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IMF Executive Board 2017 Article IV Consultation with Sudan


IMF Executive Board 2017 Article IV Consultation with Sudan

IMF Executive Board 2017 Article IV Consultation with Sudan
Photo credit: Arne Hoel | World Bank

On November 29, 2017, the Executive Board of the International Monetary Fund concluded the Article IV consultation with Sudan.

Economic conditions in Sudan have been challenging since the secession of South Sudan in 2011 and the loss of the bulk of oil production and exports, which have compounded the difficult external environment – including arrears and limited access to external financing, U.S. sanctions, and the withdrawal of correspondent bank relations. The authorities have implemented partial policy adjustments to help stabilize the economy and reestablish growth, most recently by allowing for greater exchange rate flexibility and reducing fuel subsidies. However, while these measures were helpful, they were insufficient to turn the tide toward sustained macroeconomic stability and broad-based growth.

External imbalances are moderating from previous high levels, but economic activity remains modest. The current account deficit (cash basis) is expected to decline by 3.25 percentage points to 2.75 percent of GDP in 2017, reflecting (i) the strong depreciation of the parallel exchange rate and the introduction in late 2016 of a commercial bank incentive rate close to the parallel rate for many formal transactions; (ii) fuel and electricity price hikes in November 2016, which helped curb domestic demand; (iii) quantitative import restrictions adopted in 2016; and (iv) improved the terms of trade. GDP grew at an estimated 3.5 percent in 2016, led by private and public consumption and a positive contribution from net exports. Data for the first half of 2017 indicate weaker real domestic demand, partly offset by a strengthening contribution from net exports (notably due to lower imports), and 3.25 percent growth is projected for 2017.

Loose policy settings are fueling inflationary pressures. The on-budget fiscal deficit is expected to widen from 1.6 percent of GDP in 2016 to 1.8 percent of GDP in 2017. This is slightly better than the budget target (2 percent of GDP), as revenue shortfalls (largely oil related) have been more than offset by expenditure restraint, notably in goods and services, capital expenditure, and transfers to state governments. Access to foreign currency at the overvalued official exchange rate for socially sensitive imports leads to quasi-fiscal activities that – result in continued monetization, causing monetary aggregates to expand rapidly and increasing inflationary pressures.

The recent revocation of U.S. sanctions would amplify the benefits that would arise from decisive implementation of ambitious reforms to support inclusive growth and macro stability. Associated upside risks are broadly balanced by downside risks stemming from the continuation of fiscal and monetary policy settings that are incompatible with macro stability, alongside risks to external financing that has declined from earlier peaks.

Sudan remains in debt distress and is eligible for debt relief under the Heavily Indebted Poor Countries (HIPC) Initiative. Public and external debt remain high and unsustainable, and most external debt are in arrears. Sudan’s arrears to the Fund declined to SDR 966.3 million at end-September 2017. The authorities plan to continue to engage with external creditors to secure comprehensive support for debt relief, and continue to strengthen their cooperation with the Fund on policies and payments.

Staff Report


Economic conditions in Sudan have been challenging since the secession of South Sudan in 2011, and the associated loss of the bulk of oil production and exports. Since then, the authorities have implemented partial policy adjustments to help stabilize the economy and reestablish growth, most recently by allowing for greater exchange rate flexibility and reducing fuel subsidies in November 2016. However, while these measures were helpful, they were insufficient to turn the tide toward sustained macroeconomic stability and broad-based growth, particularly given the difficult external environment – including arrears and limited access to external financing, U.S. sanctions, and the withdrawal of correspondent bank relations.

The permanent revocation of U.S. sanctions on trade and financial flows on October 12, 2017 has strengthened optimism and is a unique opportunity to implement ambitious reforms. In revoking the sanctions, the U.S. government cited progress made on cessation of hostilities in internal conflicts, and improved cooperation on regional stability, counterterrorism, and humanitarian access. Sanctions revocation will lead to significant reductions in costs of imports, trade, and international financial services, potentially also opening new import sources and export destinations. Domestic optimism has risen since January 2017 – when the sanctions were initially suspended – and there are indications that prospective foreign investor interest in Sudan could be substantial. However, most investors (and correspondent banks) are proceeding cautiously, while concerns about macroeconomic policies and the investment climate persist.

