the foreign exchange market and the accuracy of price signals.

12. Indicator 5—growing external arrears adding to an already unsustainable external debt burden. At end-2011, total external debt amounted to about US$41.4 billion (i.e., 65 percent of GDP or 350 percent of exports of goods and services), of which almost 85 percent was in arrears. Public and publicly guaranteed external debt accounted for 96 percent of total external debt and has only partially been serviced for decades. In the absence of massive debt relief, Sudan continues to be in debt distress, with limited prospects for improvement over the medium and long term. Consequently, access to external financing remains very limited.

External Non-Price Competitiveness

13. Sudan’s competitiveness also suffers from structural impediments. These inhibit its ability to produce goods and services of international quality more cost effectively than other countries. Progress in creating a stable, competitive, and diversified economy hinges on expediting reforms.

14. Both relative to historic performance and peers, structural competitiveness in Sudan is either stagnating or deteriorating. Available survey-based business and governance indicators identify cost-increasing production factors that adversely affect productivity and, thus, overall economic activity.16 More specifically:

  • (i) World Bank’s Doing Business Indicators (DBIs). Sudan ranks in the upper lowest third of countries assessed and in the midfield among its regional competitors. Since last year, Sudan did not change its overall ease of doing business rank, but it lost ranks on most sub-indicators. Priority structural areas for improvement are access to credit, trading across borders, investor protection, and the enforcement of contracts. At the same time, Sudan scores relatively well on registering property and resolving insolvency.

  • (ii) World Bank’s Worldwide Governance Indicators (WGIs). For nearly a decade, Sudan’s already weak governance indicators have been fluctuating mostly below their 2002 levels, widening the gap with its peers (Figure III.16). Most notably, Sudan’s political instability and violence have worsened in absolute and relative terms.

  • (iii) World Bank’s Country Policy and Institutional Assessment Ratings (CPIA). For nearly a decade, Sudan’s CPIA has been weak and on a slow downswing to 2.36. This is well below the threshold for medium performers (3.25) and well below its peers (Table III.4). The low quality of Sudan’s policy and institutional framework thus continues to impede poverty reduction, sustainable growth, and the effective use of development assistance. Sudan’s CPIA clusters (Figure III.17) show that the most recent decline of the overall CPIA mainly stems from a deterioration of the score for economic management (in particular monetary and exchange rate policies and fiscal policy). Over half a decade, the declining cluster scores for structural policies and public sector management and institutions mainly reflect a worsening business, regulatory, and trade environment, quality of public administration, and transparency, accountability, and corruption in public services. Only the cluster score for social inclusion and equity policies saw an improvement, owing to better scores for social protection and labor as well as gender equality.

  • (iv) Transparency International’s Corruption Perception Index. Over the last decade, also, Sudan’s index of perceived public sector corruption has deteriorated significantly and more than its regional peers, making it seventh to worst in the ranking of 183 countries in 2011 (Table III.5). This particularly highlights the need for strengthening institutions, bureaucratic effectiveness, governance, and security.

Table III.3.

Doing Business Indicators

(2012, Rank out of 183 Countries)

article image
Sources: World Bank (2012b); and IMF staff calculations.
Figure III.16.
Figure III.16.

Worldwide Governance Indicators

(2002–10, Index ranges from approximately -2.5=weak to 2.5=strong)1

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A003

Note: 1 The indicator value for 2001 is interpolated.Sources: World Bank (2011); and IMF staff calculations.
Table III.4.

CPIA Ratings

(Score ranging from 1=low to 6=high)

article image
Sources: World Bank (2012c); and IMF staff calculations.
Figure III.17.
Figure III.17.

Decomposing Sudan’s CPIA

(Score ranging from 1=low to 6=high)

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A003

Source: World Bank (2012d).
Table III.5.

Corruption Perceptions Index

(Rank and score ranging from 0=highest perception to 10=lowest perception)

article image
Sources: Transparency International (2011); and IMF staff calculations.

