POST-REFERENDUM ECONOMIC CHALLENGES FOCUSING ON NORTHERN SUDAN

1. POST-REFERENDUM ECONOMIC CHALLENGES FOCUSING ON NORTHERN SUDAN Abda Yahia El-Mahdi November 2010 Ms. El-Mahdi is the Managing Director of Unicons Consultancy Ltd, an independent Sudanese economic consultancy firm. She is a Senior Associate with the Economic Research Forum for Arabic Countries, Iran & Turkey after having worked with the Forum for several years. She was State Minister for Finance and National Economy during the period 2002-2004.

2. Section 1: Overview of Economic Environment

3. Overview of Economic ChallengesEconomic Dependence on Oil

4. Overview of Economic ChallengesNon-Oil Sectors Lagging The economy is increasingly dependent on oil • Growth in petroleum and services sectors outpaced all other sectors Non-oil sectors exhibiting slower growth rates in the latter five years compared to previous years Agricultural sector, the main productive sector in the economy, registered the slowest growth rate in 2004-2008 (but picked up in 2009) The drop in GDP growth from 10% in 2008 to 5.5% in 2009 in response to sharp drop in oil prices is further evidence of the economy’s increasing dependence on oil

5. Overview of Sudan’s External Sector

6. Overview of Sudan’s External SectorBalance of Payments Composition (USD million) Source: IMF

7. The Global Financial Crisis and Central Bank Intervention

8. Despite Central Bank Intervention, Key Challenges Remain… Expansionary fiscal policies led to inflationary pressures (15.6% in the first half of 2010) Tighter Monetary Policy – easing of inflationary pressures – yearly average 14% Central Bank announced further restrictive measures on foreign currency dealings • Increased customs and duties on certain goods with the goal of reducing the import bill by 15-20% as a preparatory step to the aftermath of the referendum Shortfall in oil earnings was short lived and oil prices soon picked up with oil exports estimated to grow by 76% in 2010, but challenges remain… Inflationary Pressures and Further CB Intervention

9. Key Issues with CB Intervention Key Issues with CB Intervention Protection of the Sudanese pound by drawing down national foreign reserves or contracting large foreign currency loans neither sustainable nor sound. Administrative measures to curb demand are only marginally and temporarily successful – they mainly serve to drive demand further into the black market. Deterrence to Foreign Investors wanting to profit. The absence of complimentary fiscal measures to curb excessive government spending, render these measures ineffective.

10. Large Budget Deficits even at a time of Rising oil Prices and High Revenue Performance

11. Government’s (Mis-) Allocations / Prioritization in Spending Government Budget Revenues and Expenditures (SDG millions) Public Health expenditure % of GDP Government Spending Allocations Public Education (incl. tertiary) Expenditure % GDP

12. Government’s (Mis) Allocations / Prioritization in Spending The UNDP Human Development Index (2008) ranks Sudan at 147 out of 177 countries Sudan consistently ranks amongst the lowest performers in the world in virtually all poverty and human development indicators. Between North and South and within the north, regional disparities and inequalities have been at the root of ongoing civil instability • Darfur key case in point The prioritization of allocations in the government budget stand in sharp contrast to the human development needs of the country

13. Oil Revenue Stabilization Account Provides Little Cushion Against Economic Shocks • The Oil Revenue Stabilization Account (ORSA) created to protect budget spending from volatility given its dependence on oil revenues and the known volatility of oil prices • The Fund is shared between the Federal Government and GOSS in accordance with the Wealth Sharing Formula stipulated in the CPA • The function of the ORSA was not adhered to and was drawn down even when oil prices were at their peak and oil revenues where over-performing

14. Mounting Public Debt & Accumulation of Arrears The Government was borrowing beyond its means at a time revenues were at their peak when oil prices where high

15. Rising Public Domestic Debt Challenge The high cost of public domestic borrowing has contributed to the widening of the budget deficit Accumulation of domestic arrears highlight the non-sustainability of Sudan’s mounting domestic debt The increasing resort of the government to domestic borrowing has crowded out the private sector The government’s domestic debt arrears have contributed to the rise in Non Performing Loans (NPLs) and weakened the banking sector The rising public domestic debt has had negative consequences on the economy

16. Unsustainable Pubic External Debt In the period 2000-2005, $7 billion of loans were contracted. In 2008 and 2009, Sudan contracted $906 and $1,055 million of new loans respectively. In 2010, external financing is budgeted to cover 70% of the budget deficit with new foreign loans to be contracted estimated at almost SDG 2 billion (more than US$ 700). At the end of 2009, total public and publicly guaranteed debt was estimated at $35.7 billion in nominal terms, of which 81% is in arrears. The Government’s external borrowing has been increasing in recent years in line with the widening of its budget deficit.

