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---

### Executive Summary — Background and Overview
- Political uncertainties ahead of the January 2011 South Sudan referendum have weighed heavily on the Sudanese economy, adding to the adverse effects of the global crisis in 2009.
- Real GDP growth in 2010 is projected to decelerate to about 5 percent.
- Average inflation is projected to remain at 11 percent.
- Fiscal and monetary policies were noticeably tightened starting the second half of 2010.
- Shortfalls in both tax revenues and oil receipts were more than offset with notable under-execution in both capital and current expenditures.
- Monetary policy remained expansionary in the first half of 2010, but was tightened starting in July.
- The central bank recently undertook an exchange rate depreciation of about 19 percent.

### Recent Economic Developments (2010 — headline indicators)
- Real GDP growth in 2010: about 5 percent.
- Oil production in 2010: declined by about 2 percent to 460,000 barrels per day (bpd).
- Twelve-month inflation: 9.8 percent in November; inflation expected to remain at about 10 percent by year-end.
- Fiscal:
  - Overall commitment fiscal deficit for 2010: 2.7 percent of GDP (about 0.6 percentage point of GDP below the program target).
  - Arrears clearance and net accumulation in the oil revenue stabilization account (ORSA) at end-October were below program levels due to shortfalls in foreign financing.
- Monetary:
  - Reserve money growth (12-month): 14.5 percent at end-October compared to 28 percent in June.
  - Broad money growth (y-o-y) in October: 26 percent; credit to nongovernment sectors: +22 percent.
  - CBOS measures in July: raised reserve requirement ratio on domestic and foreign currency deposits from 8 to 11 percent, and withdrew maturing investment deposits placed in commercial banks.
  - CBOS redeemed SDG 1.22 billion up to end-November 2010; SDG 1.16 billion remains deposited with banks and is expected to be redeemed upon maturity by end-2011.
- Exchange rate and reserves:
  - In November the CBOS introduced a daily premium for purchases of the guinea—currently equivalent to about 19 percent—on top of the official exchange rate, effectively a depreciation of about 19 percent.
  - Authorities introduced higher customs duties on various consumption goods and raised the development tax rate from 5 to 10 percent on some imports.
  - Gross international reserves continued to decline due to shortfalls in external financing and authorities’ exchange rate and intervention policies in the run-up to the November depreciation.
- External sector:
  - Export receipts (first three quarters of 2010) increased by 43 percent compared to the first three quarters of last year despite a decline in oil production.
  - Imports grew by 14 percent, driven by wheat, sugar and petroleum products.
  - Current account deficit for 2010: estimated to decline to 7.7 percent of GDP, compared to 10.8 percent of GDP in 2009.
- Financial sector:
  - Nonperforming loans (NPLs): 17 percent at end-September, down from 20 percent at end-2009.
  - Ratio of provisions to NPLs: 26 percent in September, up from 24 percent at end-2009.
  - Minimum capital requirement for banks: raised to SDG 80 million by end-2010 and SDG 100 million by end-2011 from the current requirement of SDG 60 million.
  - Average capital adequacy ratio of commercial banks: 10 percent at end-September, up from 7 percent at end-2009.

### Policy Discussions — Overview and Baseline Scenario
- Immediate priorities identified:
  - rebuild foreign exchange reserves;
  - mobilize non-oil revenue;
  - tighten monetary policy to contain inflationary and exchange rate pressures.
- Medium-term priorities:
  - strengthen non-oil revenue collection and export base;
  - develop financial system for sustainable growth.
- Under the 2011 baseline scenario (assumes unitary state):
  - Real GDP growth projected to slow to around 4½ percent.
  - Inflation projected to moderate to about 9 percent.
  - Current account deficit will remain broadly unchanged compared to 2010.
- Staff will update analysis and policy recommendations as new information becomes available.

### Staff Recommendations (summary)
- Tighten the monetary stance to reduce pressures on inflation and the exchange rate.
- Increase exchange rate flexibility in order to rebuild foreign exchange reserves.
- Enhance non-oil revenue and streamline expenditures to maintain macroeconomic stability and reduce dependence on oil revenues.
- Continue to strengthen the financial sector, including by improving banking supervision and restructuring the Omdurman National Bank.
- Initiate a dialogue with creditors with the aim of establishing wide support for arrears clearance and debt relief.

### Authorities’ Views (summary)
- Reduction of the fiscal deficit will be achieved through broadening the revenue base by reducing tax exemptions and improving administration, and reducing spending.
- Building up foreign exchange reserves is important and a cautious monetary policy is needed to achieve this objective.
- Progress on debt relief, under the HIPC initiative, is essential to remove the debt overhang and regain access to concessional financing for development and social projects.
- Various policy options are being assessed to address challenges posed by a possible independence of the South in 2011.

### Fiscal Policy — 2011 Budget and Staff Advice
- 2011 budget prepared under assumption of a unitary state; a supplementary budget could be prepared depending on referendum outcome.
- Approved budget envisages improvement in the non-oil primary balance compared to 2010:
  - Conservative assumptions for oil and non-oil revenues.
  - Current expenditures projected to compress by -2.8 percentage points of GDP.
  - Capital outlays projected to rise to 3.3 percent of GDP.
- Staff agreement and suggestions:
  - Staff suggested complementing adjustment with measures to strengthen tax revenues (an increase of 0.2 percentage point of GDP relative to the estimated level in 2010).
  - Proposed fiscal stance preserves similar spending cuts in wages and goods and services while maintaining necessary social spending to protect the poor.
  - Staff projected capital outlays lower than in the approved budget (by 0.6 percentage point of GDP) consistent with more conservative foreign financing assumptions.

### Fiscal Reforms, Revenue Mobilization, and Public Spending
- A joint committee (MOFNE, Taxation Chamber and Custom) completed a review of the current tax policy regime and recommended measures to broaden the tax base and enhance revenue administration.
- The 2011 budget incorporates measures including increases in tariff rates on certain vehicles, consumption and manufacturing goods.
- Recent fiscal reforms implemented: modernization of the Taxation Chamber; reorganization of the Ministry of Finance and National Economy; completion of the tax policy regime review.
- Customs evaluation system implementation delayed to the beginning of 2011 due to insufficient funding.
- Staff-recommended further reforms (explicit):
  - (i) reducing VAT exemptions and reforming the personal income tax based on the recent review of tax policy;
  - (ii) establishing a targeted social safety net as a prerequisite for the gradual removal of fuel subsidy;
  - (iii) developing a medium-term fiscal framework anchored around the non-oil primary balance.
- Possible measures noted by staff could include:
  - (i) tightening VAT exemptions on certain final goods and imports by certain entities;
  - (ii) extending the VAT to domestic services (such as electricity and water usage, in-city transportation, commercial rentals, etc.);
  - (iii) raising excise duties on luxury items (cars, high-end consumer goods, etc.).

