Sudan Country Economic Brief February 2011 The World Bank Africa Region PREM Unit

Sudan Country Economic Brief February 2011 The World Bank Africa Region PREM Unit I. Recent political developments The self-determination referendum was held on schedule during January 9-15, 2011 with overwhelming results in favor of secession for the South were finalized on February 7, 2011. Sudanese President Omar Hassan Al-Bashir immediately stated that he has accepted the secession outcome. The quick acceptance by the North strengthens the prospects of a continued peaceful and smooth path for the transition to two sovereign states. Formal independence of the South is expected by July 2011 at the latest, when the CPA Interim Period formally ends. The outcome of on-going negotiations will determine the post-cpa economic landscape. Negotiations between the North and South on post-cpa arrangements started before the referendum and will continue over the coming months. There are a number of key economic issues to be settled, most importantly the future treatment of oil assets (e.g., ownership, production arrangements with operators, transport of crude to refineries and export points in the North, marketing and sales, etc.). To date, the North and South have equally split the rents from oil wells in the South, as per the wealth sharing protocol of the CPA. Oil sector activity and government wealth sharing over the Interim Period have driven strong real GDP growth in the North, and accounts for over 98 percent of public revenues in the South. Thus significant adjustments on oil will have major economic implications for both sides. Other key issues under negotiation include the future treatment of external debt, currency, borders and water rights. The secession outcome will most likely put significant strain on economic stability in the North. The economic effects of secession would be transmitted largely through the fiscal and external accounts. With roughly 75 percent of GoNU oil revenues generated from southern oil production, there are expected negative fiscal and balance of payments implications of secession that will strain economic stability in the North. Growing political uncertainties in the run-up to the referendum have weakened the currency, with depleted reserves limiting the Central Bank s ability to continue its past interventions. II. Major adjustments to the fiscal outlook The federal budget was passed in November 2010, based on a unity scenario and reflecting significant fiscal tightening. The GoNU 2011 budget was passed by the National Assembly on November 10, 2010 based on the assumption of national unity. The target deficit is 3.2 percent of GDP, compared to 5.1 percent in the 2010 budget. This aggressive tightening assumes external financing will cover a major portion of the deficit (2.7 percent of GDP). Total revenue for 2011 is projected at 12.7 percent of GDP (SDG 24.2bn) compared to 11.6 percent in 2010, largely driven by improving non-oil revenues which would reach 7.1 percent of GDP (SDG 13.5bn) compared to 4.9 percent in 2010. At the same time oil revenue is programmed to decline to 5.6 percent of GDP (SDG 10.7bn), down from 6.7 percent in 2010. Total spending is cut to 15.9 percent of GDP compared to 16.7 percent in 2010, with lower federal expenditure and cuts in transfers to GoSS due to lower oil production. Transfers to Northern States are to slightly increase to 4.0 percent of GDP (up from 3.9 percent in 2010). However, weak budget execution in the past and possible mid-year adjustments may jeopardize adequate financing for service delivery at the state level. The reality of impending secession led GoNU to announce austerity measures in January 2011. A revised budget may be necessary by mid-year. The Government of National Unity (GoNU) announced major fiscal measures in early January 2011 designed to adjust the fiscal outlook to the reality of secession (Table 1). The Minister of Finance and National Economy announced a fiscal policy package to the National Assembly that includes reduced public expenditures (mostly on goods and services), increased revenues (through reduced subsidies on petroleum products and on sugar) and several safety net measures. The status of implementation is not clear at this moment, but it is expected that the measures taken will be considered in scenarios for a revised budget document. If taken, some of these measures may have negative impacts on the poor and vulnerable, 1 P a g e