A National Consensus Government, with participation from opposition parties, was installed in May 2017, and a new constitution is to be drafted. This is the result of a national dialogue that took place in 2015-16. Twelve of the 31 ministerial portfolios were given to opposition parties involved in the dialogue. First Vice President Saleh was named Prime Minister. In July 2017, the UN reported significant improvements in the humanitarian situation, though it remains difficult, with large numbers of internally displaced people and refugees from several countries including Eritrea, Central African Republic, South Sudan, Syria, and Yemen.

With sanctions now revoked, the authorities intend to pursue negotiations with the U.S. government to remove Sudan from the State Sponsors of Terrorism List (SSTL). Removal from the SSTL is necessary for the elimination of statutory prohibitions on U.S. aid to Sudan, which currently block progress toward debt relief and the clearance of large arrears to the Fund (Annex I). Sudan has had 14 Staff-Monitored Programs (SMPs), and the authorities have expressed interest in another SMP to pursue sound macroeconomic policies and fulfil debt-relief conditionality.

Developments, Outlook and Risks

External imbalances are moderating from previous high levels, but economic activity remains modest.

  • The external position is substantially weaker than implied by fundamentals, but the gap appears to be narrowing. Comparing the current account deficit to its estimated equilibrium level indicates that the overvaluation of the average real exchange rate declined from about 38 percent in 2015 to a stillhigh 30 percent in 2016 (Annex II).

Alongside, the current account deficit (cash basis) declined by 1½ percentage points to 6 percent of GDP in 2016.

  • Further moderation in external imbalances is underway in 2017. Based on H1 2017 data, a 3¼- percentage point decline in the current account deficit (cash basis) is projected, to 2¾ percent of GDP in 2017, which would imply additional substantial reduction in the overvaluation of the real exchange rate, to about 15-19 percent.

  • The recent improvement in the current account deficit primarily reflects weaker imports due to (i) the strong depreciation of the parallel exchange rate, and the introduction in late 2016 of a commercial bank incentive rate close to the parallel rate for many formal transactions; (ii) fuel and electricity price hikes in November 2016 which helped curb domestic demand; (iii) quantitative import restrictions adopted in 2016, including a negative list and a prohibited list of selected imports; and (iv) lower international import prices which improved the terms of trade,

  • However, while gross international reserves increased by $100 million in H1 2017, they remain very low ($1.1 billion, 1¾ months of imports). Moreover, the exchange rate system is highly distorted, with Multiple Currency Practices (MCPs) being used to implement various fiscal and social objectives, hampering investment and growth.

  • GDP grew at an estimated 3½ percent in 2016, led by private and public consumption and a positive contribution from net exports. Data for H1 2017 indicate weaker real domestic demand, partly offset by a strengthening contribution from net exports (notably due to lower imports), and overall, 3¼ percent growth is projected for 2017.

Policy Discussions

Re-establishing macro stability and strengthening growth will require exchange rate and structural reforms, and tighter monetary and fiscal policies – including tax and subsidy reform.

There was consensus that reforms are urgently needed to reestablish macroeconomic stability and create conditions for stronger broad-based economic growth. Without corrective measures, the circle of loose policy settings, inflationary pressures, and depreciation would continue and become unsustainable, requiring greater eventual adjustment with a higher social impact. The beneficial impact of the recent revocation of sanctions on confidence is unlikely to persist without the implementation of sound policies to capitalize on the improved external environment and domestic optimism. In addition, the recent revocation of sanctions is likely to amplify the payoff from policy adjustment – an opportunity that should not be missed. Restoring macro stability would require exchange rate reform and tighter monetary and fiscal policies – including through tax and subsidy reform. At the same time, structural reforms would be needed to help strengthen the economy’s supply response and boost inclusive growth.

