Republic Of South Sudan: Staff Report for the 2019 Article IV Consultation—Debt Sustainability Analysis1
Author: International Monetary Fund. African Dept.
Publication Date:
04 Jun 2019
eISBN:
9781498318457
Language:
English
Keywords:
ISCR; CR; authority; rate; clearance plan; fund policy advice; debt-creating flow; SOE debt; debt accumulation; sustainability analysis; debt carrying capacity; Debt sustainability; Public and publicly-guaranteed external debt
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2019 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for the Republic of South Sudan

Abstract

2019 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for the Republic of South Sudan

REPUBLIC OF SOUTH SUDAN

STAFF REPORT FOR THE 2019 ARTICLE IV CONSULTATION—DEBT SUSTAINABILITY ANALYSIS1

May 15, 2019

Approved By

Zeine Zeidane (AFR), María González (SPR) and Marcello Estevão (IDA)

Prepared by the staffs of the International Monetary Fund (IMF) and the International Development Association (IDA)

Republic of South Sudan: Joint Bank-Fund Debt Sustainability Analysis

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The combined impact of a civil conflict, a large fall in oil prices, and high levels of fiscal spending left South Sudan in debt distress in 2016. Several thresholds were breached, and external and domestic debt arrears accumulated. Since then, the fiscal situation has improved somewhat, and the economic and security outlooks are more positive with the signing of a peace agreement in September 2018. However, South Sudan still has substantial external and domestic debt arrears, and implementation of the peace agreement is putting substantial pressure on government spending in the near term, while the expected depletion of oil would pose challenges to fiscal sustainability in the long term. As a result, South Sudan continues to be in external and overall debt distress and debt is assessed to be unsustainable.

Debt Coverage

1. The DSA covers central government debt. South Sudan faces significant weaknesses with availability of debt data. Complete information about SOE debt and government guarantees is unavailable, though the size of them is negligible. Thus, the contingent liability stress test includes only SOE debt and financial market shocks. The external debt is defined using the currency criterion.

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The default shock of 2% of GDP will be triggered for countries, whose government-guaranteed debt is not fully captured under the country’s public debt definition (1.). If it is already included in the government debt (1.) and risks associated with SoE’s debt not guaranteed by the government is assessed to be negligible a country team may reduce this to 0%.

A. Background on Debt

2. South Sudan has been in debt distress for several years, owing to arrears on external and domestic public debt. The macroeconomic conditions deteriorated in 2012 due to a prolonged oil production shutdown, and despite reopening production in the second quarter of 2013, the eruption of the civil conflict in December 2013 caused further harm to the economy. Moreover, a sharp drop in international oil prices from mid-2014 and an overvalued exchange rate contributed to continued economic deterioration and rapid depletion of foreign exchange reserve. A short-term trade facility provided by the Qatar National Bank (QNB) fell into arrears in 2015. In addition, South Sudan fell behind on payments to Sudan in 2015 and 2016 under the Transitional Financial Arrangement (TFA).2 Accordingly, South Sudan was categorized as being in debt distress in the 2016 DSA.

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Gross Foreign Exchange Reserves

(Millions of U.S dollars)

Citation: IMF Staff Country Reports 2019, 153; 10.5089/9781498318457.002.A003

3. South Sudan’s external public debt, including arrears, was estimated at US$1,196 million (34 percent of GDP) as of end-March 2019. Debt to the World Bank amounted to US$53 million on IDA terms, while debt to the African Development Bank (AfDB) amounted to US$28 million. US$150 million had been borrowed from China Exim Bank to upgrade Juba International Airport. The Bank of South Sudan (BSS) has an outstanding liability to the QNB amounting to US$627 million, of which US$175 million is estimated to be in arrears as of March 2019. Oil-related short-term loans are estimated at US$338 million.

Republic of South Sudan: Public Debt Stocks as of End-March 2019

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Estimate and subject to verification

4. After the Minister of Finance announced the policy to stop direct borrowing from the BSS to finance the budget deficits in 2016, central government financing from the banking system has declined substantially. BSS net credit to the central government has declined from 13 percent of GDP in 2015/16 to 0.9 percent in 2018/19. The stock of domestic debt amounted to about SSP 38.7 billion by March 2019 (9 percent of GDP), almost entirely from the BSS, with the commercial banks accounting for only SSP 2 million. The stock of domestic arrears is estimated at about 3.2 percent of GDP, but domestic payment arrears still need to be verified.

