BY: Garang Atem Ayiik, NAIROBI, KENYA, NOV/21/2013, SSN;
In a circular from Central Bank of South Sudan (CBoSS), The Bank directed banks and other stakeholders about its regulatory change it made on 11 November 2013 to exchange rate policy. The dollar was to sell at 4.5 SSP from 3.16 SSP reducing the value of pound about 42% against the dollar.
The directive was rescinded by CBoSS after parliament did a mob justice to the governor. On 14th November 2013, the author was invited to Wake Up Juba through a phone call as a panellist that discussed the devaluation case.
This article benefited from the author’s thesis, ‘Efficiency Management of Foreign Currency in Developing Countries: A Case of South Sudan,’ presented and approved for award of masters of Art in Economic Policy and Management at the University of Nairobi’.
The aims of this article are to provide an appraisal of the current exchange rate policy, and evaluate devaluation policy by underpinning arguments in economic theory and in South Sudan economic fundamentals.
As I said while on Wake Up Juba, the intention of Central Bank was noble, how the approach was wrong. To be precise, the policy that was proposed by CBoSS is actually the same recommendation that the author presented in his thesis at the University of Nairobi in July 2013.
The difference is that the author took care of the short-term misery that the policy will causes to the public and proposed some interim economic helmets that the Central Bank ignored.
As a result, CBoSS provided a window for parliament to mob justices the governor into accepting ‘withdraw now’.
The current fixed exchange rate has many flaws.
First, it has lead to growth of shallow financial institutions that are building long-term financial instability in the future. As at end of November 2012, there were about 18 banks and 68 bureaus whose incomes are mainly from currency trading.
Second, allocating dollars to banks and bureaus has accelerated inequality and distributive injustices; the author throughout his studies has always financed his studies through buying dollars in the black market and so do many needy South Sudanese.
Thirdly, allocation of dollars has institutionalized rent-seeking behavior through licensing and allocation.
Fourthly, fixed exchange rate passes the obligation to Central Bank to maintain the exchange rate at 3.16 SSP even at times when reserves wither; a case was during oil shutdown.
With the above flaws, and mandated by Central Bank Act 2011, the CBoSS has incentive to evaluate its exchange rate policy and change the policy if appropriate.
Exchange rate policy has two extremes; float and fixed exchange rates. However, in between, there are many types. The type of exchange rate chosen by a country is determined by integration into global financial system, country specifics economic disturbances exposure, economic structure, and exchange rate risks.
I believe neither fixed or float exchange rate is appropriate for South Sudan but dirty float with strong CBoSS influences will be workable.
In this regards, first, South Sudan has only one export product – oil. If anything affects flow of oil, the ability of CBoSS to support a fixed rate is in doubt; I believe CBoSS was almost at this point of not sustaining the fixed rate before oil production resumption.
Second, a weak financial system that is not integrated into global economy renders helpless Fleming–Mundell of feedback and self-regulating view through the capital market.
South Sudan is an import country with many constraints on its export sector that inhibits short increase in export production, a key point ignored by many analysts and economists.
With oil export, transported through unreliable pipelines, it become very risky for CBoSS to run a fixed exchange rate.
Furthermore, as an import country, exchange rate can not be allowed to float as this will increase the prices causing misery to the public in short term – be aware that local production is not going to respond to devaluation incentive.
The author has established during his research that inflation and exchange rate move together (correlated) in South Sudan.
From my analysis of theoretical and economic realities of South Sudan economy, and aware of key flaws in managing fixed exchange rate in a weak institutional set up, I agreed to a need to change the exchange rate policy by the CBoSS.
In a nutshell, I agreed that the current rogue exchange market needs to be disciplined. However, I differ with CBoSS in its approach.
In the course of my research, it is worth to note that dollars supplied by CBoSS to the market are not based on any economic data – neither demand nor exports are considered.
A trend analysis of dollars supply for 2011 – 2012 does not provide any meaningful relationship. An indication that dollars supply is done on an ad hoc basis.
This justifies that equilibrium is never met and that is why there is a black market.
The lesson is that if the price of a dollar is increased to 4.5 SSP and demand/supply equilibrium is not met at this rate, the black market will go up.
In the case of the devaluation policy that was proposed, the exchange rate in the black market I supposed was going to stabilize at about 6-6.5 SSP.
Hence from black market perspective, the policy was going to disturb the two-market equilibrium prices but the fundamentals were the same. The policy was not going to solve the black market problem.
