Abstract
Sudan is a low-income fragile country facing significant domestic and international constraints and large macroeconomic imbalances despite notable progress toward macroeconomic stability and growth. Following the shock of the secession of South Sudan five years ago, policy adjustments helped to contain the fiscal deficit, slow money growth, reduce inflation, and support economic recovery. Institutional reforms strengthened tax collections and public financial management, and social spending increased. Despite these efforts, however, large macroeconomic imbalances-triggered by the loss of three-quarters of oil exports-continue to constrain growth prospects, along with weak policies, internal conflicts, and U.S. sanctions. Domestic and international efforts to end internal conflicts have yet to bear fruit, and the humanitarian situation remains difficult. Sanctions and the withdrawal of correspondent bank relations weigh on trade, investment, and growth. Absence of progress toward debt relief limits access to official external financing.
The Sudanese authorities appreciate the continued engagement with the Fund and thank Staff for the constructive discussions during the Article IV mission in Khartoum. They broadly concur with the analysis of the challenges facing Sudan and agree with the assessment and conclusions of the Staff report.
Background and context
Despite underlying challenges, the authorities are making concerted efforts to manage the Sudanese economy and unlock its great potential. Being one of the largest countries in Africa, in both population and surface area, the country is well-endowed with natural resources, including minerals, water and arable land. Benefitting from the successful implementation of the 2012-2014 three-year Program for Economic Stabilization, Sudan has maintained reasonable GDP growth rates, exceeding 3 percent post secession of South Sudan. That said, the country continues to face challenges. The structural weaknesses and limited market penetration compounded by US imposed economic sanctions, internal conflicts and debt overhang have limited economic growth and constrained the country from attaining its full potential. The situation was exacerbated by the country’s separation from the South which, created huge financing needs and led to both internal and external imbalances.
Notwithstanding the authorities’ stabilization efforts, the loss of significant oil reserves has necessitated concerted effort to transform the economy. Within this context, the authorities have prioritized addressing the structural rigidities to encourage export diversification. They have adopted a successor five-year (2015-2019) Program for Economic Reform. The successor program seeks to consolidate progress made under the three-year stabilization program in order to further enhance economic stability, promote inclusive growth and achieve sustainable development. To complement the economic reform agenda, the authorities have also prepared the 2016-2020 Poverty Reduction Strategy (PRS).
At the same time, the sanctions, by preventing trade between the US and Sudan, and limiting access to the international financial system, lowers Sudan’s capacity to attract foreign direct investment. In addition, foreign banks have been slowly withdrawing their correspondent banking relations, especially following the recent enforcement actions against international banks for violating US sanctions. This has also had unintended consequences on private sector activity and ordinary citizens, including the most vulnerable, in particular through remittances, export receipts, and import financing. Transaction costs have increased significantly, as well as cash transactions. At the regulatory level, recent developments are undermining efforts to strengthen the AML/CMT framework.
On the political front, the authorities have made notable progress toward resolving internal conflicts. They successfully and peacefully concluded the administrative referendum in Darfur held in April 2016. At the same time, the National Dialogue is still ongoing and a comprehensive road map for peace was signed by the leading opposition parties and armed rebels on August 8, 2016 in Addis Ababa. These positive developments have laid the foundation for restoring peace and security in Darfur and the country as a whole. They will encourage reprioritization of resources from war to development spending. The authorities have also endeavored to normalize relations with the international community and creditors and to mobilize support for removal of sanctions and debt relief.
Recent economic developments and outlook
Economic growth slowed to 3.5 percent in 2014 before rebounding to 4.9 percent in 2015. The recovery was supported by better than expected performance in agriculture. The authorities’ stabilization policies curbed inflationary pressures and helped reduce inflation from 36.9 percent in 2014 to 17. 3 percent in 2015. Further central bank efforts to contain growth in reserve money have dampened inflationary pressures and inflation is expected to average 13 percent in 2016, remaining within the authorities’ target.
The slump in oil and commodity prices led to the deterioration of the current account as commodity other export earnings declined significantly. This coupled with higher import transactions costs contributed to widening of the current account. However, external support from Gulf States helped cushion erosion of international reserves which contracted to 1.4 months of import cover. Even though the budget targeted a primary deficit of 1.6 percent of GDP, the deficit is expected to reach 1.9 percent of GDP for 2016 due to implementation of the Darfur referendum.