### Monetary Policy, Liquidity, and Exchange Rate
- Authorities plan to maintain a tight monetary stance and have taken measures to reverse the expansionary stance since the second half of 2010.
- Authorities have withdrawn more than half of the deposits placed with banks in 2009 as temporary liquidity support, and plan to withdraw the remaining deposits as they mature.
- CBOS is proceeding to strengthen open market operations and deepen the interbank market, but effective domestic liquidity management remains constrained by limited policy instruments.
- Authorities view the recent de facto depreciation of the guinea as reducing FX market pressure and aligning official and parallel rates; they avoid an outright depreciation and introduced a premium mechanism.
- Staff view:
  - Continued exchange rate flexibility is important.
  - The mechanism introduced could create market distortions and undermine transparency in CBOS policy implementation.
- Fiscal measures to curb FX demand include prohibition of selected imported items, higher tariffs, excise taxes, development tax on imports, and tightening requirements for foreign currency accounts; staff cautioned these measures are likely to add price distortions and are unlikely to yield intended objectives.

### Financial Sector and Banking
- Measures to strengthen regulatory and supervisory framework include loan provisioning and capital adequacy reforms.
- Most banks are expected to meet the new minimum capital requirement of SDG 80 million by end-2010, and SDG 100 million by end-2011.
- Government repayment of a portion of its arrears to banks contributed to a reduction in non-performing loans (NPLs).
- Restructuring of Omdurman National Bank is underway with some delay.

### External Debt, Arrears, and Relations with Creditors
- Total external debt obligations reached $36.2 billion by the end of September, with $30.5 billion estimated to be in arrears.
- Contracting of nonconcessional external borrowing in 2010 amounted to $269 million, compared to an annual limit of $700 million.
- Such loans are earmarked for infrastructure projects and have long maturity and some grant element, though below the 35 percent threshold.
- Payments to the Fund in 2010 exceeded the minimum commitment; payments in 2011 to be finalized after referendum outcome.
- Fund and Bank staff co-led a Technical Working Group (TWG) on Sudan’s external debt; workshop held December 12, 2010, with representatives from both North and South and the donor community.

### Performance under Staff-Monitored Programs (SMPs)
- Under the 2009–10 SMP:
  - Three end-June quantitative targets were missed: NIR accumulation, domestic financing and arrears clearance (arrears clearance missed by only a very small margin). The NDA and nonconcessional borrowing targets were met.
  - All structural benchmarks through end-June were met, albeit with a delay. The tax policy review was finalized in September; the review of tax exemptions under the Investment Encouragement Act (IEA) was completed in October.
  - Payments to the Fund in 2010 reached US$11.2 million, exceeding the minimum commitment under the SMP.
  - Staff believes the 2009–10 SMP met the standard of upper-credit tranche conditionality, except for the non-concessional borrowing.

### Macroeconomic Implications of a Possible South Sudan Independence — Illustrative Scenario
- Under the illustrative scenario discussed:
  - North Sudan could lose about 75 percent of its gross oil revenues.
  - Government oil revenues are expected to drop by about 75 percent (equivalent to 6 percent of GDP).
  - With about half of this revenue loss offset by reduction in transfers to the South, the overall fiscal deficit is projected to widen by about 3 percent age points of GDP.
  - The North’s current account is expected to deteriorate by 4 percent age points of GDP during 2010–12.
  - Capital inflows, including FDI, are expected to decline in the short-run, contributing to a financing gap that could reach 3–4 percent of GDP in 2012.
- Scenario assumptions (staff’s illustrative assumptions):
  - (i) a decline of about 75 percent in oil production;
  - (ii) a 10 percent decline in non-oil GDP;
  - (iii) an increase in service receipts to reflect transportation fees charged for the transportation of South’s share of oil;
  - (iv) a decline in transportation payments and investment income payments to reflect lower oil production;
  - (v) a decline in imports of goods to reflect shares of the oil sector and the South;
  - (vi) an increase in imports of petroleum products to reflect the shortfall in domestic production.
- Additional illustrative estimates:
  - North’s share of exports prior to secession estimated roughly 60 percent of total exports and with secession drops to 25 percent.
  - Projected decline in oil exports of the North during 2010-2012 is roughly 50 percent reflecting a decline of 60 percent in volume offset by a 13percent projected increase in international oil prices.
- Policy measures recommended under secession scenario:
  - Exercise fiscal restraint by streamlining non-priority spending, reducing fuel subsidies, reducing tax exemptions and enhancing revenue administration.
  - Allow greater exchange rate flexibility, tighten monetary policy, and swiftly implement structural reforms.

### Staff Appraisal and Additional Policy Recommendations
- Key recommendations:
  - Improve deficit financing mix to reduce heavy reliance on CBOS for budget financing; adopt conservative foreign financing assumptions in the budget.
  - Step up efforts to enhance donors’ budget support, focusing on grants and concessional lending.
  - Deepen fiscal reforms to widen the tax base and enhance tax administration; streamline VAT and personal income tax exemptions.
  - Gradually phase out fuel subsidies while designing a targeted social safety net using the recently completed household survey.
  - Maintain a monetary tightening bias while ensuring sufficient credit to the private sector; closely monitor price developments and liquidity conditions.
  - Reverse the temporary depreciation mechanism once market conditions improve and reverse recently introduced quantitative fiscal measures aimed at discouraging some types of imports.

### Debt Distress, Arrears, and Access to External Financing
- Sudan is in debt distress and its arrears continue to constrain access to external financing.
- Authorities’ record of cooperation on economic policies and payments to the Fund augur well for the clearance of Sudan’s arrears at the appropriate time.
- Authorities should minimize contracting or guaranteeing of nonconcessional external borrowing.
- Staff welcomes the authorities’ payments to the Fund in excess of the minimum commitment for 2010 and encourages increased payments as payment capacity improves.