D. Policy Recommendations and Conclusions

15. Sudan’s competitiveness and external stability could be at risk.

  • (i) Price indicators suggest that the recent reforms have helped, but were not sufficient to realign the real exchange rate with economic fundamentals. REER overvaluation pressures, multiple parallel exchange rates, and administrative restrictions on access to foreign exchange persist. Undoing them would help (i) restore competitiveness and current account sustainability; (ii) reduce dead-weight loss ensuing from the use of informal channels by encouraging financial inflows (incl. remittances) through official channels; (iii) foster the credibility of the exchange rate system and its resilience to adverse exogenous shocks by accumulating international reserves; and (iv) remove the adverse impact of uncertainty relating to the exchange rate and foreign exchange regime on investment and diversified economic growth.

  • (ii) Non-price indicators show that Sudan lost ground relative to its own historical performance and its peers. A challenging business environment impedes private sector development, hampering the competitiveness that would help the economy to expand and diversify away from natural resources.

16. Although recent reforms will help remove some distortions and ease some pressures, Sudan needs to sustain macroeconomic policy and structural reform efforts to restore Sudan’s price and non-price competitiveness.

  • (i) To restore price competitiveness, adjusting the exchange rate policy is only a necessary but not a sufficient condition for a successful external adjustment.

  • Exchange rate policy. After the recent step devaluation of the exchange rate, the authorities need to allow the exchange rate to move in line with market fundamentals and gradually phase out administrative restrictions. This will help to achieve convergence of a single unified official exchange rate to the curb market rate.

  • Flanking complementary macroeconomic policies. To ensure that the recent nominal depreciation of the exchange rate translates into a sustained real depreciation, fiscal discipline and tight monetary policy are crucial. In particular, Sudan should:

    • (a) reinforce efforts to stop monetizing the fiscal deficit, through continued fiscal consolidation. In the absence of international financial assistance, and in order to regain confidence in its economy and thus in its currency, Sudan must rigorously implement the recently adopted reform program. It also needs to sustain adequate reform efforts to manage the transition to an economy with reduced fiscal space and to put a halt to the monetary financing of the budget.

    • (b) foster central bank independence and monetary policy. Freeing the CBOS from financing the budget and supporting the exchange rate would open room for an independent and consistent monetary policy primarily devoted to price stability.

    • (c) increase external financing. Sudan needs capital inflows—especially in the form of official assistance and highly concessional loans—to ease domestic financing pressures, reform its economy, and develop its infrastructure. To this end, it also needs to prudently manage its debt and establish broad support for debt relief under the Enhanced HIPC Initiative.

    • (d) promote growth, boost productivity, and diversify exports. Sudan must pursue prudent macroeconomic policies and structural reforms to improve the business climate: these reforms should be geared towards fostering growth, increasing productivity, rebuilding nontraditional exports (such as manufacturing and agriculture), and attracting FDI.

  • (ii) To restore non-price competitiveness, Sudan needs to implement substantial structural reforms. While improving the business environment and cross-border trading, accelerating financial sector development, diversifying the economy and investing in infrastructure to reduce production and distribution costs are crucial, improving the political and security environment and enhancing governance are equally important.

Appendix III. Reserve Adequacy Assessment

1. Sudan’s international official reserves have remained inadequately low –providing only a small buffer against external shocks that threaten to undermine domestic economic welfare and constraining CBOS’ ability to support the official exchange rate.1

  • (i) Sudan’s reserve levels fall short of the minimum level suggested by traditional rules of thumb and the levels of its peers. For most of the past decade, Sudan’s reserve levels have fallen short of the threshold of three months of prospective imports (Appendix III, Figure 1.a). Moreover, the reserve levels have only temporarily risen above the 20 percent of M2 threshold in the mid-2000s and are since gradually approaching the 5 percent of M2 threshold (Appendix III, Figure 1.b). At the same time, Sudan also falls short of its peers’ performance.

