The Exchange Rate and the Economic Crisis

Economic Turmoil
Economic Turmoil

Exchange rate reform has had a disastrous impact on households, with some even forced to leave the country. Just where is South Sudan’s economy headed?

A fixed exchange rate has its benefits. It gets rid of uncertainty, which is a big concern for those who want to do business with a country that has weak or immature institutions. The stability keeps unruly speculators away, preventing the buying and selling of the currency for profit. And a fixed exchange rate is a good antidote to inflation, as the right rate can keep the cost of imports low.

But a fixed exchange rate needs careful management and a suitable cache of hard currency to make the kind of timely interventions needed to prop up the currency when needed. Unfortunately, political tensions, loose government spending, cross border disputes and a global decline in the price of crude oil have, over the years, depleted South Sudan’s hard currency reserves.

Authorities couldn’t keep up with the demand for hard currency. South Sudan’s overwhelming dependence on imports made it an impossible task. A flourishing black market was the inevitable consequence. At its height in 2015, the black market premium was well over 500% the official rate. Authorities couldn’t let things carry on. South Sudan looked set for economic disaster unless corrective action were taken.

A previous attempt (in much less volatile circumstances I might add) to switch to a floating exchange rate was roundly criticised by both politicians and public alike. This time, the government chose to abandon the fixed exchange rate system by adopting a hybrid system. The currency would be allowed to float, but should it start to drift below a specified rate, the government would intervene with dollar auctions. These auctions inject hard currency into the system and push the value of the South Sudan Pound back to a more acceptable level.

The approach has been somewhat successful. The black market’s premium has dropped to only 27% of the official rate. A dramatic improvement, but still worryingly high. Concerns have been raised about the commercial banks participating in the auction process. They appear to be holding onto the dollars purchased from the central bank instead of promptly passing them on to the public. And the bids awarded to home-grown banks, with smaller customer bases and weaker capacities to pass on the dollars, also has a whiff of insider trading.

But a change of exchange rate regime is in itself not enough. In other countries where such a change has been successful, authorities have followed things through with tighter fiscal policy. That basically means less government spending and better tax collection. But South Sudan’s authorities continue to spend. In its first quarter macro fiscal report for 2016, published in January, the finance ministry noted a budget deficit of 2.4 billion SSP. The ministry has gone on to estimate a deficit of 12 billion SSP for the fiscal year 2015/2016. The strain on South Sudan’s reserves risks undermining the hybrid exchange rate regime and will once again open the door for the black marketers.

The security sector and civil service salaries continue to account for the lion’s share of this spending. But authorities find themselves in a difficult position. Without a thriving private sector, able to provide alternative employment opportunities, it would be political suicide to make the massive job cuts needed to bring government salaries to a more affordable level. Similarly, whilst insecurity and rebellion plagues the country, authorities are unwilling to curb security sector spending.

In an attempt to address the impact that currency devaluation has had on government employees and the security sector’s rank and file, authorities have pushed through a large pay increase for lower grade civil servants, soldiers and policemen. Although well intentioned, this only serves to make an already bad situation worse.

Non-oil revenue by way of tax collection has failed to meet the authorities’ ambitious expectations. The government has resorted to forcing the central bank to print money. The practice is widely perceived to be self-defeating in the context in which South Sudan finds itself. This has, in the finance ministry’s own words, “increased the money supply leading to rising inflation and further depreciation in the black market exchange rate”.

Having invested heavily in South Sudan since 2005, international donors, spearheaded by the USA, are cautious about throwing good money after bad and indirectly propping up what they believe to be an unsustainable economic system in South Sudan. Any further donor support will likely be conditional, and tied to substantial reforms which authorities may be unwilling or politically incapable of making.

In a recent policy brief on South Sudan’s exchange rate regime, the Sudd Institute noted that “the economy runs the risks of crumbling under the heavy weight of uncontrolled public expenditures, deficit-financing, and repeated episodes of devaluations of the local currency and hyperinflation”. This chilling assessment hints at the disastrous impact of the economic crisis on South Sudan’s long suffering citizens.

A civil society study commissioned by Community Empowerment for Rehabilitation and Development (CEFORD) conducted in Yei, Lainya & Morobo areas found that 80% of residents were living on just 10 SSP per day – around half a dollar at current official rates.

In such an environment it comes as no surprise that 50 families had abandoned their homes in Torit and made the arduous journey to the Kakuma refugee camp in Kenya. The families weren’t fleeing violence or persecution. They were driven out by poverty and hunger, having found their gardens blighted by drought and unable to afford the price of food at the local market.