### Northern Part of Sudan — Recent Developments and Fiscal Issues (supplement)
- Inflation increased to 15.4 percent in December (y-o-y) compared to about 10 percent in November.
- Food prices increased by almost 20 percent during the same period.
- Contributing factors: increase in international food prices, referendum uncertainties, depreciation of the Sudanese pound, high money growth, and speculation about subsidy removals.
- Fiscal tightening continued in Q4 2010: both revenues and expenditures declined by an estimated 0.7 percentage point of GDP.
- Preliminary December data: twelve-month reserve money grew by 17 percent and broad money grew by 25 percent; credit to nongovernment sectors grew by about 15 percent.
- Exchange rate developments:
  - Official and parallel rates continued to converge; the premium slightly dropped to about 16 percent.
  - This allowed CBOS to limit intervention and rebuild international reserves.
- Indicative targets (preliminary end-December): four targets were missed — NDA, NIR accumulation, domestic financing, and arrears clearance. Nonconcessional borrowing and payment to the Fund targets were met.
- Structural measures implemented (with some delay): tax review completed; revenue administration reform incorporated within the 2011 budget; customs evaluation system upgrade expected to be finalized by September 2011.

- Authorities announced early January 2011 measures and plan a supplementary budget in Q2 2011; subsidy reductions and social safety nets announced:
  - Prices raised for some fuel products and sugar expected to yield about one percentage point of GDP in savings compared to 2011 projections.
  - New social safety measures include:
    - an across-the-board increase in civil servants and pensioners’ wages (SDG 100 per month),
    - targeted support to poor families and students,
    - further transfers to health insurance programs,
    - additional resources for agriculture and industry development funds.
- Staff recommended gradual increase in price of crude oil delivered to refineries to make subsidy more explicit and transparent; staff urged limiting the SDG100 salary increase to the lowest tiers of the wage scale.
- Additional supplementary budget measures (expected yield about 0.2 percent of GDP this year): salary cuts for senior ministerial positions; reduction in mission travel and diplomatic spending; removal of VAT exemptions on some computer and medical supplies, and on sport equipments.
- Specific price changes announced:
  - Diesel: raised from SDG4.5 to SDG6.5 per gallon.
  - Gasoline: raised from SDG6.5 to SDG8.5.
  - Fuel jet: raised from SDG4.65 to SDG6.5.
  - Cooking gas: raised from SDG12 to SDG13 per container.
  - Price of a 50 kilogram sack of sugar: rise from SDG128 to SDG 148.
  - Last increase in fuel prices was in 2006.
  - Price of the crude oil delivered to refineries has remained unchanged at $49/barrel since 2004.

### South Sudan — IMF Engagement and Currency Advice
- Local authorities intend to apply for IMF membership soon after referendum results are finalized.
- South Sudan plans to issue and manage its own currency by the end of the year, but preparations may be protracted.
- Discussion of possible continued use of the Sudanese pound for 6-9 months after CPA expiration in July.
- Mission advised that a fixed regime, possibly through a currency board arrangement (CBA), would likely serve South Sudan best; mission advised against adopting a flexible exchange rate regime given institutional requirements.
- Technical assistance: various donors (DFID, EU, Norway, Swiss, USAID, UN, and WorldBank) are providing support; Fund offered coordination and technical assistance.

### Debt Issues — end-2010 / early-2011 status and reconciliation
- Estimated total external debt obligations reached $36.8 billion by end-December, of which $30.8 billion are estimated to be in arrears.
- Post-referendum push for debt relief: CPA parties urge a roadmap towards debt relief; both parties agreed to tackle the debt relief process jointly.
- Divergent views on debt apportionment: Khartoum sees debt solved in context of comprehensive agreement; South refuses to take on debt or prefers geographic allocation by ultimate beneficiary principle.
- Debt reconciliation progress: creditor statements received from most multilaterals, half of Paris Club bilaterals, and about a third of non-Paris Club bilaterals as of mid-January 2011; progress on private debt reconciliation had yet to start.
- Institutional action: Sudan Debt Technical Working Group (TWG) met February 3, 2011.

### Selected Key Statistics and Targets (as reported)
- Nominal GDP (in millions of Sudanese guinea, at market prices): 93,811; 121,287; 128,429; 159,174; 184,277
- Nominal GDP (in millions of U.S. dollars): 46,531; 58,028; 55,802; 64,365; 65,554
- Oil production (average, in thousands of barrels per day): 484; 462; 474; 460; 465
- Population (in millions): 37.2; 38.1; 39.1; 40.1; 41.2
- GNP per capita (in U.S. dollars): 1,147; 1,394; 1,316; 1,488; 1,465
- Real GDP (annual change): 10.2; 6.8; 6.0; 5.1; 4.7
- Oil (real change): 33.0; -4.4; 2.6; -3.0; 1.1
- Non-oil (real change): 7.5; 8.5; 6.4; 6.1; 5.1
- Consumer prices (average): 8.0; 14.3; 11.3; 11.0; 9.0
- Consumer prices (end of period): 8.8; 14.9; 13.4; 10.0; 8.0
- Gross investment (percent of GDP): 26.5; 22.7; 21.7; 21.2; 21.9
- Gross national saving (percent of GDP): 15.6; 15.0; 10.9; 13.5; 14.1
- Central government total revenue (percent of GDP): 20.6; 21.8; 15.4; 16.0; 16.4
- Central government total expenditure (percent of GDP): 23.6; 23.2; 20.8; 19.0; 17.6
- Overall balance (commitment basis, percent of GDP): -5.4; -1.4; -4.6; -2.7; -1.1
- Non-oil primary balance (percent of non-oil GDP): -10.4; -7.6; -6.5; -5.5; -3.6
- Non-oil primary operating balance (percent of non-oil GDP): -4.5; -3.6; -3.4; -2.7; 0.3
- Broad money (change in percent): 10.3; 16.3; 23.5; 23.0; 16.2
- Reserve money (change in percent): 12.8; 22.2; 28.1; 14.3; 13.2
- External debt (in billions of U.S. dollars): 31.9; 33.7; 35.7; 37.8; 40.1
- External debt (percent of GDP): 68.5; 58.1; 64.0; 58.8; 61.2
- Debt service ratio (commitment basis, percent of exports): 11.2; 9.5; 18.1; 15.7; 12.0
- Debt service ratio (cash payments, percent of exports): 2.4; 2.9; 5.7; 4.2; 3.9
- Gross international reserves (in millions of U.S. dollars): 1,378; 1,399; 897; 1,081; 1,111
- In months of next year’s imports: 1.4; 1.6; 0.9; 1.0; 1.0
- Sudan’s crude oil export price (U.S. dollars per barrel): 58.08; 81.34; 47.46; 69.17; 72.9

*Prepared by the Middle East and Central Asia Department; Approved by Alan MacArthur and Jan Kees Martijn; February 4, 2011.*

### Executive Summary ......................................................................................................