  • (ii) Sudan’s reserves also fall short of the optimal level determined by a new methodology presented by Dabra-Norris et al. (2011) and IMF (2011b). Unlike the traditional rules of thumb, it accounts for the costs and benefits of holding reserves, whilst also adjusting for country characteristics and policy fundamentals:2

    • As summarized in the text table, the baseline analysis sets fundamentals (i.e. fiscal balance and CPIA) at their most recent realized levels (2011). It further uses the bottom 10th percentile of the country-specific distribution over the past 10 years (2002–11) for the shock variables (i.e., terms of trade, external demand, FDI to GDP ratio, and aid to GDP ratio). Moreover, the baseline analysis assumes a crisis probability that reflects 1½ crises per decade and factors in the absence of a Fund program.

    • Under these assumptions, the baseline scenario finds that the optimal level of reserves varies from almost 3.8 to 8.3 months of 2011 imports,3 depending on the unit cost of holding reserves (Appendix III, Figure 2). However, if the fiscal position improved (e.g., to be in balance), the optimal level of reserves would be smaller, reflecting the fact that higher fiscal buffers will help fight a crisis. Also, if institutional capacity improved (and led to a higher CPIA of, for example, 3.25, the World Bank’s threshold between weak and medium performer), the optimal level of reserves would also fall, reflecting the fact that stronger institutions would lower the probability of a crisis. For these reasons, also, a Fund program would reduce the optimal level of reserves to a range of 3 to 6.6 months of 2011 imports.

Appendix III. Figure 1.
Appendix III. Figure 1.

Common Rules of Thumb for Assessing Reserve Levels

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A003

Sources: WEO; IFS; and IMF staff estimates.
article image
Appendix III. Figure 2.
Appendix III. Figure 2.

Optimal Level of Reserves

Citation: IMF Staff Country Reports 2012, 299; 10.5089/9781616355722.002.A003

Source: IMF staff estimates.

2. Altogether, the assessment suggests that Sudan should significantly increase reserve holdings to be in the position to mitigate the impact of external shocks. The measures suggest that reserves should cover at least three months, but under the current baseline some four to eight months of imports (depending on the opportunity cost of capital) would be optimal. However, the model fails to account for Sudan’s large infrastructure investment needs and the cost of its external debt. As these tend to further increase the opportunity costs of holding reserves, it would be appropriate for Sudan to target the lower middle of the suggested range of reserve coverage.

References

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  • World Bank (2011), “The Worldwide Governance Indicators, 2011 Update,” available at www.govindicators.org.

1

Prepared by Kerstin Gerling.

2

Sudan’s fiscal dependence on oil revenues lesened in 2005, when the Comprehensive Peace Agreement entitled what is South Sudan today to withhold roughly half of the proceeds of oil produced in the South.

3

The peer groups are (i) regional peers (i.e., Angola, Central African Republic, Chad, Egypt, Equatorial Guinea, Eritrea, Ethiopia, Nigeria, Yemen); (ii) members of the Common Market for Eastern and Southern Africa (COMESA); (iii) LICs; (iv) oil-exporting LICs; and (v) fragile LICs (see World Bank, 2012a). The LIC group comprises those countries currently eligible for the Fund’s Poverty Reduction and Growth Trust (PRGT), whereof the World Economic Outlook (WEO) considers four to be oil exporters (Republic of Congo, Nigeria, Sudan, and Yemen). The peer group median excludes Sudan.

4

The HHI is defined as the sum of the squares of the shares of commodity groups or destination countries.

5

See IMF (2011a). The de facto exchange rate arrangement has been reclassified retroactively from floating to other managed arrangement, effective December 1, 2009.

6

The SDG/USD rate was determined through direct transactions between participants in the interbank market. Yet, CBOS participated in the market through swaps under a rules-based mechanism that triggers interventions if the exchange rate exceeds a band of ±3% around the previous day’s closing rate. The main objective of the policy was to achieve exchange rate stability. The CBOS does not publicly disclose information on its interventions.

