Statement by Mr. Mkwezalamba, Executive Director for South Sudan and Mr. Nakunyada, Advisor to the Executive Director March 15, 2017

South Sudan has suffered civil conflict, political instability and external shocks in the past three years. A steep decline in oil production and a sharp drop in oil prices have caused large shortfalls in foreign exchange receipts and government revenue. Continued high government spending led to massive fiscal deficits that were either monetized or financed through accumulation of arrears. The country is in a deep economic crisis with annual inflation peaking at 550 percent in September 2016 and a precipitous currency depreciation. Gross international reserves have dropped to about one week of import cover. A relapse of violence in July 2016 following the formation of the Transitional Government of National Unity three months earlier compounded the already existing humanitarian crisis and derailed the peace process. The hope is that the country charts a new course toward a broad-based and inclusive political process and economic development.

Abstract

South Sudan has suffered civil conflict, political instability and external shocks in the past three years. A steep decline in oil production and a sharp drop in oil prices have caused large shortfalls in foreign exchange receipts and government revenue. Continued high government spending led to massive fiscal deficits that were either monetized or financed through accumulation of arrears. The country is in a deep economic crisis with annual inflation peaking at 550 percent in September 2016 and a precipitous currency depreciation. Gross international reserves have dropped to about one week of import cover. A relapse of violence in July 2016 following the formation of the Transitional Government of National Unity three months earlier compounded the already existing humanitarian crisis and derailed the peace process. The hope is that the country charts a new course toward a broad-based and inclusive political process and economic development.

Introduction

1. Our South Sudanese authorities appreciate the constructive engagement during the recent 2015/16 Article IV Consultation mission. Broadly, they agree with staff’s assessment of economic challenges and the key policy recommendations.

2. South Sudan continues to face economic and development challenges compounded by renewed conflict and exogenous shocks. Given its high dependence on oil for export receipts and fiscal revenues, the collapse of international oil prices in 2014 coupled with the re-emergence of conflict in July 2016 have weighed down economic activity over the past three years. Against this background, the country has experienced export and fiscal revenue shortfalls as well as declining donor support, amplifying budgetary pressures and leading to the depletion of foreign exchange reserve buffers. Consistent with Fund advice, the authorities are intensifying efforts to restore macroeconomic stability through fiscal consolidation, tightening of monetary policy, and implementation of measures to mitigate emerging banking sector vulnerabilities. At the same time, the government is spearheading the establishment of a broad-based and inclusive national dialogue process to restore peace.

Recent Economic Developments and Outlook

3. Real GDP growth in South Sudan declined by 12.8 percent and 6.9 percent in FY2014/2015 and FY2015/2016, respectively. The contraction in economic activity is attributed to declines in the key sectors, notably oil, agriculture, construction, and services. In the oil sector, which is the mainstay of the economy, production was scaled back from 165,000 barrels/day in 2015 to 130,000 barrels/day in 2016, on the back of low international oil prices. Should oil prices remain subdued, production is projected to decline further in the near term. The decline in oil output has been exacerbated by lack of capital to invest in efficient oil recovery techniques, occasioned by low investment returns. In the agricultural sector, production was mainly affected by declines in subsistence farming activities owing to drought conditions and displacement effects related to the civil conflict. As a result, the food security situation has worsened particularly in conflict affected areas, with the UN and the government of South Sudan recently declaring a famine in two northern counties.

4. Persistent foreign exchange shortages exerted incessant pressure on the exchange rate and inflation. Accordingly, the South Sudanese Pound (SSP) depreciated by an estimated 95 percent in 2016, compounded by high import dependence. This followed exchange rate reforms in December 2015 aimed at allowing the interplay of market forces in the foreign exchange market, and removing most restrictions and multiple currency practices (MCPs). The remaining restrictions will be dealt with as conditions improve. The depreciation of the exchange rate, coupled with an earlier monetization of the fiscal deficit, accelerated inflation from 187 percent in June 2016 to 550 percent in September 2016, which eventually moderated to 370 percent in January 2017 following the winding down of expansionary monetary policy.

5. Going forward, growth prospects remain challenged by volatility in oil prices, the country’s susceptibility to adverse weather conditions, and political instability. The implementation of fiscal reform measures as well as the tightening of monetary conditions are, however, expected to curb high money supply growth, reduce inflation, and stabilize the foreign exchange market in the medium term. On the other hand, the rebound in international oil prices and the success of the inclusive national dialogue process to improve the security situation may present additional upside risks to the outlook.

Policy Reform Measures

6. The 2016/2017 National Budget, which was fully supported and approved by Cabinet, outlined comprehensive fiscal policy and public financial management reform measures geared at restoring fiscal sustainability. The ambitious fiscal consolidation measures enunciated in the budget are envisaged to reduce the deficit to levels that support price and exchange rate stability.