### Executive Summary

### Background
- Political uncertainties ahead of the January 2011 South Sudan referendum on self-determination have been weighing heavily on the Sudanese economy, adding to the adverse effects of the global crisis in 2009.
- Economic growth in 2010 is projected to decelerate to about 5 percent.
- Average inflation is projected to remain at 11 percent.
- Fiscal and monetary policies were noticeably tightened starting the second half of 2010.
- Shortfalls in both tax revenues and oil receipts were more than offset with notable under-execution in both capital and current expenditures.
- Monetary policy remained expansionary in the first half of 2010, but was tightened starting in July.
- The central bank recently undertook an exchange rate depreciation of about 19 percent.

### Recent Economic Developments
- Real GDP growth in 2010: about 5 percent.
- Oil production in 2010: declined by about 2 percent to 460,000 barrels per day (bpd).
- Twelve-month inflation: 9.8 percent in November; inflation expected to remain at about 10 percent by year-end.
- Fiscal:
  - Overall commitment fiscal deficit for 2010: 2.7 percent of GDP (about 0.6 percentage point of GDP below the program target).
  - Arrears clearance and net accumulation in the oil revenue stabilization account (ORSA) at end-October were below program levels due to shortfalls in foreign financing.
- Monetary:
  - Reserve money growth (12-month): 14.5 percent at end-October compared to 28 percent in June.
  - Broad money growth (y-o-y) in October: 26 percent; credit to nongovernment sectors: +22 percent.
  - Central Bank of Sudan (CBOS) measures in July: raised reserve requirement ratio on domestic and foreign currency deposits from 8 to 11 percent, and withdrew maturing investment deposits placed in commercial banks.
  - CBOS redeemed SDG 1.22 billion up to end-November 2010; SDG 1.16 billion remains deposited with banks and is expected to be redeemed upon maturity by end-2011.
- Exchange rate and reserves:
  - In November the CBOS introduced a daily premium for purchases of the guinea—currently equivalent to about 19 percent—on top of the official exchange rate, effectively a depreciation of about 19 percent.
  - Authorities introduced higher customs duties on various consumption goods and raised the development tax rate from 5 to 10 percent on some imports to curb foreign currency demand.
  - Gross international reserves continued to decline due to shortfalls in external financing and authorities’ exchange rate and intervention policies in the run-up to the November depreciation.
- External sector:
  - Export receipts (first three quarters of 2010) increased by 43 percent compared to the first three quarters of last year despite a decline in oil production, reflecting higher international prices.
  - Imports grew by 14 percent, driven by wheat, sugar and petroleum products.
  - Current account deficit for 2010: estimated to decline to 7.7 percent of GDP, compared to 10.8 percent of GDP in 2009.
- Financial sector:
  - Nonperforming loans (NPLs): 17 percent at end-September, down from 20 percent at end-2009.
  - Ratio of provisions to NPLs: 26 percent in September, up from 24 percent at end-2009.
  - Minimum capital requirement for banks: raised to SDG 80 million by end-2010 and SDG 100 million by end-2011 from the current requirement of SDG 60 million.
  - Average capital adequacy ratio of commercial banks: 10 percent at end-September, up from 7 percent at end-2009.

### Policy Discussions — Overview and Scenario
- Immediate priorities: rebuild foreign exchange reserves, mobilize non-oil revenue, and tighten monetary policy to contain inflationary and exchange rate pressures.
- Medium-term priorities: strengthen non-oil revenue collection and export base; develop financial system for sustainable growth.
- Under the 2011 baseline scenario (assumes unitary state):
  - Real GDP growth projected to slow to around 4½ percent.
  - Inflation projected to moderate to about 9 percent.
  - Current account deficit will remain broadly unchanged compared to 2010.
- Staff is following developments in consultation with the authorities and will update analysis and policy recommendations as new information becomes available.

### Staff Recommendations
- Tighten the monetary stance to reduce pressures on inflation and the exchange rate.
- Increase exchange rate flexibility in order to rebuild foreign exchange reserves.
- Enhance non-oil revenue and streamline expenditures in order to maintain macroeconomic stability and reduce dependence on oil revenues.
- Continue to strengthen the financial sector, including by improving banking supervision and restructuring the Omdurman National Bank.
- Initiate a dialogue with creditors with the aim of establishing wide support for arrears clearance and debt relief.

### Authorities’ Views
- Reduction of the fiscal deficit will be achieved through broadening the revenue base by reducing tax exemptions and improving administration, and reducing spending.
- Building up foreign exchange reserves is important and a cautious monetary policy is needed to achieve this objective.
- Progress on debt relief, under the HIPC initiative, is essential to remove the debt overhang and regain access to concessional financing for development and social projects.
- Various policy options are being assessed to address the significant challenges posed by a possible independence of the South in 2011.

### Fiscal Policy (2011 Budget and Staff Advice)
- The 2011 budget reflects an ambitious effort to undertake a large fiscal adjustment while recognizing significant uncertainties about possible independence of South Sudan.
- Budget prepared under assumption of a unitary state; a supplementary budget could be prepared depending on the referendum outcome.
- Approved budget envisages improvement in the non-oil primary balance compared to 2010:
  - Conservative assumptions for oil and non-oil revenues.
  - Current expenditures projected to compress by -2.8 percentage points of GDP.
  - Capital outlays projected to rise to 3.3 percent of GDP, reflecting optimistic foreign financing assumptions.
- Staff agreement and suggestion:
  - Staff agreed with the intention to reduce the deficit.
  - Staff suggested complementing the adjustment with measures to strengthen tax revenues (an increase of 0.2 percentage point of GDP relative to the estimated level in 2010).
  - Proposed fiscal stance preserves similar spending cuts in wages and goods and services while maintaining necessary social spending to protect the poor.
  - Capital outlays projected by staff to be lower than in the approved budget (by 0.6 percentage point of GDP) consistent with more conservative foreign financing assumptions.