7

Bilateral trade shares remained roughly constant in recent pre-secession years. Preliminary post-secession data, however, show that Gulf countries are becoming the main trading partners.

8

Data limitations are severe, including short time series and structural breaks (e.g., the secession of South Sudan in mid-2011) and volatility (e.g., terms of trade shocks, institutional changes, market imperfections, volatile financing flows, multiple exchange rate practices, and capital controls). Besides, significant uncertainties complicate the outlook (especially earnings from mineral resources and from a potential transitional financial agreement with South Sudan). For a general discussion of issues complicating REER assessments in LICs in general, see, e.g., Di Bella et al. (2007).

9

The existence of severe foreign exchange restrictions, multiple currency practices, and parallel exchange rate markets prevents a meaningful calculation of elasticities and, consequently, of the needed extent of exchange rate adjustment.

10

The Balassa–Samuelson effect claims that productivity increases in the tradable sector relative to the nontradable sector—if higher than abroad—cause real exchange rate appreciation. This explains the observation that in poor countries, average prices are lower and real incomes therefore higher than they would appear from simply converting prices in rich countries at nominal exchange rates.

11

ITT is defined as the ratio of the price of nontradables to that of tradables.

12

See the reserve adequacy assessment in the Appendix.

13

Rare monthly intervention data confirms net sales of foreign exchange amounting to US$147 million in January 2012 (with gross purchases amounting to US$5 million only), up from US$110 million in the previous month. Available data suggest that net sales have been reduced in recent months. This mainly reflects CBOS’ policy of allowing banks and foreign exchange bureaus to trade at rates close to the curb market rate for specific categories of transactions and then expecting them to meet their foreign exchange needs through their own resources.

14

Especially when not applied temporarily, restrictions prove inefficient and costly. They hamper productivity (by inciting trade flows redirection, product substitution, and corruption) and erode investor confidence, fuelling capital flight and dollarization.

15

These restrictions were approved by the IMF Board until end-June 2010 in light of the authorities’ intention to eliminate them. An assessment is currently under way of the implications of the recent exchange rate regime reforms on Sudan’s compliance with its obligations under Art. VIII of the Fund’s Articles of Agreement.

16

Data shortcomings limit the availability of indicators. For instance, in the past decade, Sudan has neither been included the Heritage Foundation’s Index of Economic Freedom, nor in the World Economic Forum’s Global Competitiveness Report. It has been included in the World Bank’s Doing Business Indicators since 2010.

1

See e.g. Jeanne and Ranciere (2006, 2008). There are also other motives for reserve accumulation, such as mercantilist motives discussed in Dooley et al. (2004).

2

The optimal level of reserves balances reserves’ crisis prevention and mitigation benefits against their net financial cost. While a crisis is defined as a sharp drop in absorption, net financial costs are defined as foregone investment opportunities measured by the marginal product of capital.

3

Note that the model yields an import coverage based on imports of the last year of the observation period. That usually tends to be slightly higher than that based on prospective imports, but not for Sudan in 2012, mainly because of the secession-induced contraction of imports.

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Cover IMF Staff Country Reports
Sudan: Selected Issues Paper
Author:
International Monetary Fund. Middle East and Central Asia Dept.
Volume/Issue:
Volume 2012: Issue 299
Publisher:
International Monetary Fund
ISBN:
9781616355722
ISSN:
1934-7685
Pages:
76
DOI:
https://doi.org/10.5089/9781616355722.002
  • Figure III.1.
    View in gallery
    Figure III.1.

    Key Macroeconomic Developments

  • Figure III.2.
    View in gallery
    Figure III.2.

    Trade Volumes and Terms of Trade

    (Index, 2000=100)

  • Figure III.3.
    View in gallery
    Figure III.3.

    Cross-Country Comparison of Exports and FDI

  • Figure III.4.
    View in gallery
    Figure III.4.