Staff’s analysis suggests significant short-term costs to reform, but sound policies and improved competitiveness would substantially improve the medium term economic outlook. In a scenario with full exchange rate liberalization, phasing-out of fuel and wheat subsidies with compensating targeted social spending, and supply side reforms, the immediate impact of policy adjustment and reform would lead to inflation accelerating above 36 percent (compared to 23 percent in the baseline scenario), and GDP growth slowing to 2 percent (compared to 4 percent in the baseline scenario). Over the medium term, policy adjustment and reform would lead to significant improvements in the fiscal and external balances and inflation, and a significantly stronger growth outlook (Annex III).

Exchange Rate Reforms to Boost Competitiveness and Public Finances

Staff and the authorities broadly agreed that exchange rate liberalization is critical for restoring macro stability and eliminating the distortions that hamper investment and growth. A unified market-based exchange rate would boost competitiveness by (i) removing the adverse incentives against exports implicit in the overvalued exchange rate, and (ii) improving the profitability of domestic companies competing against more-appropriately priced imports in the domestic market. It would reduce rent-seeking activities, helping to establish a level playing field that would encourage more investment. It would also improve fiscal policy by boosting revenues, and monetary policy by relieving the central bank of responsibility for subsidies and other quasifiscal activities.

Staff recommended unifying all exchange rates at the same time, thus eliminating distortions upfront and sending a clear signal to investors about the credibility of the authorities’ reform agenda. This would also be consistent with the authorities’ plans to embark on deep macroeconomic and structural reforms to strengthen economic growth and facilitate WTO membership. Upfront unification would also reduce the risk of delay and interference from vested interests. Prior to reform, however, it would be important to review banks’ financial positions and asset quality to assess their resilience to exchange rate changes and identify measures to address potential risks. The authorities requested Fund Technical Assistance (TA) to help them conduct bank stress tests and identify appropriate remedial measures as needed.

Exchange rate unification would substantially increase revenues and strengthen the fiscal position. Assessing import duty and US dollar-denominated oil revenues at the parallel exchange rate (rather than at overvalued official exchange rates), and adjusting for import volume changes using plausible price elasticities, results in an estimated revenue gain of about 5 percent of GDP. Thus, exchange rate unification would generate a large revenue windfall, with the true deficit (including all fuel and wheat subsidies) falling from 6½ percent of GDP to 3½ percent of GDP, even accounting for increases in foreign currency denominated expenditure. Deficit monetization would in turn fall sharply, and this – after the initial impact of the unification on prices – would reduce inflationary pressures and help buy additional time for socially sensitive subsidy reforms. With the heavier import duty burden, there may be a need to reduce import tariff rates to mitigate their distortionary impact – the World Bank has recommended that the number of tariff peaks should be reduced; the maximum tariff rate reduced from 40 percent to 25 percent; and tariffs on food phased out. The negative impact on revenues caused by tariff rate reduction and simplification should be offset by broadening the tax base and strengthening customs administration.

The authorities agreed in principle with staff’s advice, but were concerned about the potential for exchange rate overshooting, and the social impact of adjustment. With minimal international reserves, there is no cushion to use to moderate exchange rate volatility. Moreover, exchange rate liberalization – even with gradual phasing out of energy and wheat subsidies – would generate substantial increases in prices that could raise social tensions among vulnerable groups and the middle class. They indicated that after suffering for 20 years under sanctions, it would be difficult to ask the population to make further substantial sacrifices with no clear guarantee that reforms would better their lives. Moreover, Sudan would be one of the few countries to undertake deep reforms without the benefit of concessional loans from International Financial Institutions to cushion the pain of adjustment.

Thus, the authorities leaned toward a gradual pace of exchange rate reforms. An alternative under consideration was a phased approach, where the commercial bank incentive rate and the parallel rate are unified, with the new private-sector rate determined thereafter by market forces; the other official rates would then be moved gradually toward the market rate, at a pace that is yet to be determined.