especially those affecting fuel and food prices. Higher sugar prices are likely to directly reduce the purchasing power of the poor while the cut in the subsidy on gasoline has more of an indirect impact overall. The latter may have a substantial direct impact on the urban poor who tend to rely more on public transportation, for example. Table 1: Policy package to face fiscal challenges, January 2011 Reduction of public expenditure Increasing revenues Strengthen safety nets 25% reduction of salaries of senior ministerial positions. 30% reduction of budget for travelling abroad. 10% reduction of the diplomatic missions budgets. Halt on purchases of new government cars. Stop on approval of new constructions and purchases of new furniture for government units. 30% reduction of purchases of goods and services during the first quarter 2011. Downsize central and state governments. 20% reduction of development budgets of all public corporations. Freeze on new staff recruitment except for newly established ministries. Freeze on the creation of new government units. All public units required to deposit foreign proceeds in their accounts with CBoS. Transfer of all royalties collected by public corporations to the national budget Privatize all public companies by end-2011. Sale of all government shares in joint investments to the private sector. Eliminate VAT exemptions granted on commodities. Increase the price of diesel to 6.5 SDG (per gallon) Increase the price of benzene to 8.5 SDG per gallon. Increase the price of cooking gas to 13 SDG (per container). Increase the price of fuel jet to 6.5 SDG per gallon. Levy 20 SDG excise tax on each sack of sugar (i.e. 50 kg). Source: Speech of the Minister of Finance and National Economy to the National Assembly, January 2011. A monthly increase in the salary of civil service employees by 100 SDG; applies also to pensions. Provide a free meal to poor students and a subsidized meal to all students. Provide tuition fees for poor students. Provide bursaries to 200,000 students. Give support to 500,000 families. Increase free health support through the health insurance program. Establish an agriculture support fund with US$ 150mn. Establish an industry support fund with US$150mn. Grant special incentives to investors from the Arab region (Presidential decree). GoSS has presented a 2011 budget to the Southern Sudan Legislative Assembly, however, revisions to reflect new post-cpa arrangement can be expected mid-year. The theme for the 2011 budget is ensuring smooth transition to independence. The budget focuses around three main areas: stability, improving services, and managing transition to independence. Importantly, the headline numbers are only indicative, pending legislative approval. Total revenues of SDG 5.7bn are proposed, consisting of SDG 5.6bn from oil transfers (98 percent of total revenue) and SDG 0.1bn from non-oil sources. The latter includes SDG 40mn from the Personal Income Tax, SDG 54mn from other Government of Southern Sudan revenues (not specified in the Minister s speech), and SDG 17mn from GOSS share of national taxes. Total expenditures are projected to equal total revenues of SDG 5.7bn. Operating costs are SDG 2.1bn, leaving capital expenditures of only SDG 1.2bn. The Ministry of the SPLA and Veteran Affairs is allocated the largest share (SDG 1.6bn or 28 percent of the budget). The Ministry of Roads and Transport follows second with SDG 0.5bn, and the Ministry of Internal Affairs third with SDG 0.4bn. The Office of the President is allocated a total budget of SDG 274mn, an increase of SDG 100mn from last year. III. External account pressures include a weakened Sudanese pound due to political uncertainties The Sudanese national economy remains largely reliant on the exports of oil and oil-related products, which accounted for 92 percent of overall export volumes in 2010 (projected). Imports are dominated by foreign machinery and equipment (often for oil production), manufactured goods, transport equipment and selected food items. The trade balance was in deficit for three out of the last five years but is projected to have a slight surplus in 2010. Oil exports account for two-thirds of foreign exchange earnings, while non-oil exports contribute a mere 5 percent. However, oil production growth has stalled lately, with crude exports falling 9 percent in 2010 to roughly 376,000 barrels per day. 2 P a g e

Sudan continues to face currency pressures on the foreign exchange market, with major uncertainties around the oil sector, fiscal outlooks and political adjustments. The official exchange rate was 2.51 SDG/US$ in January 2011 compared to 2.23 SDG/US$ in January 2010 (Figure 1), and reserves have been run down to critical levels to defend the exchange rate. A significant premium has opened up in the parallel markets, widening the gap between the official and market rates. The exchange rate has fluctuated between 2.67 SDG/US$ to 2.70 SDG/ US$ in the commercial banks foreign exchange windows, Figure 1: Sudan official exchange rate, Jan 07 Jan 11 while the street rate (black market) 2.5 Sudan Offical Exchange rate (period average); Jan 2007-Jan 2011 2.51 3.5 was around an average rate of 3.2 SDG/US$ in early February 2011. Source: CBoS SDG to Euro (right scale) 3.43 2.3 SDG to USD (left scale) The Central Bank has imposed import controls in an attempt to 2.1 3.1 lessen foreign exchange 2.01 pressures and safeguard the 3.016 foreign exchange reserve 1.9 2.9 position. These measures include reduced allowances for amount of hard currency available to 1.7 2.7 individuals travelling abroad. A 100 percent cash margin was 1.5 2.5 imposed on most imports to limit J- J- A- S- O-N-D-J- J- A- S-O-N-D-J- J- A- S- O-N-D-J- J- A- S-O-N-D-J- 07 07 07 07 07 07 07 07 07 07 07 0708080808080808080808080809090909090909090909090910101010101010101010101011 foreign exchange primarily to serve genuine market needs. Source: Central Bank of Sudan (CBoS). Custom duties on all imported goods were increased with the exception of food items, wheat, sugar and capital good used by local manufacturers, which are projected to result in a 15-20 percent drop in imports. Import bans have been placed on a list of imported products, including furniture, imports of live animals and birds, soda drinks, mineral water, and others. 3.3 IV. Rising domestic food prices drive inflation upward to double digits The inflation rate in December 2010 and January 2011 has risen to 15.4 and 16.7 percent, respectively. The latter is the highest since 2008. Rising food prices in particular cereals (sorghum), beard, meat, oils, and sugar which have a significant weight in the consumer s basket (53 percent), are the major contributors to inflation. Figure 2: Sudan inflation rate, Jan 2008 Jan 2011 35 30 25 20 15 10 5 0 Sudan National Inflation Rate (% change from the same month of the previous year) 32 21.8 Overall Inflation Source: Central Bureau of Statistics (CBS). Food Price Inflation 19.7 19.8 J- F- M- A- M- J- J- A- S- O- N- D- J- F- M- A- M- J- J- A- S- O- N- D- J- F- M- A- M- J- J- A- S- O- N- D- J- 08 08 08 08 08 08 08 08 08 08 08 08 09 09 09 09 09 09 09 09 09 09 09 09 10 10 10 10 10 10 10 10 10 10 10 10 11 15.4 16.7 Domestic food prices increased 19.7 percent in December and 19.8 percent January (Figure 2). Several factors are behind these recent food price trends. First, the December jump can be partly attributed to rising speculation about impending removal of subsidies on oil, sugar and other products. The removal of some key subsidies in January (Table 1) further cemented the double digit growth rate in the first month of the year. Second, as a net food importer Sudan is particularly vulnerable to increases in global food price, which have picked up considerably in recent months. 3 P a g e