17. Rising Debt ChallengeArrears with IFIs: Limited Availability of Concessional Loans Non-concessional loans are the least sustainable form of funding for numerous reasons: • High interest rates, short repayment schedule and/or short grace period. Highly expensive development projects - financial burden on government - serious sustainability issues to be considered • Guarantees of future oil sales or are tied to forward selling of oil. Adding to the complexity of the debt issue should Sudan become two countries after the referendum • The contraction of non-concessional loans jeopardizes Sudan’s access to possible relief the enhanced HIPC Initiative and MDRI The Sudanese government has increasingly been resorting to non-concessional loans to finance its development projects and more recently even as a form of budgetary / balance of payments support

18. Rising Debt Challenge The Need for Debt Relief and Key Challenges Government needs to actively consider debt relief opportunities, but key issues make Sudan’s ability to qualify challenging • Political and human rights problems • Lack of a comprehensive Poverty Reduction Strategy formulated with wide participation from civil society • Track record of successfully implemented economic stabilization programs Sudan in debt distress in the foreseeable future even under a benign global environment and the implementation of appropriate policies

19. Section 2: The Possible Oil Deal

20. Possible Outcomes for the Upcoming Referendum Voluntary Unity Peaceful Separation /Secession Forced Unity Unilateral Declaration of Independence Economic challenges inextricably linked to political, institutional and social issues facing the two sides 2. Peaceful Separation /Secession • An Oil Deal must be struck if we are to have any hope of transforming the oil into a “Blessing” • It is in the interest of the North and the South to reach a deal for sharing the oil Oil: “Curse” or “Blessing” ?

21. Why South Sudan Benefits from an Oil Deal An independent Southern Sudan will be land locked country in need of access to coastal ports Totally dependent on oil proceeds: ~ 98% of government revenues The newly formed state needs to ensure its oil continues to be refined and transported to a coastal port for export. Needs managerial expertise of oil resources which is still concentrated in Northern Sudan Transport of oil through Kenya is not economically feasible. The ISS report of the European Union Institute for Security Studies reported that: “A small-sized refinery could supply local and some regional demand in the south, but existing northern infrastructure remains the most sensible point of export post- 2011.”

22. Why North Sudan Benefits from an Oil Deal The revenue loss associated with the separation of South Sudan will have far reaching implications for the economy’s foreign sector and government budget • Extraordinary measures will need to be made to minimise the impact of such a loss Failure to reach agreement on an oil sharing deal is bound to lead to renewed conflict with extensive social and political ramifications

23. The Possible Oil DealOverview Benefit from Refineries Benefit from operational and managerial expertise Estimation of how much the South could realistically expect to pay in pipeline fees is a complex matter The two ruling parties –the NCP and SPLM – are negotiating behind closed doors with Norwegian technical assistance. On-going discussion estimate the fee to be paid to the North in the range of 10% to 30% of the South’s oil production South would utilize the pipeline running from the oil fields in the Southern part of the country to Port Sudan South would pay the North a percentage of its oil production

24. Some Principles that Must Govern the Oil Deal to Ensure its Sustainability Audit of all current agreements by an independent auditor The oil deal is fair and transparent A system for full disclosure that will allow for compliance to the agreement Easily verifiable and monitoring system in place

25. Section 3: Impact of Secession on the North Economy The External Sector, Government Budget and Public Debt

26. Impact on the North Sudan Economy Even with implementation of an oil deal, the North will face a large and possibly sudden loss in oil revenues/ exports. The oil sector will be directly impacted but so will all other sectors - agriculture, manufacturing and particularly services – with a multiplier effect. The large drop in GDP growth following the financial crisis is evidence that a shock to the oil sector affects all parts of the economy. Estimate of the loss to GDP due to the separation of the South should take into account the removal of 15-20% of GDP which will have a significant impact on the Northern economy. Economic Growth

27. Impact on the North Sudan Economy The External Sector

28. Impact on the North Sudan EconomyThe External Sector Fall in FDI Similar Effect as the Financial Crisis (“First Shock”) South Secedes Increased Demand for Foreign Currency Widening of BoP

29. Impact on the North Sudan Economy – The External Sector Positive Differences From The Financial Crisis Ample time for the authorities to prepare for this “second shock” • National reserves re-built to comfortable levels Possible Cushion for Economy Against Shocks Relatively favourable external environment with the rebound in oil prices • Adequate balances in ORSA