### External Debt and Relations with Creditors
- Staff recommended initiating a dialogue with creditors aimed at establishing wide support for arrears clearance and debt relief.
- Authorities emphasized that progress on debt relief under the HIPC initiative is essential to remove the debt overhang and regain access to concessional financing.

### Macroeconomic Implications of a Possible South Sudan Independence
- The full implications will only be clear in coming months; the impact on the macroeconomic framework for Sudan will be large in many dimensions.
- Staff and authorities are assessing various policy options and will continue monitoring and updating policies as the post-referendum transition unfolds.

*Source: Executive Summary (excerpt).*

### 5.5 percent of non-oil GDP in 2010 to 3.6 percent in 2011.

### _cr1186 - 5.5 percent of non-oil GDP in 2010 to 3.6 percent in 2011.

### Fiscal reforms, revenue mobilization, and public spending
- A joint committee (MOFNE, Taxation Chamber and Custom) completed a review of the current tax policy regime and recommended measures to broaden the tax base and enhance revenue administration.
- The 2011 budget incorporates measures including increases in tariff rates on certain vehicles, consumption and manufacturing goods.
- Recent fiscal reforms implemented: modernization of the Taxation Chamber; reorganization of the Ministry of Finance and National Economy; completion of the tax policy regime review.
- Customs evaluation system implementation delayed to the beginning of 2011 due to insufficient funding.
- Establishment of a medium-term fiscal framework and transfer of oil companies’ profits to the Ministry of Finance (instead of the Sudan Petroleum Company) will be implemented after the referendum.
- Staff-recommended further reforms (explicit):
  - (i) reducing VAT exemptions and reforming the personal income tax based on the recent review of tax policy;
  - (ii) establishing a targeted social safety net as a prerequisite for the gradual removal of fuel subsidy;
  - (iii) developing a medium-term fiscal framework anchored around the non-oil primary balance to improve fiscal management against the uncertainties of oil revenue volatilities.
- Possible measures noted by staff could include:
  - (i) a tightening of VAT exemptions granted to imports of certain final goods and imports by certain entities;
  - (ii) extending the VAT to domestic services (such as electricity and water usage, in-city transportation, commercial rentals, etc.);
  - (iii) raising excise duties on luxury items (cars, high-end consumer goods, etc.).

### Monetary policy, liquidity, and exchange rate
- Authorities plan to maintain a tight monetary stance and have taken measures to reverse the expansionary stance since the second half of 2010.
- Authorities have withdrawn more than half of the deposits placed with banks in 2009 as temporary liquidity support, and plan to withdraw the remaining deposits as they mature.
- CBOS is proceeding to strengthen open market operations and deepen the interbank market, but effective domestic liquidity management remains constrained by limited policy instruments.
- Authorities view the recent de facto depreciation of the guinea as reducing FX market pressure and aligning official and parallel rates; they avoid an outright depreciation and introduced a premium mechanism.
- Staff view:
  - Continued exchange rate flexibility is important.
  - The mechanism introduced could create market distortions and undermine transparency in CBOS policy implementation.
- Fiscal measures to curb FX demand include prohibition of selected imported items, higher tariffs, excise taxes (by expanding goods subject to excises), development tax on imports, and tightening requirements for foreign currency accounts; staff cautioned these measures are likely to add price distortions and are unlikely to yield intended objectives.

### Financial sector and banking
- Measures to strengthen regulatory and supervisory framework include loan provisioning and capital adequacy reforms.
- Most banks are expected to meet the new minimum capital requirement of SDG 80 million by end-2010, and SDG 100 million by end-2011.
- Government repayment of a portion of its arrears to banks contributed to a reduction in non-performing loans (NPLs).
- Restructuring of Omdurman National Bank is underway with some delay.

### External debt and creditor relations
- Total external debt obligations reached $36.2 billion by the end of September, with $30.5 billion estimated to be in arrears.
- Contracting of nonconcessional external borrowing in 2010 amounted to $269 million, compared to an annual limit of $700 million.
- Such loans are earmarked for infrastructure projects and have long maturity and some grant element, though below the 35 percent threshold.
- Payments to the Fund in 2010 exceeded the minimum commitment; payments in 2011 to be finalized after referendum outcome.
- Authorities emphasize comprehensive debt relief as critical for external debt sustainability.
- Fund and Bank staff co-led a Technical Working Group (TWG) on Sudan’s external debt; workshop held December 12, 2010, with representatives from both North and South and the donor community, focusing on debt relief process and arrears clearance.

### Performance under Staff-Monitored Programs (SMPs)
- Under the 2009–10 SMP:
  - Three end-June quantitative targets were missed: NIR accumulation, domestic financing and arrears clearance (arrears clearance missed by only a very small margin). The NDA and nonconcessional borrowing targets were met.
  - All structural benchmarks through end-June were met, albeit with a delay. The tax policy review was finalized in September; the review of tax exemptions under the Investment Encouragement Act (IEA) was completed in October.
  - Payments to the Fund in 2010 reached US$11.2 million, exceeding the minimum commitment under the SMP.
  - Staff believes the 2009–10 SMP met the standard of upper-credit tranche conditionality, except for the non-concessional borrowing.
- Assessment of engagement under previous SMPs found significant progress towards restoration of macroeconomic stability and implementation of comprehensive structural reforms, but problems remain in public financial management, weak build-up of international reserves, and rising expenditure pressures.

### Macroeconomic implications of a possible independence of South Sudan (illustrative scenario)
- Under the illustrative scenario discussed:
  - North Sudan could lose about 75 percent of its gross oil revenues.
  - Government oil revenues are expected to drop by about 75 percent (equivalent to 6 percent of GDP).
  - With about half of this revenue loss offset by reduction in transfers to the South, the overall fiscal deficit is projected to widen by about 3 percent age points of GDP.
  - The North’s current account is expected to deteriorate by 4 percent age points of GDP during 2010–12, reflecting a decline in oil exports and an increase in petroleum product imports.
  - Capital inflows, including FDI, are expected to decline in the short-run, contributing to a financing gap that could reach 3–4 percent of GDP in 2012.
- Scenario assumptions (staff’s illustrative assumptions):
  - (i) a decline of about 75 percent in oil production;
  - (ii) a 10 percent decline in non-oil GDP;
  - (iii) an increase in service receipts to reflect transportation fees charged for the transportation of South’s share of oil;
  - (iv) a decline in transportation payments and investment income payments to reflect lower oil production;
  - (v) a decline in imports of goods to reflect shares of the oil sector and the South;
  - (vi) an increase in imports of petroleum products to reflect the shortfall in domestic production.
- Additional illustrative estimates:
  - North’s share of exports prior to secession estimated roughly 60 percent of total exports and with secession drops to 25 percent.
  - Projected decline in oil exports of the North during 2010-2012 is roughly 50 percent reflecting a decline of 60 percent in volume offset by a 13percent projected increase in international oil prices.
- Policy measures recommended to maintain macroeconomic stability under secession scenario:
  - Exercise fiscal restraint by streamlining non-priority spending, reducing fuel subsidies, reducing tax exemptions and enhancing revenue administration.
  - Allow greater exchange rate flexibility, tighten monetary policy, and swiftly implement structural reforms.

