Public Information Notice No. 03/145

Public Information Notice: IMF Concludes 2003 Article IV Consultation with Sudan

December 19, 2003

On October 31, 2003, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Sudan.¹

Background

Sudan has been cooperating with the IMF under successive Staff-Monitored Programs (SMPs) since 1997 and substantial progress has been achieved in stabilizing and restructuring the economy. The recent progress on peace negations could pave the way for a resolution to the conflict in the South, which together with the progress achieved on the economic front, could accelerate growth and economic development in Sudan and lead to a normalization of the relations with international financial institutions.

Sudan adopted in 2002 and 2003 a strengthened economic reform program to consolidate macroeconomic stability, reinforce the reform momentum, and modernize the macroeconomic management regime. Under this program, Sudan switched to indirect monetary management and broad money targeting, introduced a managed-float exchange rate system, and began strengthening the fiscal regime (including the new focus on non-oil balances, the establishment of the Oil-revenue Savings Account, or OSA, and the move to medium-term budgeting). These reforms have helped reinforce economic stability.

Real GDP growth in 2002 slowed slightly from about 6 percent in 2001 to 5.5 percent in 2002, because of delayed rainfalls that adversely affected agriculture production as well as infrastructure bottlenecks (in power generation, in particular) that reduced the manufacturing sector's productivity. Real GDP growth in 2003 is expected to rise to at least 5.8 percent led by a pickup in non-oil GDP growth. Oil sector growth, however, is expected to slow down to 13.8 percent in 2003, compared with 24.7 percent in 2002. Inflation rose to 8.6 percent in 2002, reflecting expansionary policies in early 2002 and large inflow of foreign exchange in the second half of the year. Inflation, however, declined to 7.6 percent at end-June 2003, and is expected to be in line with the program target of 7 percent. The external current account deficit declined to 6.8 percent of GDP in 2002 from 10.7 percent in 2001, but increased in the first half of 2003 to 7.7 percent of GDP, reflecting a surge in imports (mostly machinery and transport equipment) and services, and income payments. Large private inflows, including foreign direct investments, continued to finance the current account deficit. Usable international reserves reached US$415 million at end-June (1.8 months of imports), compared with US$243 million at end-2002, and US$45 million at end-2001.

Sudan continues to maintain a low fiscal deficit that was kept at 0.9 percent of GDP in 2002, the same ratio targeted for 2003 (compared to the average of 0.8 percent of GDP for the period from 1997 to 2001). This was achieved by measures to contain expenditures and aided by rising oil revenues. Steps are being implemented to strengthen tax revenue, including reducing tax exemptions and reforming the direct tax system. Progress has been modest thus far and additional steps are envisaged. In mid-2002, the OSA was established to save oil revenue arising from oil market prices above the price benchmark in the budget. The savings will be used to stabilize expenditures in the event of falling prices.

Broad money growth accelerated in the second half of 2002 because of a sharp increase in private capital inflows, reaching 30.3 percent by the end of the year. Concerted efforts by the Bank of Sudan (BOS) in late 2002 and early 2003 reduced the 12-month rate growth of broad money to 22 percent by mid-2003. These actions included open market operations in securities and, to a lesser extent, in foreign exchange to mop up liquidity, and were aided by the government repayment of part of its loans borrowed from the BOS and the continued saving of oil revenue in the OSA. Banking soundness indicators are broadly improving along the trend of past few years, although the ratio of nonperforming loans to total loans has risen somewhat in 2003.

Sudan maintains a relatively open trade regime with few nontariff trade barriers and a simple average tariff rate of 22.7 percent (after the elimination of the defense tax on imports in early 2003). Overall, the openness of the trade regime in Sudan compares favorably with that of the advanced economies. Furthermore, progress is being achieved with regard to Sudan's application for World Trade Organization accession and the authorities expect to conclude negotiations in five years. Finally, Sudan accepted on October 8, 2003, the obligations under Article VIII, Sections 2, 3, and 4, of the Fund's Articles of Agreement, indicating that the exchange system shall be free from restrictions relating to current account transactions.