B. Outlook and Key Assumptions

5. The revised macroeconomic assumptions reflect the recent positive political and security developments (Box 1). The revitalized peace agreement, signed in September 2018, has helped to stabilize the political and security situation in South Sudan. The baseline scenario assumes the peace agreement will be broadly implemented and that the cessation of hostilities will hold. With implementation of economic stabilization policies and peace, oil production is projected to recover above the pre-2016 levels, which helps ease pressure on the fiscal and foreign exchange markets. A significant increase in oil production has already occurred with the re-opening of some damaged oil wells. The improved government oil revenue would reduce the risk of recourse to deficit financing from the central bank. Higher oil export will also support a gradual increase in foreign exchange reserves. Based on updated information, the baseline growth trajectory has been slightly modified compared to the one used in the 2016 DSA (Box 2).

6. South Sudan will likely require inflows from donors to finance the peace process. While external support is unlikely to come forward in the near term, the baseline assumes that some inflows will come to support macroeconomic stabilization, resettlement of the internally displaced and returning refugees, construction of feeder roads and rural infrastructures, and disarmament, demobilization and reintegration of former combatants.

7. Over the medium term, the improved political and security environment will support broader economic recovery, including both the oil and non-oil sectors, followed by new investments. The economy is projected to grow at close to 4 percent annually through the late 2020s when oil production is projected to reach a peak. While oil production is expected to gradually decrease in aging oil fields after reaching its peak in the late 2020s, the non-oil sectors are projected to grow to partially offset falling oil production. At the same time, the government is expected to embark on a reform program, focusing on shifting the composition of spending towards social and infrastructure spending, and fostering transparency and accountability in the management of public resources. Those efforts would improve the business climate and thus help to attract foreign direct investments. However, significant downside risks to the growth estimates remain. The first challenge is restoring peace and security. The revitalized peace agreement between President Salva Kiir and opposition leader Riek Machar had been seen as a break-through in efforts to end South Sudan’s civil war, but since then there has been little progress in implementing governance and security arrangements. Without action to end the conflict and stabilize the economy, a post-conflict path for the economy remains uncertain.

Key Macroeconomic Assumptions

Real sector: After negative growth in 2018 due to continued conflict and a sharp decline in international oil prices, real GDP is projected to recover and expand by an average of 4.3 percent through 2029. Oil production is projected to increase gradually with the peak at 204,000 barrels per day in 2028. After 2028, oil production is projected to fall gradually to below 70,000 barrels per day by end of 2030s. Meanwhile, the non-oil sectors––agriculture, fisheries, mining, construction and services––are projected to grow robustly. During 2030–2039, real GDP is projected to increase by an average of 3.6 percent.

Fiscal sector: Total revenue and grants are projected to rise from 34.3 percent of GDP in 2018 to 42.4 percent of GDP in 2025, and thereafter gradually decrease to 14.1 percent of GDP by the end of 2030s as oil revenues decrease. Noninterest expenditure is projected to remain high in the short and medium term due to the costs for the implementation of peace and reconstruction. While trying to scale down its expenditure, South Sudan is projected to experience prolonged primary deficits in 2030s because of the decline in oil revenue.

External sector: Exports of goods and services as a share of GDP are projected to increase in the short and medium term, supported by growth in both the oil and the non-oil sectors. The share of imports of goods and services to GDP is projected to increase in the short and medium term because of scaling up of public (and later private) investment and return of refugees and internally displaced people. Current transfers to Sudan under the TFA are expected to be paid off by 2021/22.1 Budgetary external borrowing is assumed to rise as the peace process takes hold.

1 The completion of transfers to Sudan under the TFA depends on international oil prices.

8. The realism tools suggest that the macroeconomic projections are reasonable and consistent with historical patterns and those observed in other LICs (Figure 4). Cross-country experience suggests that the baseline fiscal adjustment is feasible. The projected adjustment over the next 3-year period is a 3-percentage point increase in the primary surplus-to-GDP ratio, supported by increase in oil revenue. Fiscal multipliers suggest a more pessimistic growth, but the baseline assumes robust growth of oil production.