### Staff appraisal and policy recommendations
- Economic context: successive shocks (food and fuel crisis in 2008; global financial crisis in 2009–10; political and economic uncertainties ahead of January 2011 referendum).
- Authorities’ resolve to preserve macroeconomic stability is encouraging; continuing reform momentum is critical to mitigate impacts of a possible South independence.
- Key staff recommendations:
  - Improve deficit financing mix to reduce heavy reliance on CBOS for budget financing; adopt conservative foreign financing assumptions in the budget to avoid heavy domestic financing in event of shortfalls.
  - Step up efforts to enhance donors’ budget support, focusing on grants and concessional lending.
  - Deepen fiscal reforms to widen the tax base and enhance tax administration; streamline VAT and personal income tax exemptions.
  - Gradually phase out fuel subsidies while simultaneously designing a targeted social safety net using the recently completed household survey.
  - Maintain a monetary tightening bias while ensuring sufficient credit to the private sector; closely monitor price developments and liquidity conditions and adjust monetary policy as appropriate.
  - Reverse the temporary depreciation mechanism once market conditions improve and reverse recently introduced quantitative fiscal measures aimed at discouraging some types of imports.

*Source: _cr1186 - 5.5 percent of non-oil GDP in 2010 to 3.6 percent in 2011.*

### 35.      Sudan is in debt distress and its arrears continue to constrain access to external

### _cr1186 - 35.      Sudan is in debt distress and its arrears continue to constrain access to external

### Debt distress, arrears, and access to external financing
- Sudan is in debt distress and its arrears continue to constrain access to external financing.
- Authorities’ record of cooperation on economic policies and payments to the Fund augur well for the clearance of Sudan’s arrears at the appropriate time.
- In the meantime, the authorities should minimize to the extent possible the contracting or guaranteeing of nonconcessional external borrowing, which would further weaken debt sustainability.
- The authorities should strive to begin a dialogue with creditors and donors with the aim of establishing wide support for debt relief.
- Staff welcomes the authorities’ payments to the Fund in excess of the minimum commitment for 2010.
- Given the recent deterioration in payment indicators, staff encourages the authorities to significantly increase payments to the Fund as Sudan’s payment capacity improves.

### Preparations for potential independence of South Sudan
- Staff welcomes the authorities’ efforts so far to prepare for a potential independence of South Sudan and encourages them to take appropriate measures to preserve macroeconomic stability.
- The 2011 budget is described as a step in the right direction.
- In the event of a South Sudan independence, staff underscores the importance of bolder policy actions and strong coordination among government agencies to ensure a smooth transition in the period ahead through further determined adjustment measures.

### Policy directions and structural priorities
- Staff welcomes the authorities’ resolve to undertake appropriate policies commensurate with the challenges they are facing, namely:
  - (i) the need to exercise fiscal restraint, especially by mobilizing non-oil revenue and streamlining expenditure;
  - (ii) greater exchange rate flexibility;
  - (iii) tighter monetary policy; and
  - (iv) swift implementation of structural reforms.

### Selected key statistics and targets (as reported)
- Nominal GDP (in millions of Sudanese guinea, at market prices): 93,811; 121,287; 128,429; 159,174; 184,277
- Nominal GDP (in millions of U.S. dollars): 46,531; 58,028; 55,802; 64,365; 65,554
- Oil production (average, in thousands of barrels per day): 484; 462; 474; 460; 465
- Population (in millions): 37.2; 38.1; 39.1; 40.1; 41.2
- GNP per capita (in U.S. dollars): 1,147; 1,394; 1,316; 1,488; 1,465
- Real GDP (annual change): 10.2; 6.8; 6.0; 5.1; 4.7
- Oil (real change): 33.0; -4.4; 2.6; -3.0; 1.1
- Non-oil (real change): 7.5; 8.5; 6.4; 6.1; 5.1
- Consumer prices (average): 8.0; 14.3; 11.3; 11.0; 9.0
- Consumer prices (end of period): 8.8; 14.9; 13.4; 10.0; 8.0
- Gross investment (percent of GDP): 26.5; 22.7; 21.7; 21.2; 21.9
- Gross national saving (percent of GDP): 15.6; 15.0; 10.9; 13.5; 14.1
- Central government total revenue (percent of GDP): 20.6; 21.8; 15.4; 16.0; 16.4
- Central government total expenditure (percent of GDP): 23.6; 23.2; 20.8; 19.0; 17.6
- Overall balance (commitment basis, percent of GDP): -5.4; -1.4; -4.6; -2.7; -1.1
- Non-oil primary balance (percent of non-oil GDP): -10.4; -7.6; -6.5; -5.5; -3.6
- Non-oil primary operating balance (percent of non-oil GDP): -4.5; -3.6; -3.4; -2.7; 0.3
- Broad money (change in percent): 10.3; 16.3; 23.5; 23.0; 16.2
- Reserve money (change in percent): 12.8; 22.2; 28.1; 14.3; 13.2
- External debt (in billions of U.S. dollars): 31.9; 33.7; 35.7; 37.8; 40.1
- External debt (percent of GDP): 68.5; 58.1; 64.0; 58.8; 61.2
- Debt service ratio (commitment basis, percent of exports): 11.2; 9.5; 18.1; 15.7; 12.0
- Debt service ratio (cash payments, percent of exports): 2.4; 2.9; 5.7; 4.2; 3.9
- Gross international reserves (in millions of U.S. dollars): 1,378; 1,399; 897; 1,081; 1,111
- In months of next year’s imports: 1.4; 1.6; 0.9; 1.0; 1.0
- Sudan’s crude oil export price (U.S. dollars per barrel): 58.08; 81.34; 47.46; 69.17; 72.9

### Fiscal and program implementation notes
- Staff notes targets and ceilings in the 2009–10 Staff-Monitored Program including:
  - Central Bank of Sudan net domestic assets (Ceiling) and Domestic financing of the central government (Ceiling).
  - Reduction in the stock of domestic arrears of the central government (Floor).
  - Net international reserves (Floor).
  - Ceiling on contracting or guaranteeing of external nonconcessional debt by the government or the central bank (in millions of U.S. dollars).
  - Payments to the Fund (in millions of U.S. dollars) (Floor).
- Arrears are defined as overdue financial obligations of the central government outstanding for 90 days or more.

