Letters of Credit

Letters of Credit
Letters of Credit

Even the Vice-President, James Wani Igga, has called for Letters of Credit to be scrapped, blaming the system for driving up inflation and enabling corruption.

He’s not alone. From market traders in Torit to the International Monetary Fund (IMF), many are lining up to denounce the system. So why did the government introduce it in the first place and why are they now dragging their feet about its abolition?

What are Letters of Credit?

A letter of credit comes from a bank and guarantees that a buyer’s payment to a seller will be received on time and for the correct amount. Should the buyer fail to make or complete payment, the bank is required to cover the full or remaining amount of the purchase. Letters of Credit are considered a secure means for handling cross border transactions.

The benefits for importers (and let’s face it, we South Sudanese are always the ones doing the importing) is that payment is only triggered once evidence has been received that the goods were delivered as expected. For exporters, who can never be too sure about seeking redress in foreign jurisdictions, there is a near cast iron guarantee that they’ll be paid in a timely manner after delivery. But this isn’t the reason they were introduced in South Sudan. Our Letters of Credit are issued by government and the central bank and have a very different goal in mind.

Why were they introduced?

Our government is determined to fix the exchange rate of SSP against the US dollar. A strong SSP means cheaper imports and for a country that is so reliant on imports, even for the most basic commodities, keeping imports cheap is the only way to keep such a deeply unbalanced economy viable. In order to do this effectively, our central bank needs vast amounts of dollars in reserve. Unfortunately, our reserves are critically low. According to the IMF, we had as little as $340 million in late 2014, which was only enough to cover around three weeks’ worth of imports.

Officials are keeping tight lipped about current level of reserves, but there are suggestions it could be as low as $110 million. An artificially fixed exchange rate and a lack of supply coupled with the unrelenting demand for dollars can lead to only one thing – an increase in the value of USD against our SSP and a thriving black market to express that increase. So far this year, the unofficial price of $1 USD has been pushed to as high as 15 SSP in some parts of South Sudan. Along with a fixed exchange rate, the government also introduced an ostensibly strict dollar allocation system. The government has been aggressively turning to this mechanism to address the threat of a runaway black market. It would starve the black market of USD by forcing all transactions to go through a Letter of Credit system. And, so went the thinking, without a black market, the USD could be forced to stay at the official rate.

So what’s gone wrong?

Besides the war? Without bothering to address the underlying cause of the central bank’s shrinking dollar reserves (e.g. profligate spending during a period of reduced oil revenue) the policy has proved a spectacular failure. Black marketers continue to ply their trade. The dollar rate continues to creep up. And prices continue to rise in response.

According to the previous Finance Minister, Aggrey Tisa, instead of dampening the black market, Letters of Credit served as a catalyst by “benefiting a select number of South Sudanese who have preferential access at the expense of the vast majority” who are forced to get dollars through the black market. All the while, banks and foreign exchange bureaus sprang up at a staggering rate, profiting hugely from the system with the more unscrupulous among them allegedly doubling up their profits through active engagement in the black market. The real effects of this disastrous policy are felt by the ordinary citizens of South Sudan.

A member of the Eastern Equatoria’s State Legislature reported:

“A 50kg bag of sugar, which previously sold at SSP300, now costs SSP650. One kilo of meat is at SSP40 while a bag of cement, which was SSP80, now costs SSP250. Transport on a motorcycle within Torit increased from SSP3 to SSP5 or even SSP10, while transport by vehicle to Kapoeta now costs SSP160, up from SSP60.”

Prices change regularly and citizens, whose wages aren’t rising to keep up with inflation, are having to make increasingly difficult financial decisions on a near daily basis.

What could the government be doing instead?

Different economists will give different answers. The IMF proposes scrapping the Letters of Credit system, which benefits only a well-connected few, and at the same time aligning the official exchange rate with the unofficial rate. Removing Letters of Credit would ensure a fairer distribution of dollars among traders and the general public. And making dollars ‘officially’ more expensive, it reasons, will dampen demand in general which should help drive down dollar prices.

Personally, I think this reasoning misses the elephant in the room. South Sudanese will continue to demand dollars as long as our country insists on being a net importer of goods. We know that this disastrous civil war is slowly starving our country of much needed infrastructure investment necessary for nurturing home-grown businesses and industries. We know that two thirds of government spending is being financed through debt. We also know that debt has been secured against future oil production. The government simply will not be in a position to replenish its dollar reserves for years to come. Our economy is too unbalanced and with crude oil prices unlikely to return to 2013 levels, continued inflation is inevitable. So, best to manage your expectations. But at least the few well-connected individuals won’t be profiting as much at our expense. And maybe, the more transparent distribution of foreign exchange may re-open the door for foreign direct investment.

So why is the government hesitating?

The Vice President clearly didn’t mince his words: “We can do without letters of credit that go through government ministries or the central bank. When we take it upon ourselves and enter into it, corruption sets in, Let’s forget about this issue of letters of credit and leave it under the management of the commercial banks. Let it be determined by the market forces.” But the current Finance Minister was a little more circumspect when he said: “People have agreed that the letters of credit did not seem to have delivered what it was intended for and therefore, people will have to find another way of trying to lower the prices in the market.” No commitments have been made. None should be expected.

I fear, as long as the civil war continues, this government will resist reform of the currency system. As long as the military has continued access to cheap imports, the impact on the wider society will be perceived as the collateral damages of war. Perhaps more importantly, the removal of Letters of Credit will have profound implications for officials who have grown used to abusing it to maintain their patronage networks. Threatening a mechanism they have come to rely on is not an easy thing, especially for a government which desperately needs to shore up internal support. Ultimately, this is may prove counter-productive as the population grows ever more restive.

Recently, the Mayor of Torit, Martin Odeki admitted that he narrowly averted a demonstration over high prices, where protesters threatened to burn down Torit market. Their anger was mistakenly turned on the business community, who are as much victims of this manufactured disaster as their patrons. One can only conclude a desperate government, finding itself cornered, is playing a very dangerous game indeed.