Staff observed that gradual exchange rate reforms would incur other costs that would have to be mitigated, and adjustment should be time-bound to ensure its credibility. Notably:

  • Weaker competitiveness, investment, and economic growth from incomplete exchange rate adjustment and the continued adverse impact of MCPs and rent seeking activities on the business environment. This could be a particularly costly missed opportunity given the revocation of sanctions. Mitigating this would require stronger efforts to upgrade the business environment and improve governance. Tighter monetary and fiscal policies would also be needed to help contain external imbalances.

  • Continued fiscal revenue losses from the use of overvalued official exchange rates in customs duty assessments and the valuation of foreign currency denominated revenues. Mitigating this would require stronger up-front revenue mobilization, which would also reduce the monetization of deficits and buttress macro stability.

  • Continued large costs from the provision of foreign currency at overvalued official exchange rates for fuel and wheat imports, on the central bank’s balance sheet. Mitigation would require additional increases in domestic energy and wheat prices.

Irrespective of the pace of exchange rate unification, its success would require appropriate supporting fiscal, monetary, and structural policies to ensure macroeconomic stability and lay the foundation for higher growth. Clear communication and implementation of a comprehensive reform package would boost its credibility and help contain overshooting pressures. It would also be important to disentangle exchange rate and fiscal issues during the reform process. Transparently presenting subsidies on the budget and breaking the formal link with the overvalued official exchange would allow for better informed policy making, including on subsidy removal, without hindering the pace of exchange rate reform.

Supply Side Reforms

While exchange rate and trade policy reform would be important contributions to competitiveness, the business climate will also need to be overhauled to support investment and growth. Sudan ranks 168 out of 190 countries on the 2017 World Bank Doing Business rankings, with major improvements needed especially in getting credit, protecting minority investors, and trading across borders. Efforts to boost investment and productivity in key sectors such as agriculture, gold, and oil, as well as better public infrastructure and human capital, could also bear large dividends. Staff encouraged the authorities to explore and address any additional constraints that hinder female entrepreneurship and employment.

The authorities have intensified efforts to modernize the business environment, notably in the context of their application for WTO membership. A high-level committee and eight sub-committees have been formed to coordinate this effort, and they have already identified 151 laws to be amended or completely modernized; staff encouraged them to press on with this effort. The authorities also continue to develop measures to fight corruption, including the Auditor General Act of 2017 which permits the Auditor General to audit any entity with at least 1 percent government ownership, the establishment of a Special Prosecutor General to investigate cases of abuse of public funds, and the establishment of an Anti-Corruption Commission.

Selected Issues Paper

Challenges facing correspondent banking with Sudan

Since 1997, economic sanctions weighed heavily on CBRs with Sudanese banks. The U.S. imposed sanctions on Sudan that include arms and trade embargoes, a prohibition on the provision of financial services and of transactions related to the oil industry, and the freezing of assets of designated persons. The European Union (EU), the United Nations (UN), and others followed, mostly by imposing an arms embargo and targeting the assets of designated persons. The cost of compliance with these sanctions led U. S. and global financial institutions to stop dealing with Sudanese banks. Central Bank of Sudan (CBOS) data for the period 2012-2015 indicates that 168 correspondent banking relationships have been restricted (e.g., limitation of account activity; exclusion of categories of customers), and 248 have been terminated. A 2012-2016 Financial Stability Board survey covering 150 correspondent banks revealed that Sudan is one of the world’s 10 most affected jurisdictions, in terms of the absolute number of complete exits and the number of restrictions.

The enforcement of U.S. sanctions in the private sector affected significantly global transactions in U.S. dollars (USD) with Sudan. Starting 2009, forfeitures and fines imposed on financial institutions operating in the United States for breaching the economic sanctions regime against Sudan multiplied and amounted in hundreds of millions of USD, and continued to increase significantly as with the 2012 HSBC case. However, it was not until the 2014 settlement with BNP Paribas4 that Sudan began to lose most of its CBRs. Since then, correspondents have generally refused transactions involving Sudan or Sudanese entities or individuals, including those covered by licenses issued by the Office of Foreign Assets Control (OFAC), to avoid potential sanctions. The impact of such decisions on Sudanese economy has been significant.