*Prepared by the Middle East and Central Asia Department; Approved by Alan MacArthur and Jan Kees Martijn; February 4, 2011.*

### 1.      This supplement provides additional information on developments and

### _cr1186 - 1.      This supplement provides additional information on developments and

### I.   NORTHERN PART OF SUDAN — Recent Developments
- Inflation increased to 15.4 percent in December (y-o-y) compared to about 10 percent in November.
- Food prices increased by almost 20 percent during the same period.
- Contributing factors to the surge in food prices included: an increase in international food prices, uncertainties in the run-up to the referendum, depreciation of the Sudanese pound, high money growth, and early speculation about possible removal of subsidies on petroleum products, sugar and other products.
- Fiscal tightening continued in the last quarter of 2010: both revenues and expenditures declined by an estimated 0.7 percentage point of GDP in the fourth quarter.
  - About half of the drop in revenue was due to lower-than-expected oil production; the remainder was due to a shortfall in non-oil revenue.
  - Authorities compressed current spending in response.
  - The estimated overall commitment-based deficit for 2010 remained in line with the estimate in the staff report.
- Preliminary December data: twelve-month reserve money grew by 17 percent and broad money grew by 25 percent.
  - Broad money growth was largely driven by an increase in the banking system’s lending to the government; credit to the nongovernment sectors grew by about 15 percent.
- Exchange rate developments:
  - Pressure on the exchange rate eased somewhat following the November de facto depreciation.
  - Official and parallel rates continued to converge; the premium slightly dropped to about 16 percent.
  - This allowed the Central Bank of Sudan (CBOS) to limit intervention and rebuild international reserves.
  - Anecdotal evidence suggests depreciation enabled banks and exchange bureaus to attract foreign inflows from the informal market.
- Indicative targets (preliminary end-December data): four targets were missed — NDA, NIR accumulation, domestic financing, and arrears clearance.
  - Nonconcessional borrowing and payment to the Fund targets were met.
  - NDA target missed due to shortfall in government revenues and foreign financing.
  - NIR target missed due to continued intervention in the foreign exchange market, although reserves rebounded somewhat since the November depreciation.
- Structural measures implemented (with some delay):
  - Tax review completed; main recommendations to be incorporated within the supplementary budget expected in the second quarter of the year.
  - Revenue administration reform incorporated within the 2011 budget.
  - Customs evaluation system implemented, including purchase of new software and training to core staff with UNCTAD assistance; authorities expect to finalize the upgrade by September 2011.

### I.   NORTHERN PART OF SUDAN — Fiscal Issues
- Authorities announced measures in early January 2011 and plan to issue a supplementary budget during the second quarter of the year; design will depend on expected CPA-related agreements, particularly oil revenue sharing.
- Subsidy reductions and social safety nets announced in early January:
  - Prices raised for some fuel products and sugar to contain budgetary impact; expected to yield about one percentage point of GDP in savings compared to the 2011 projections.
  - New social safety measures include:
    - an across-the-board increase in civil servants and pensioners’ wages (SDG 100 per month),
    - targeted support to poor families and students,
    - further transfers to the health insurance programs,
    - additional resources for the agriculture and industry development funds.
- Staff recommendations and commentary:
  - Staff welcomed the price increases and social safety nets.
  - Staff recommended for future subsidy reductions a gradual increase in the price of the crude oil delivered to the refineries to make the subsidy more explicit and transparent.
  - Staff emphasized avoiding non-targeted measures and called on authorities to limit the SDG100 salary increase—equivalent to a 20 percent increase in the wage bill—to the lowest tiers of the wage scale.
- Additional measures proposed in the supplementary budget to tighten spending and enhance non-oil revenue collection in light of expected independence of South Sudan:
  - Expenditure-side proposals: salary cut for senior ministerial positions; reduction in purchase of some goods and services; budget cut for mission travel; reduction in diplomatic missions’ spending; restructuring ministries to downsize central and state governments.
  - Revenue-side measures: removal of VAT exemptions on some computer and medical supplies, and on sport equipments.
  - Expected yield of these measures: about 0.2 percent of GDP in budgetary savings this year.
  - Plans to further streamline tax exemptions and enhance revenue administration.
- Staff view: supports proposed measures but notes the required budget adjustment is likely to exceed current steps; staff underscored importance of streamlining all exemptions, considering further reduction in fuel subsidies, and moving swiftly with the reform agenda.

- Specific price changes (authorities’ announcement footnote):
  - Diesel: raised from SDG4.5 to SDG6.5 per gallon.
  - Gasoline: raised from SDG6.5 to SDG8.5.
  - Fuel jet: raised from SDG4.65 to SDG6.5.
  - Cooking gas: raised from SDG12 to SDG13 per container.
  - Price of a 50 kilogram sack of sugar: rise from SDG128 to SDG 148.
  - Last increase in fuel prices was in 2006.
  - Price of the crude oil delivered to refineries has remained unchanged at $49/barrel since 2004.