Figure 1.
Figure 1.

Republic of South Sudan: Indicators of Public and Publicly Guaranteed External Debt Under Alternatives Scenarios, 2019–291

Citation: IMF Staff Country Reports 2019, 153; 10.5089/9781498318457.002.A003

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in or before 2029. Stress tests with one-off breaches are also presented (if any), while these one-off breaches are deemed away for mechanical signals. When a stress test with a one-off breach happens to be the most exterme shock even after disregarding the one-off breach, only that stress test (with a one-off breach) would be presented.2/ The magnitude of shocks used for the commodity price shock stress test are based on the commodity prices outlook prepared by the IMF research department.
Figure 2.
Figure 2.

Republic of South Sudan: Indicators of Public Debt Under Alternatives Scenarios, 2019–29

Citation: IMF Staff Country Reports 2019, 153; 10.5089/9781498318457.002.A003

* Note: The public DSA allows for domestic financing to cover the additional financing needs generated by the shocks under the stress tests in the public DSA. Default terms of marginal debt are based on baseline 10-year projections.Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in or before 2029. The stress test with a one-off breach is also presented (if any), while the one-off breach is deemed away for mechanical signals. When a stress test with a one-off breach happens to be the most exterme shock even after disregarding the one-off breach, only that stress test (with a one-off breach) would be presented.
Figure 3.
Figure 3.

Republic of South Sudan: Drivers of Debt Dynamics––Baseline Scenario External Debt 1/

Citation: IMF Staff Country Reports 2019, 153; 10.5089/9781498318457.002.A003

1/ Analyses on unexpected changes in debt are unavailable due to the lack of data.2/ The current DSA assumes more external financing for peace process than the previous DSA, which makes its Gross Nominal PPG External Debt and Gross Nominal Public Debt larger than the previous DSA.
Figure 4.
Figure 4.

Republic of South Sudan: Realism Tools

Citation: IMF Staff Country Reports 2019, 153; 10.5089/9781498318457.002.A003

9. Continued current account deficit and negative real GDP growth contributed to external debt-creating flows and this situation is expected to turn around (Figure 3). The accumulation of external debt in South Sudan over the last 5 years has been primarily driven by current account deficits and negative real GDP growth. Looking forward, the improved current account and positive real GDP growth are expected to partly offset debt accumulation mainly caused by unfavorable nominal interest rates.

Republic of South Sudan: Key Macroeconomic Assumptions Comparison with the Previous Debt Sustainability Analysis

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10. Continued negative real GDP growth and primary deficits contributed to public debt-creating flows and this situation is expected to turn around (Figure 3). Over the last 5 years, negative real GDP growth and primary deficits have been the main factors of debt accumulation, which was offset by favorable interest rates and real exchange rates. Looking forward, positive real GDP growth and improved primary balances are expected to partly offset debt-creating flows mainly caused by unfavorable real interest rates.

Country Classification and Determination of Scenario Stress Test3

11. South Sudan’s debt carrying capacity is assessed as “weak.” South Sudan’s Composite Indicator (CI) score is calculated to 1.42, and the country has ‘weak debt carrying capacity.’ The CI is based on a weighted average of several factors, such as the country’s real GDP growth, remittances, international reserves, and world growth and the Country Policy and Institutional Assessment (CPIA) score, and the calculation of the CI is based on 10-year averages of the variables, across 5 years of historical data and 5 years of projection, and the corresponding CPIA. South Sudan’s CI has been calculated based on the October 2018 WEO and 2017 CPIA update. This classification remains unchanged from the previous DSA framework applied in the 2016 DSA With this assessment, the DSA uses the following thresholds to assess risk of external debt distress:

  • Present value of public and publicly guaranteed debt (PPG) external debt-to-GDP: 30 percent

  • Present value of PPG external debt-to-exports: 140 percent

  • PPG external debt service-to-exports: 10 percent

  • PPG external debt service-to-revenue: 14 percent

Calculation of the Cl Index

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12. Given the sensitivity to international oil prices, a tailored stress test for a lower oil price was conducted. As oil exports account for about 97 percent of total exports of goods and services, South Sudan’s economy is very sensitive to international oil prices.4 In this context, in addition to standard stress tests, the commodity price stress test, which assumes oil prices fall by 1 standard deviation and the gap closed over 6 years, has been applied.