Executive Board Assessment

Executive Directors commended the Sudanese authorities for the recent progress achieved in macroeconomic stabilization and economic reforms, which has contributed to reasonably strong, broad-based growth while containing inflation. They welcomed in particular the introduction of the managed-float exchange rate regime, the strengthening of revenue and expenditure management, and the acceleration of the privatization program. A key challenge will be to reduce the still considerable vulnerabilities facing Sudan, and safeguard against downside risks arising from uncertainties on foreign exchange inflows and expenditure pressures related to the floods and the situation in western Sudan. This will require resolute pursuit of sound macroeconomic policies, as well as strengthened management of expenditures and external debt, and implementation of further fiscal and structural reforms, including an enhanced legal framework to foster private sector development.

Directors considered that conclusion of a lasting peace agreement should open the door for the required support of the donor community for the reconstruction and development of Sudan to promote growth, alleviate poverty, and restore debt sustainability. In this context, Directors were encouraged by renewed indications of interest in the establishment of a support group of creditors and donors to prepare to mobilize financing for Sudan to clear its arrears and reduce its heavy debt burden following a peace agreement. They requested the staff to keep all options under review, and looked forward to coming back to them at the appropriate juncture. Most Directors considered that the authorities' policy efforts under the 2002 and 2003 SMPs were equivalent in strength to that under a Rights Accumulation Program (RAP), and that this should be fully reflected in the period of a RAP. A few others cautioned that it was premature to consider the treatment of the SMP under an eventual RAP, until financing assurances are in place. Directors were confident that the authorities' track record of policy implementation will contribute to strengthening the foundation for the progressive re-engagement of Sudan with the international financial institutions. Directors strongly supported the provision of technical assistance and training to Sudan, including those by the Fund.

Directors commended the authorities for their success in maintaining low fiscal deficits, which have underpinned Sudan's macroeconomic stabilization efforts. They welcomed the planned introduction of a medium-term economic program based on a three-year rolling budget geared toward consolidating macroeconomic stability, addressing the post-conflict challenges, and facilitating implementation of poverty reduction policies. Directors strongly emphasized that steps to further improve tax revenues, including through significant reductions in tax exemptions, and adoption of a comprehensive tax reform program should be critical elements of the medium-term strategy. The greater focus on poverty alleviation and agricultural sector development in the post-conflict period will require careful management of the fiscal policy implications of reintegration.

Directors emphasized the need for the authorities to continue to contain spending, and they welcomed their commitment to maintain the deficit target despite the spending pressures arising from flood relief in the east and civil disturbances in the west. They recognized that there could be calls to increase civil service salaries, which are low, but recommended that any wage increase be considered in the context of needed civil service reform.

Directors welcomed the steps to increase the transparency of the oil sector financial accounts. They also welcomed the establishment of the OSA as an instrument to stabilize budgetary outlays in the face of oil price fluctuations. Directors acknowledged that massive developmental and reconstruction needs may obviate the need to use the OSA as a "fund for future generations." Once sufficient reserves have been accumulated, the additional resources should be used to support the country's growth and development potential, while minimizing non-priority outlays.

On monetary policy, Directors welcomed the successful transition to a broad money targeting regime and an indirect monetary management framework. They were encouraged by the authorities' sustained efforts to ensure the availability of suitable instruments to build up the necessary expertise and institutional setting, and to strengthen coordination with fiscal policy. Directors considered that monetary policy will have to remain vigilant, and ready to adapt, as needed, in the face of balance of payments uncertainties and potential inflationary pressures. Directors welcomed the enactment of legislation on anti-money laundering and combating the financing of terrorism.

Directors considered that the managed-float exchange rate regime has served Sudan well and remains appropriate given the thinness of the foreign exchange market. They called on the authorities to monitor developments closely and to ensure exchange rate flexibility, with a view to safeguarding competitiveness and facilitating adjustment to external shocks. Directors welcomed the authorities' acceptance of the obligations under Article VIII, Sections 2, 3, and 4, of the Fund's Articles of Agreement. This, combined with recent reforms, underscores Sudan's welcome commitment to an open economy. Directors noted that the staff will conduct the necessary review of Sudan's exchange system as soon as possible. Directors urged the authorities to formulate a clear policy regarding the contracting of external debt, and in particular they attached the highest importance to avoiding new non-concessional borrowing, as a key element in a strengthened external debt management framework. They urged the authorities to avoid drawing down on the two nonconcessional loans recently contracted.