Critical in economic policy is the objective. There are two key objectives of exchange rate policy; macroeconomic stability and international competitiveness.
Devaluation was going to increase the prices of imports instantly for about 42%. There has been argument even from respected South Sudanese economists and analysts that the increase was going to be a short-term problem.
Devaluation encourages exports and discourages imports. In theory, if exports are encouraged, firms and individuals are expected to act rationally by investing in exports that has been subsidised.
What these economists and analysts ignored are structural problems that will not allow the subsidies to trickle to the export sector.
In the case of South Sudan, insecurity, infrastructures, technology, capital, entrepreneurship, institutions and attitude are key impediments to workability of Fleming–Mundell on whose basis much analysis and policy relied.
It will take long for local producers to produce import–substitutes.
Elasticity and multiplier are going to be inconsequential in minimizing the impacts of devaluation. The theory did not consider these impediments and hence applying a theory without appraising it, is suicidal.
With minimum export sector and structural impediments to its growth, the author would not recommend international competitiveness as an objective to be pursued with exchange rate policy.
I believe only macroeconomic stability is achievable with this tool.
There is need to focus on local production for local consumption as current economic structure does not permit huge increase in exports.
This article illustrated three weakness of the devaluation policy that was proposed by CBoSS. One, it ignores to address weakness in estimating market demand and supply and hence not providing solution to black market it pretended to eradicate;
second, the policy ignores the unique structural socio-economic fundamentals of South Sudan and,
finally, the policy deviates from providing macroeconomic stability to South Sudan.
The author believes no policy that does not address these key issues was going to succeed. How did the most knowledgeable economic institution fail to address these issues in its policy?
My hypothesis is that this policy was initiated to fail. Could it be that donors, development partners or Khartoum bothered CBoSS with devaluation?
Just to cover its back, could it be that CBoSS proposed a policy that it was aware was not workable and likely to cause uproar and likely to be stop by the public?
Then CBoSS goes back to the old order of allocating dollars to banks and bureaus! The author leaves this to academic and policy curiosity.
The author believes that we could have done something different to minimize the attention the policy caused and the affected constituents.
In this regards, the author proposes that CBoSS should not have interfered with the official rate instantly; the rate should have been left at 2.96 SSP. However, the author supports the view that banks and bureaus should bid for the dollars from 2.96 SSP as in the proposed policy. This will lead to gradual depreciation of pound in the long run.
However, CBoSS will have control on the depreciation as it will control the supply of dollar amounts.
This would have many effects; first, it will diminish the black market incentives and reducing black market role.
Second, it will gradually weed out shallow financial institutions that are building future financial tsunami.
Third, it would enable CBoSS to protect the citizens by keeping depreciation within acceptable limits.
As this happens, policies should be instituted to solve current structural impediments that I believe could inhibit growth of export sector rendering the economic foundation on which the policy was built unworkable.
In addition to internal challenges of fixed exchange rate, there are external factors that could have softened CBoSS to lean towards float exchange rate regime.
The economic changes in Sudan, Khartoum probably asked South Sudan to devalue its currency to reduce possible currency arbitrage between the two Sudans.
Liberalized monetary system is a requirement for candidates joining East Africa Community. With recent passion to join the community, this could also influence and thirdly, as a float rate is good for the World economy, donors and development partners might have advised CBoSS to devalue the pound and lastly, I believe CBoSS was in a tight economic position in regards to sustaining a fixed exchange rate during oil shutdown and that is why it was passing part of the obligation to the public through depreciation.
The author believes none of these institutions is our enemy or economic commander, CBoSS is at liberty to accept policies that take care of its current and future macroeconomic fundamentals.
After the dust settles, there are key lessons, one, there is need for consultations between government institutions, civil societies and relevant professions on any policy.
Second, rejection of the policy by parliament has exposed the Bank as weak and non–consultative institution whose policies are not reliable and acceptable and this will encroach on the independent of the Bank.
Third, rejection of the policy confirms time value for money – people are concerned with immediate gains not long term theoretical fundamentals.
It is my view that nothing is right between the old order and the new policy. We need something between and that is what the whole nation must aspire for.
We should neithe allow a few brokers to run the foreign exchange market nor should we allow misery to the masses with the proposed policy.
Garang Atem Ayiik is a Certified Public Accountant, holds B.A in Economics (Moi University) and expected to graduate with master in Economic Policy and Management at the University of Nairobi in 2013. He can be reached at email@example.com or +211955115299