Third, the ongoing currency devaluation leads to yet even higher prices for imported food in domestic currency. In the case of food, the exchange rate pass-through plays an important role; for non-food imported items the effect is more limited due to the relative low weight of those products within the consumer price basket. V. Economic growth and the non-oil sector Recent political uncertainties have translated into economic dimensions, including the potential economic downside for the North under a secession scenario and a wait and see attitude for some investors. With stagnate oil production, uncertainty about the referendum and its influence on government revenues, the non-oil sector is in the spotlight as a new driver of growth. This is consistent with the call for a new growth strategy in the World Bank s 2010 Country Economic Memorandum. At the centre of attention are the need for recovery and sources of new growth in the agricultural sector, the crucial role of the private sector and the provision of efficient services to facilitate real sector development. Real GDP growth reached about 5 percent in 2010 (projected). This is substantially lower than the doubledigit growth rates recorded pre-2008. Within this recent, lower growth trajectory, the non-oil sector has taken over the role as main contributor to economic growth. This is led by the rising importance of the agricultural sector. Agriculture contributed one-third to GDP growth in 2010 (projected), up from agriculture s less than onefourth weight in GDP growth in 2008. On the other hand, the relative importance of non-oil also is owed to the impact of stagnant oil production growth. Looking at the service sector, its influence on Sudan s overall growth in economic activities is strong, but on a steadily decreasing path in recent years. The service sector contribution to overall GDP growth was still slightly above the agriculture s sector impact in 2010, according to the IMF. Services play a crucial role in the development of other non-oil sectors, including agriculture. Encouraging services in the economy will require a stimulation of private sector activities. On the external side, with 5-10 percent of overall trade values, non-oil exports represent only a fraction of exports. Yet, non-oil exports rose by 15.5 percent in the first half of 2010 compared to the first half of 2009. But the largest components of these non-oil exports which make up more than 60 percent of the total such as cotton, gum, sesame, livestock, meat and gold increased by 4 percent only. In fact, the good overall increase was driven largely by one single commodity, i.e. ethanol. Virtually non-existent in 2009, exports of ethanol shot up to US$ 16mn (5 percent of all non-oil exports) in the first half of 2010 (CBoS, Foreign Trade Statistical Digest, 2009/10). On a full-year basis non-oil exports are projected to show an increase by 5 percent to US$ 810mn in 2010. Currency depreciation has the potential to positively affect non-oil exports, but productivity is paramount. Only a productivity-enhanced domestic economy will be able to maintain the production of competitive products to boost and keep up non-oil exports. This, in turn would help to sustain the newly found growth path. A depreciating exchange rate can support these efforts, but will likely be insufficient to trigger the required export boom. VI. External debt and associated arrears constrain normal relations with many development partners Sudan s external debt is now near US$ 37bn, and continues to constrain access to concessional financing. According to preliminary data from the Central Bank, Sudan s external debt stood at roughly US$ 36.8bn at end-2010, of which US$ 30.8bn is in arrears. Bilateral creditors account for 68 percent of obligations, split roughly equally between Paris Club and non-paris Club bilateral (Figure 3). Multilaterals comprise 15 percent of the total, including US$ 1.45bn to the World Bank and US$ 1.54bn to the IMF. Private creditors account for US$ 5.9bn. The debt burden continues to be a significant development constraint, as arrears to the World Bank and other Figure 3: Sudan external debt, end 2010 Private Creditors $6 bn Multilaterals $6 bn Bilaterals $25 bn Paris Club $12 bn Source: Central Bank of Sudan (CBoS), preliminary data. Non-Paris Club $14 bn 4 P a g e

development partners prevent normalized relations and constrain access to concessional financing. Thus, a solution to the debt problem can improve prospects for growth and poverty reduction. The World Bank is co-leading a Debt Technical Working Group, together with the IMF, comprised of Sudan's major creditors. This group aims to forward the discussion on debt relief, with a focus on providing supportive technical analyses. The terms of reference for the group were endorsed at the seminal meeting held on February 3, 2011 in Washington, and the work program will be defined at the next meeting expected on the sidelines of the Spring Meetings. Please send your queries regarding the Country Economic Brief to Bill Battaile (bbattaile@worldbank.org), Mosllem Alamir (malamir@worldbank.org) or Michael Geiger (mgeiger@worldbank.org). 5 P a g e