External Debt Sustainability Analysis

13. The baseline shows the stock of PPG external increases gradually toward mid-2020s, then declining slowly thereafter (Table 1). Under the baseline scenario, the PV of debt-to-GDP ratio gradually increases and remains above the thresholds during 2021–2028, with its peak at about 9 percentage points above the threshold in 2024. The debt service-to-exports ratio and the debt service-to-revenue ratio are above the thresholds in the early years because of repayments of short-term oil-related loans. These ratios are projected to increase after the mid-2020s as grace periods of new longer-term debt expire and export-to-GDP ratio and revenue-to-GDP ratio decreases due to the decline in oil production. The PV of debt-to-exports ratio remains below the thresholds throughout the sample period under the baseline.

Table 1.

Republic of South Sudan: External Debt Sustainability, Baseline Scenario, 2018–39

(in percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

Includes both public and private sector external debt.

Derived as [r – g – ρ(1+g)]/(1+g+ρ+gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and ρ = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arr ears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from pr ice and exchange rate changes.

Current-year interest payments divided by previous period debt stock.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

Assumes that PV of private sector debt is equivalent to its face value.

Historical averages are generally derived over the past 10 years, subject to data availability, whereas projections averages are over the first year of projection and the next 10 years.

14. The stress tests confirm breaches of thresholds in most indicators (Figure 1 and Table 3). In the PV of debt-to-GDP ratio, the debt service-to-exports ratio, and the debt service-to-revenue ratio, both the historical scenario and the most extreme shock test show breaches of the thresholds. In the PV of debt-to-exports ratio, the historical scenario shows breaches of the threshold (140 percent of GDP) after 2028.

Table 2.

Republic of South Sudan: Public Sector Debt Sustainability Framework, Baseline Scenario, 2018–39

(in percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

Coverage of debt: The central government, central bank. Definition of external debt is Currency-based.

The underlying PV of external debt-to-GDP ratio under the public DSA differs from the external DSA with the size of differences depending on exchange rates projections.

Debt service is defined as the sum of interest and amortization of medium and long-term, and short-term debt.

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period and other debt creating/reducing flows.

Defined as a primary deficit minus a change in the public debt-to-GDP ratio ((-): a primary surplus), which would stabilizes the debt ratio only in the year in question.

Historical averages are generally derived over the past 10 years, subject to data availability, whereas projections averages are over the first year of projection and the next 10 years.

Table 3.

Republic of South Sudan: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2019–29

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Sources: Country authorities; and staff estimates and projections.

A bold value indicates a breach of the threshold.

Variables include real GDP growth, GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Includes official and private transfers and FDI.

Public Debt Sustainability Analysis

15. South Sudanese domestic financial market remains undeveloped. In 2018, external debt accounts for about 80 percent of PPG debt and this situation is expected to continue over the short and medium term. Over the long term, domestic debt is projected to be more dominant as domestic financial market reforms are implemented.

16. The public debt in the baseline is projected to increase gradually toward the late-2020s, but to increase rapidly thereafter due to higher primary deficit linked to a decline in oil production (Table 2). Under the baseline scenario, the PV of debt-to-GDP ratio decreases in 2019 as central government financing from the banking system has declined substantially. However, it remains above the threshold (35 percent of GDP) throughout the sample period. In the long term, it is projected to increase rapidly after 2030 as South Sudan is expected to experience fiscal deficits because of a decline in the oil revenue.

17. Indicators of public debt are very sensitive to non-debt flows (Figure 2 and Table 4). Compared to the baseline and historical scenarios, the decline in non-debt flows, such as foreign direct investments, brings about an explosive impact on the PV of debt-to-GDP ratio and the PV of debt-to-revenue ratio.

Table 4.

Republic of South Sudan: Sensitivity Analysis for Key Indicators of Public Debt, 2019–29

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Sources: Country authorities; and staff estimates and projections.

A bold value indicates a breach of the threshold.

Variables include real GDP growth, GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Includes official and private transfers and FDI.