The economic outlook remains positive, although the low commodity prices, sanctions and the recent floods are expected present downside risks to growth prospects in 2016.
Fiscal policy
The authorities have endeavored to maintain fiscal restraint while preserving social spending. However, financing needs remain large, in part, due to the significant fall in oil prices and also on account of the considerable revenue gaps created by the secession of South Sudan. Given the limited access to external budgetary and balance of payments support, the authorities will continue to implement fiscal consolidation with the view to reduce the deficit to 0.4 percent by 2019. The consolidation plan will combine expenditure restraint, revenue mobilization and enhanced public finance management.
On the revenue side, the authorities have made significant efforts to increase domestic revenues. Since tax revenue performance is still relatively low by comparison, they continue to focus on strengthening revenue mobilization by enforcing compliance, reducing tax exemptions, reviewing the taxation and royalties on extractive industries and, reviewing direct taxes including income and corporate taxes. The program for economic reform also focuses on reviewing and harmonizing the tax codes. On the expenditure front, the authorities will continue to rationalize subsidies and strengthen the social safety net. In this regard, they are implementing gradual liberalization of wheat, hydrocarbons and electricity.
The authorities will continue to strengthen public finance management. Benefiting from Fund technical assistance, they have introduced an integrated financial management system and the Treasury Single Account (TSA).
External Debt and the Zero Option
Sudan remains in debt distress and despite significant progress made in meeting the technical prerequisites under the Fund SMPs, the country has not received positive response from the international community on debt relief and prospects have not improved significantly. In addition, the two-year ‘Zero Option Agreement’ which was seen by the authorities as a means to strengthen efforts through joint outreach between Sudan and South Sudan towards seeking debt relief expired in 2014. The extension, in turn, is due to expire in October 2016 without any favorable prospects. Hence the authorities face a dilemma, the lack of progress has dampened the political appetite for a further extension while without the zero option the debt has to be apportioned and this too will be politically challenging. That said, the authorities are cognizant of the developments in South Sudan characterized by rising conflicts and instability. In this regard, they may be open to considering further extension of the ‘Zero Option’ which expires in October 2016 with the anticipation of a positive outcome on debt relief.
Monetary policy
The authorities agree on the need to adopt tighter fiscal and monetary policy to anchor macroeconomic stability and reduce financing gaps in light of the uncertain and short-term nature of financing. In this context, monetary policy will continue to focus on containing reserve money growth and are in the process of developing instruments for effective liquidity management. The authorities’ consolidation efforts will also focus on reducing the government deficit and minimizing the central bank’s quasi fiscal activities. They have also made efforts to strengthen the AML/CFT framework. Successful implementation of the key recommendations of the MENAFAFT led to Sudan’s removed from the ‘gray list’ of countries requiring regular follow-up to biennial updates.
Exchange rate policy
Large external imbalances compounded by the loss of correspondent banking relations created instability in the exchange rate and led to foreign exchange shortages which have exerted significant pressures on the exchange rate. As a result, the differential between the official and parallel rates has widened significantly. The authorities recognize that distortions in the foreign exchange market are weakening the credibility of the exchange rate policy thereby underlining the need to reform the foreign exchange regime. Though the rationale for harmonizing the exchange rate and introducing greater exchange rate flexibility is acknowledged by the authorities, they remain cautious and emphasize the need for a gradual approach to minimize destabilizing the financial sector and the impact on the vulnerable population.
Structural reforms
The authorities acknowledge that concerted efforts are required for Sudan’s economic potential to materialize and are focusing on addressing key structural impediments in the economy to encourage private sector activity and attract FDI. Although removal of sanctions would benefit the economy significantly the authorities are taking important measures aimed at improving the business environment. In this regard, the investment law is currently under review and should be issued end 2016. The new law focuses on removing legal and administrative obstacles to private sector investment and growth. In addition, they will continue investing in infrastructure, particularly roads, ports and electricity. Further, the authorities are strengthening their efforts to improve human capital development by designing programs that will remove disparities and strengthen provision of education and health services.
Conclusion
The authorities will continue to strengthen their efforts to attaining peace and stability by enhancing progress toward resolving internal conflicts. They remain committed to cooperating with the Fund on policies and have made progress in strengthening economic policies and institutions benefiting from Fund support. The authorities will continue their efforts to normalize relations with the US, which has been an impediment to progress on debt relief, as well as with creditors in particular to garner support for removal of sanctions and possibly debt relief.