The implications of South Sudan’s decision to float its currency

The government of South Sudan announced on Tuesday, December 15 the floating of the country’s currency. After the announcement, the value of the South Sudanese pound (SSP), which had been pegged to the U.S. dollar at an official rate of 2.96 SSP to the dollar, fell to levels approaching the parallel market rates of 18.50 SSP to the dollar.

Why float the South Sudanese pound?

The South Sudanese pound’s previous exchange rate arrangement (a conventional peg to the U.S. dollar according to the IMF Annual Report on Exchange Rate Arrangements and Exchange Restrictions, ARREAR) required the country to maintain an adequate level of foreign exchange reserves and show sufficient fiscal restraint. Recently, South Sudan has increasingly struggled to do this.

Oil revenues represent about 95 percent of the country’s foreign currency revenues. However, years of civil war and difficult relations with Khartoum resulting in reduced oil output (a 15-month shutdown in oil production), as well as a drastic fall in oil prices (now under $40 per barrel) have made U.S. dollars increasingly scarce in the country and have depleted foreign exchange reserves at the Bank of South Sudan (with the admirable acronym of BoSS).

The level of the peg (2.96 SSP to the dollar) also made export competitiveness challenging for sectors where South Sudan has great potential, such as agriculture.

The co-existence until now of an official rate (2.96 SSP per dollar) with a parallel market rate in the foreign exchange market (say 18.50 SPP per dollar) was a multiple currency practice in the IMF ARREAR parlance that created distortions in the market. It also reinforced perceptions of corruption. For a long time there has been a significant gap between the two rates, an indicator of the overvaluation of the official exchange rate. Indeed, a common practice was for a selected few and well-connected people to buy cheap U.S. dollars at the official rate and sell them for a hefty profit in the black market.

Why float now?

The decision to float the South Sudanese pound should not be a surprise: The government had, in the past, indicated its intention to devalue and unify the exchange rate. Indeed, in November 2013 the BoSS announced a 34 percent devaluation of the currency but reversed the decision immediately because of strong pressure from vested interests. Apparently, this time the government has now mustered the political will to implement this long-time wish. In addition, the price of oil falling below $40 per barrel must have been a factor in the decision. In this sense, South Sudan is following the lead of a number of oil exporters that are scrambling to manage the decline in oil prices. For instance, Kazakhstan also floated its currency in August this year.

What are the potential repercussions of this decision?

There are a number of advantages to this decision: The cheaper South Sudanese pound should help improve the government’s fiscal situation as revenues from oil exports (as well as aid flows) increase in local currency. It should also help replenish the BoSS foreign exchange reserves. In addition, corruption in the foreign exchange market will likely reduce. From now on, the BoSS will be able to conduct U.S. dollar auctions, and banks will be able to bid a maximum of 20 percent of the total amount auctioned.

In the medium term, a better functioning foreign exchange market should reduce U.S. dollar shortages and high transaction costs, and support trade. A cheaper local currency should also help improve the competitiveness of exporting sectors (again, such as agriculture) and make foreign direct investment relatively more attractive (there are, of course, other bottlenecks to foreign investment, including the security situation and lack of infrastructure).

Challenges lie in the short term, though:  Inflation remains high as South Sudan imports a lot of goods, including food and fuel. Although South Sudan exports oil, the landlocked country still lacks functioning refineries and imports fuel from its neighbors. Now that the SSP is floating, it will be important for the BoSS to develop the capacity to conduct monetary policy and develop the tools to implement such a policy very quickly in order to manage inflation.

In conclusion, floating the currency alone will not solve all the problems of the world’s youngest African nation but it should be used as an opportunity to accelerate structural reforms to kick-start the non-oil economy. Depending on oil revenues alone is not sustainable for South Sudan.