    Export Structure

    (In Billions of USD)

  • Figure III.5.
    View in gallery
    Figure III.5.

    Export Concentration

    (Index, 1=high and 0=low)

  • Figure III.6.
    View in gallery
    Figure III.6.

    SDG Bilateral Exchange Rates Against Major Trading Partners’ Currencies

    (Period averages, 2000M1–2012M7)

  • Figure III.7.
    View in gallery
    Figure III.7.

    BOP Dynamics

    (In percent of GDP)

  • Figure III.8.
    View in gallery
    Figure III.8.

    SDG/USD Exchange Rates

    (Monthly Average 2007M1–2012M7)

  • Figure III.9.
    View in gallery
    Figure III.9.

    Domestic Price and Exchange Rate Changes

    (Percent, 2007M1–2012M6)

  • Figure III.10.
    View in gallery
    Figure III.10.

    SDG/USD Exchange Rates

    (Daily June 2–August 28, 2012)

  • Figure III.11.
    View in gallery
    Figure III.11.

    Real Exchange Rate Developments (2000M1–2012M6)

  • Figure III.12.
    View in gallery
    Figure III.12.

    Exchange Rate and Per Capita GDP

    (2011, cross-country comparison)

  • Figure III.13.
    View in gallery
    Figure III.13.

    Internal Terms of Trade Index

    (2007=100, 2007M1–2012M6)

  • Figure III.14.
    View in gallery
    Figure III.14.

    Annual Stock of Usable Reserve Assets

  • Figure III.15.
    View in gallery
    Figure III.15.

    Monthly Stock of Usable Reserve Assets (2006M1–2012M6)

  • Figure III.16.
    View in gallery
    Figure III.16.

    Worldwide Governance Indicators

    (2002–10, Index ranges from approximately -2.5=weak to 2.5=strong)1

  • Figure III.17.
    View in gallery
    Figure III.17.

    Decomposing Sudan’s CPIA

    (Score ranging from 1=low to 6=high)

  • Appendix III. Figure 1.
    View in gallery
    Appendix III. Figure 1.

    Common Rules of Thumb for Assessing Reserve Levels

  • Appendix III. Figure 2.
    View in gallery
    Appendix III. Figure 2.

    Optimal Level of Reserves

Figure III.1.

Key Macroeconomic Developments
Figure III.2.

Trade Volumes and Terms of Trade

(Index, 2000=100)
Figure III.3.

Cross-Country Comparison of Exports and FDI
Figure III.4.

Export Structure

(In Billions of USD)
Figure III.5.

Export Concentration

(Index, 1=high and 0=low)
Figure III.6.

SDG Bilateral Exchange Rates Against Major Trading Partners’ Currencies

(Period averages, 2000M1–2012M7)
Figure III.7.

BOP Dynamics

(In percent of GDP)
Figure III.8.

SDG/USD Exchange Rates

(Monthly Average 2007M1–2012M7)
Figure III.9.

Domestic Price and Exchange Rate Changes

(Percent, 2007M1–2012M6)
Figure III.10.

SDG/USD Exchange Rates

(Daily June 2–August 28, 2012)
Figure III.11.

Real Exchange Rate Developments (2000M1–2012M6)
Figure III.12.

Exchange Rate and Per Capita GDP

(2011, cross-country comparison)
Figure III.13.

Internal Terms of Trade Index

(2007=100, 2007M1–2012M6)
Figure III.14.

Annual Stock of Usable Reserve Assets
Figure III.15.

Monthly Stock of Usable Reserve Assets (2006M1–2012M6)
Figure III.16.

Worldwide Governance Indicators

(2002–10, Index ranges from approximately -2.5=weak to 2.5=strong)1
Figure III.17.

Decomposing Sudan’s CPIA

(Score ranging from 1=low to 6=high)
Appendix III. Figure 1.

Common Rules of Thumb for Assessing Reserve Levels
Appendix III. Figure 2.

Optimal Level of Reserves