### II.   SOUTH SUDAN
- Mission engagements and topics discussed with local authorities: general IMF membership process, debt relief, currency issues, exchange rate regime, and technical assistance needs.
- IMF membership:
  - Local authorities intend to apply for IMF membership soon after the referendum results are finalized.
  - Mission explained membership is open only to countries and the Fund’s determination whether an applicant is a country is informed by the views of the international community, in particular Fund members; mission highlighted steps required under the membership process.
- Currency and timing:
  - South Sudan plans to issue and manage its own currency by the end of the year, but preparations may be protracted.
  - Authorities discussed with Northern Sudan the possibility of continuing to use the Sudanese pound for 6-9 months after the expiration of the CPA in July.
  - Mission advised caution and offered IMF technical assistance.
  - Authorities discussed possibility of redemption of Sudanese pounds currently in circulation in the South by the North.
- Exchange rate regime advice:
  - Mission noted a fixed regime, possibly through a currency board arrangement (CBA), would likely serve South Sudan best due to relative simplicity and its potential to ensure fiscal discipline and economic stability.
  - A CBA would require sound public finances, absence of lending to the government, and an adequate banking supervisory framework.
  - Mission advised against adopting a flexible exchange rate regime given institutional requirements.
  - Mission cautioned against involvement of the new monetary authority in economic activities outside core central bank functions.
  - Mission emphasized importance of ownership, consensus, and political support at the highest level for any chosen regime, particularly a CBA.
- Technical assistance: various donors (DFID, EU, Norway, Swiss, USAID, UN, and WorldBank) are providing technical assistance; mission described Fund’s readiness to assist in coordination with other donors.

### III.   DEBT ISSUES
- External debt developments:
  - Sudan’s external debt obligations continued to increase during 2010 (albeit at a slower pace reflecting a slowdown in loan disbursements compared to 2009).
  - Estimated total debt obligations reached $36.8 billion by end-December, of which $30.8 billion are estimated to be in arrears.
- Post-referendum push for debt relief:
  - With the referendum completed peacefully and successfully, CPA parties urge a roadmap towards debt relief as soon as possible.
  - Both parties agreed to tackle the debt relief process jointly, even in the absence of an agreement on debt apportionment, and to launch high-level political efforts to establish broad-based international support.
- Divergent views on debt apportionment:
  - Khartoum authorities: debt can only be solved in the context of a comprehensive agreement on all outstanding CPA-related issues and believe the South should shoulder part of this debt.
  - South: refuses to take on any of the debt; in case of apportionment, debt should be allocated geographically according to the ultimate beneficiary principle.
- Debt reconciliation progress:
  - Authorities initiated a debt reconciliation exercise with creditors.
  - As of mid-January 2011, authorities received creditor statements from most multilaterals, half of the Paris Club bilaterals, and about a third of the non-Paris Club bilaterals.
  - Progress on private debt reconciliation had yet to start.
- Institutional action:
  - The Sudan Debt Technical Working Group (TWG) met for the first time on February 3, 2011 to discuss objectives and work program.

### Statement by Mr. Moeketsi Majoro, Executive Director for Sudan (February 9, 2011) — Key points
- Authorities demonstrated commitment to peace and democracy by ending internal conflict and holding the referendum on schedule.
- Past decade: series of successful Staff Monitored Programs (SMPs) improved economic management capacity; authorities continued cooperation with the Fund on policy implementation and clearing of arrears and benefited from IMF technical advice.
- Authorities’ disappointment at slow pace of full normalization with the Fund; external debt relief remains critical for economic normalcy.
- Debt burden not sustainable without debt relief; limited access to concessional financing has led to borrowing on non concessional terms, compounding the debt problem.
- Economic outlook and policy priorities:
  - Authorities implementing Medium Term 5 Year Plan (2007-2011) through the FY 2011 budget designed under assumption of a unitary state; near-term outlook needs to reflect recent political developments and referendum results.
  - Supplementary budget expected to capture implications of possible secession.
  - Medium-term development financing needs expected to be enormous; significant international support and external debt resolution required.
  - Authorities favor diversification of sources of growth and promotion of private sector–led growth.
  - Increased government financing to the agricultural sector via Green Mobilization Program (2008-2011).
  - Commitment to improving business environment, market institutions, infrastructure, and reducing administrative barriers.
- Monetary policy stance:
  - Authorities committed to prudent monetary policy with primary objective of containing inflation.
  - Liquidity management and interventions in the foreign exchange market aim to restrain inflation.
  - Foreign reserve strategy: rationalize demand for foreign exchange through restraint on non-priority imports, promote non-oil exports, and encourage non-debt creating flows such as foreign direct investment.
  - Authorities taking a cautious move towards a flexible exchange rate and intend to achieve exchange rate stability by pegging the Sudanese currency to a basket of currencies.
- Fiscal policy and public finance management:
  - Authorities implemented measures to enhance tax revenue mobilization and are committed to strengthen public finance management (PFM).
  - Tax measures since 2000 include introduction of VAT, a petroleum excise tax, and import tariff improvements.
  - Objectives include reducing tax exemptions and evasion and expanding the tax base; discontinuation of ad hoc exemptions under the Investment Encouragement Act (IEA) and consideration of taxing a large section of the agricultural sector.
  - Challenges: growing services sector (SMEs) and large informal sector complicate tax compliance; deeper tax reforms expected following tax policy review.
  - Significant PFM reforms implemented including establishment of a modern budget management system, but more work remains, complicated by limited fiscal decentralization and capacity constraints at state and local levels.
- Overdue obligations and debt expectations:
  - Authorities continued to meet overdue obligations to the Fund with 2010 payments exceeding obligations falling due and commitments; overdue obligations have declined.
  - Expectation that the Technical Working Group on Debt will finalize debt stock reconciliation soon to complete the process in the transition period.
  - Authorities optimistic about reaching agreement on sharing debt obligations with the GOSS and call on donors to support debt relief to create macroeconomic space for growth and poverty reduction.
- Post-referendum considerations:
  - Final official announcement of the referendum results will be made on February 14, 2011.
  - Authorities are assessing macroeconomic implications of possible secession: independence of the South would mean significant loss of oil revenue for the North, resulting in domestic and external imbalances requiring strong donor support; the South would require assistance to build institutions and manage the economy.
  - A balanced international approach to assist both North and South is critical for peace and stability.
  - Outstanding CPA issues (wealth and debt sharing, currency, nationality and borders) must be resolved in the transition period to maintain stability and progress.
  - Authorities committed to respect referendum outcome and to support viability of the Southern Sudan economy, including providing technical assistance to GOSS.
  - GOSS expected to use the Sudanese pound until their legal tender is in place and expects Fund technical assistance on monetary system design.
  - Northern Sudan committed to continue IMF membership and retain quota; GOSS may apply for IMF membership in due course and is counting on Executive Board support.

*Source: IMF staff supplement based on a staff visit to Khartoum and Juba during January 21-31, 2011.*

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