Sudan was also subject to enhanced monitoring by the Financial Action Task Force (FATF), but managed to address its AML/CFT concerns by October 2015. In February 2010, the FATF identified Sudan as a jurisdiction with strategic AML/CFT deficiencies. Two years later, Sudan was placed under monitoring due to remaining deficiencies, and agreed with the FATF on an action plan with a timetable to address these deficiencies. IMF technical assistance to Sudan on AML/CFT started in December 2013, and helped in reforming the legal, regulatory, and institutional frameworks. Consequently, Sudan met its commitments to the FATF by end 2015 and is no longer subject to enhanced monitoring. This development prompted foreign governments to encourage Sudan to pursue reforms that can help reconnect its economy with the rest of the world.

In October 2017, the U.S. revoked its sanctions on trade and financial flows against Sudan following their suspension in early 2017. The suspension of sanctions in January 2017 generally authorized U.S. persons to transact with individuals and entities in Sudan, and unblocked the property of the Government of Sudan subject to U.S. jurisdiction. U.S. banks were authorized to process transactions in relation to Sudan and finance trade in USD. In October 2017, following a review period, the U.S. revoked E.O.s 13607 and 13412, having assessed continued positive cooperation with Sudan on internal conflicts, regional stability and humanitarian issues. Therefore, SDN list related to these E.O.s is now revoked, which allows U.S. persons to deal with those designated persons and entities.

Prospects for Re-connecting Sudanese Banks with the International Financial System

Banking relationships between Sudanese banks and foreign correspondents are likely to be gradually reestablished. CBOS officials and commercial banks interviewed by the mission reported that negotiations with correspondent banks started since early 2017; however, they did not report material change to CBRs yet. CBOS officials also indicated that foreign banks have expressed interest for dealing with Sudan again. European and Middle-East banks are reportedly waiting for U.S. banks to begin operating in Sudan before taking action, and expect delays in resuming transactions between 6 to 12 months, despite the lifting of US sanctions, due to the need for compliance reports from the requesting bank.

Due to challenges of compliance with regulatory requirements, larger domestic banks are likely to attract new CBRs, which may further accentuate the banking concentration in Sudan. In May 2011, OFAC removed two designated entities from the Sudan SDN list, one of which was the largest bank in Sudan. Since then, this bank has reportedly developed its access to Eurodenominated transactions through relationships with banks in Sweden, Switzerland, Belgium, Turkey, and France, but not yet to USD denominated ones. CBOS officials consider that the near-exclusive access to CBRs by this bank contributed significantly to further enhance its growth and market dominance. From a correspondent banks' perspective, dealing with a large bank would probably be more substantial and lucrative, less costly, and supported by a better risk management and compliance with the AML/CFT requirements. A large domestic bank with a satisfactory ability to understand prevailing risks and identify and review transactions and individuals represents, obviously, a good entry point for foreign correspondents.

Even with the lifting of sanctions, establishing a new CBR with a Sudanese bank may continue to pose challenges to a potential correspondent bank. Due to remaining sanctions by the U.S., UN, and other countries, banks engaging in trade with Sudan should still exercise necessary due diligence to ensure that no transactions are connected to the SDN list under the Darfur related sanctions, and comply with other applicable measures outside the scope of the SSR. It was observed that even for transactions where sanctions have been revoked, U.S. financial institutions conducted enhanced and lengthy due diligence, to ensure compliance with the remaining sanctions. Although Sudan is no longer under the FATF's enhanced monitoring, it has been called to improve the effectiveness of its AML/CFT regime, including in the implementation of its mechanism for targeted financial sanctions. Addressing these challenges would mean, for a correspondent bank, enhancing due diligence on CBRs thus increasing the budget for compliance, and expecting no compliance failures from respondent banks.

Continued U.S. enforcement actions against banks breaching the remaining sanctions regimes or AML/CFT requirements may discourage some correspondent banks. The risk of civil and criminal sanctions remains significant, discouraging banks from potential exposure to sanctions. Due to compliance costs and challenges, correspondent banks may perceive a low profitability of CBRs in Sudan and have less appetite for them.


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