Fiscal Policy and Public Financial Management Reforms

7. The authorities are placing greater emphasis on the mobilization of additional domestic revenues. Accordingly, government is taking steps to increase sales tax and excise duty on selected products and services; impose withholding tax on government contracts; introduce a new departure tax; and eliminate exemptions on personal income and corporate tax. In this regard, the authorities have made progress towards establishment of the National Revenue Authority (NRA), which should improve tax administration and promote the mobilization of both tax and non-tax revenues, particularly in non-oil sectors. In this regard, the National Legislature has passed the National Revenue Authority Bill, while appointments to the NRA Board of Directors are expected in the near-term. The NRA is expected to commence operations by the end of 2017.

8. The containment of expenditures to levels consistent with available resources remains high on the authorities’ reform agenda. In this respect, the authorities are implementing measures to reduce the civil service wage bill by freezing new recruitments, payroll screening, and the biometric registration of civil servants to eliminate ghost workers. The government has since kick-started the process of cleaning and updating the payroll system and removing ghost workers through the application of identification codes. External support will be critical in helping the authorities successfully screen the payroll. Furthermore, strict spending limits have been set across the board, particularly on travel, goods and services, wages, and domestic capital expenditure. Cabinet also approved the downsizing of staff in diplomatic and foreign missions. This is expected to result in an estimated 50 percent reduction in expenditures of running the country’s diplomatic missions.

9. To further contain spending, the authorities are taking steps to remove subsidies to Nile Petroleum Corporation1 (NilePet) to lessen its burden on the budget. Accordingly, Parliament agreed that subsidies to NilePet should be phased out. Moreover, the authorities have engaged Ernst and Young to undertake audits of NilePet and pave the way for the publication of NilePet’s financial statements on an annual basis. Progress on this front, however, stalled on account of the renewed political conflict. Subject to improvements in security conditions, the audit process is expected to resume.

10. The South Sudanese authorities established a Cash Management Committee (CMC) to control expenditures within the broader Public Finance Management reform framework. The CMC, comprising senior officials from the Ministry of Finance and Economic Planning and the Bank of South Sudan, has been mandated to institute strict expenditure prioritization measures consistent with budget constraints. Within this context, the authorities intend to publish detailed quarterly CMC reports, and make regular presentations to cabinet to enhance transparency. Presently, the CMC operates on strict cash budgeting principles with priority accorded to critical government expenditures. The operations of the CMC also benefitted from the transfer of government accounts from commercial banks to the consolidated treasury account. In line with the provisions of the Public Financial and Accountability Act, the authorities also agreed with the Fund to enforce the accountability of under-secretaries to contain the breaching of budget limits.

11. Work is currently underway to install the Integrated Financial Management Information System (IFMIS) geared to controlling commitments made by government departments. Once installed, the system will be rolled out to various government departments to control the undertaking of commitments and curtail further accumulation of domestic arrears. In addition, government is preparing budget execution procedures while strengthening internal expenditure control mechanisms. Further, the authorities intend to strengthen government procurement processes. In this regard, the National Procurement Bill is currently before the National Legislature, awaiting approval before implementation.

Financial and Monetary Sector Policy Measures

12. The authorities have made progress towards promoting the building of capital buffers to cushion banks from vulnerabilities emanating from capital inadequacy. In this context, the Bank of South Sudan (BSS) raised minimum capital requirements to US$30 million for foreign banks and US$15 million for domestic banks over a two-year period ending December 31, 2016. Non-compliant banks will be forced to either merge their operations or liquidate by mid-2017, following proper due diligence by the BSS. Furthermore, the BSS is finalizing the legislative framework guiding the merger and liquidation of under-capitalized banking institutions in consultation with regional counterparts.

13. To further strengthen the efficacy of monetary policy, the BSS is taking initiatives to enforce reserve requirements. In this vein, the BSS will enforce compliance with already approved reserve requirements once work to enhance commercial banks’ preparedness has been completed. To date, regulations on banks’ compliance with required reserves have been signed, and the appropriate template has been circulated to all banks.

14. Consistent with the central bank’s disinflation efforts, the government recently discontinued recourse to central bank borrowing to bridge budget deficits. In response to the tightening of monetary conditions, inflationary pressures have since subsided. This measure will be complemented by the gradual scaling down of Treasury Bill issuances, to reduce the banking sector’s exposure to government and avoid crowding-out the private sector. The authorities also plan to introduce repurchase agreements to strengthen liquidity management efforts.

Conclusion

15. The authorities of South Sudan remain committed to the steadfast implementation of sound macroeconomic policies consistent with Fund policy advice despite difficult domestic and external conditions. More importantly, they acknowledge the severity of the prevailing macroeconomic challenges, and the need to urgently implement reforms to turn-around the economy and improve living standards. In this regard, the authorities expect to leverage on the far-reaching fiscal reform measures outlined in the 2016/2017 National Budget. In addition, the authorities are optimistic that ongoing initiatives to establish an inclusive national dialogue process will foster cohesion and broad consensus required to lay a solid foundation for the restoration of lasting peace and stability. In that context, they look forward to continued close collaboration with the Fund to help strengthen policies and unlock external support, both technical and financial.

1

Nile Petroleum Corporation (NilePet) is South Sudan’s state owned oil company which imports petroleum products, and holds and manages South Sudan’s stake in crude oil production ventures.