30. Key Challenges to the External Sector Unlike the financial crisis (“first shock”), the “second shock” resulting from secession of the South will be a non-reversible one and the Northern economy will have to structurally and permanently adjust to the lower oil revenues Current Economy is in a relatively weaker state, that will exacerbatethe effects of the second shock as well as challengeability to rebound Lower GDP growth Tight external sector

31. Key Challenges to the External Sector Highly indebted public sector with mismanagement of resources Low National Foreign Reserves: Contracting foreign loans will not be as readily possible given the country’s weaker economic situation The exchange rate is far from stable and there continues to be wide gap between official and black market rates Inflationary pressures remain while economy grows at a slower pace (danger of stagflation)

32. Key Challenges to the External Sector Post Referendum, FOREX will be extremely tight. In the short-run, there will be no option but to allow the for gradual currency depreciation. Actions Needed In order for it to be effective, flexible exchange rate policy must be undertaken within a comprehensive package of structural reforms that include monetary, fiscal and institutional reforms.

33. Key Challenges to the North Sudan EconomyImpact on the Government Budget Full impact will be felt in the government’s 2012 budget given the six month transition period after the referendum results are announced The budget deficit will no doubt widen and the magnitude of the loss in revenues to Northern Sudan can be calculated If the government is to take serious actions to improve the livelihoods of its people, it must drastically reduce current expenditures, restructure and re-allocate development expenditures while implementing policies to bolster non-oil revenues

34. A Possible Monetary Union during a Transitional Period Such a union will allow for smoother transition, with other benefits including: Use of the same currency for a longer period of time will allow the South to implement currency exchange in an orderly manner with less immediate budgetary pressures. South will have time to build the reserves needed to support a new currency. South can benefit from accumulated experience in management of National Reserves North will have more time to adjust to the fall in oil exports as the South will continue to trade its Petro dollars/Euro for SDG. Agreement on Monetary Union , at least in the first 3-5 years after secession, will be beneficial for both Sudans.

35. Key Challenges to the North Sudan EconomyImpact on the Government Budget 70% of current Government spending is inflexible Rationalization of expenditure will mean • Comprehensive restructuring of Federal spending and state transfers • Significantly lower military and security spending Actions Needed • Resolution to the country’s political problems • Comprehensive Restructuring of the Government machinery • Strongly pro-poor fiscal policy within a medium term program • Execution of reforms in an open and transparent manner where clear lines of responsibility and accountability are drawn

36. Impact on the Government BudgetThe Oil Revenue Stabilization Account 2010 Mid-year budget report indicates that no such monies have been saved in the year. 2011 budget does not indicate a conservative approach • Oil price set at $63 per barrel in the budget whereas the international price for Sudanese oil is projected at $69/barrel for 2011 - leaving small room for manoeuvre and savings Will the authorities save the proceeds of ‘above budget’ revenues in 2010 and 2011 in the ORSA so as to assist in meeting the demands on the economy in the aftermath of the referendum?

37. Implications of Secession to the Debt Crisis in North Sudan Option 1: Division by utilization of the loan on a regional basis • Can only be used for loans utilized for financing development projects. Small proportion of such loans utilized for Southern Sudan projects. Option 2: Debt per Capita • Possible criterion for loans utilized for balance of payments support. • Approximately 20% of such loans can be apportioned to a newly formed Southern Sudan. How will the debt burden be shared between North and South in light of a 2-state referendum outcome? • Approximately 20% of the debt is allocated to the independent Southern state.

38. Implications of Secession to the Debt Crisis in North Sudan • Sudan’s total debt is predicted to reach US$39 billion by 2011. • Under the greatly simplified debt sharing formula - Northern Sudan would have ~ US$30-31 billion of debt post–referendum • Debt sustainability indicators will worsen given that all of GDP, exports and revenues will drop by larger amount than the reduction in debt

39. Debt Relief will require a comprehensive change in policies Northern Sudan will be under greater debt distress with an untenable arrears situation and little or no access to concessional lending needed to finance its development Large debt obligations and arrears situation will act as a deterrent for both creditors and potential investors North Sudan will be in dire need of debt relief but there are key obstacles: • The political obstacles that stood in the way of debt relief in the past continue to be a problem • Condition of an economic track record will be hard to meet given new strains in the economy In order to access debt relief, a political turnaround accompanied by economic policies aimed at ensuring economic stability and reducing poverty will need to be in place.