Economic Research Forum (ERF)

Sudan and the pandemic: reforms for a vulnerable economy

Sudan’s economy was in a fragile state even before Covid-19 and the lockdown measures implemented to control the virus. This column outlines the bold yet practical reforms that are needed to help the country move to a virtuous cycle of rising productivity and incomes – and hence sustained reduction in poverty.

In a nutshell

Sudan’s fiscal system is fundamentally flawed: it does not perform the core functions of funding public service provision and reducing income and wealth inequality.

The government must address three major fiscal challenges: the bloated share of subsidies and military and security expenditures; the negligible share of progressive direct taxation; and the insufficient allocation of resources to basic social services.

Financial support from Sudan’s international friends would allow the country to engage in the structural reforms needed to get the economy moving.

Sudan is dealing with the Covid-19 pandemic from a position of extreme vulnerability. Foreign exchange reserves have hit rock bottom. The country’s main export markets in the members of the Gulf Cooperation Council (GCC) are expected to contract by 3% based on an oil price of $35 per barrel. Remittances will decline by as much as $500 million as lockdown measures in GCC countries disproportionately affect the sectors where Sudanese migrants work. Livestock exports to Saudi Arabia may decline by $360 million.

Oil export earnings are also expected to decline by 80% or $400 million. The total loss in foreign exchange receipts is likely to be around $1.2 billion. The good news is that this will be offset by a likely decline of $1 billion in oil import costs due to a substantial reduction in oil prices from over $60 a barrel in 2019 to $30 for 2020. An expected drop of 75% in transit fees for South Sudanese oil will add downward pressure to foreign exchange receipts, accelerating the depreciation of the Sudanese Pound.

Sudan’s economy before Covid-19

Sudan has seen its GDP halve between 2011 and 2019. A big reason for this is the loss of 75% of oil revenues following the separation of South Sudan in July 2011. Sudan’s current GDP per capita is only $800. Moreover, it is unevenly divided with over half the population estimated to be living in poverty. The country has unsustainably high levels of trade and budget deficits at respectively 15 and 11 percent of GDP. Sudan also has one of the lowest tax revenues in the world at under 6% of GDP, mostly from regressive indirect taxes.

The economy is basic with 58% of GDP coming from low value-added services, 22% from industry and mining, and a mere 20% from agriculture and livestock, the sector that employs most of the population. With 11% of GDP allocated to fuel and food subsidies, the state has failed to fund basic service provision adequately for many years. For example, out-of-pocket healthcare costs stand at 69% and three million kids are out of school.

Most workers in the bloated service sector engage in informal labour with no social protection. Inflation spiked to a double-digit monthly rate in January 2018 and has since remained stubbornly high. It reached its highest level of 98.8% in April 2020, as Covid-19 hit the country.

Sudan exhibits substantial regional disparities on many measures. Only one third of the country has simultaneous access to improved water and sanitation facilities. Access to improved water varies from a high of 90% in the Northern and Gezira states to a low of one third in the Gedaref, White Nile and Red Sea states. Primary school enrolment rates range from a high of 90% in North Kordofan to a low of 50% in the Red Sea State.

There are also huge disparities with respect to health, with the five states of Red Sea, Blue Nile, White Nile, East Darfur and Central Darfur classified as having extremely high level of health risks. Dilapidated transport systems impose high costs on internal movement of goods and are reflected in wide variations in inflation rates among states. The inflation rate in April 2020 exceeded 138% in the East, West and South Darfur states, with the rate double the national average in East Darfur at 197%.

Socio-economic ramifications

The strict measures put in place by the authorities to control the pandemic, while understandable given the fragility of the healthcare system, risk tipping the tenuous socio-economic balance into major instability. The government is aware of the fragile situation, which explains why the decision to lockdown Khartoum was not implemented earlier. They have taken steps such as distributing necessities to some of the poorest households in Khartoum as the lockdown went into effect, in order to cushion the blow.

But the loss in income imposed on millions of Khartoum residents is far higher than the value of commodities distributed. In addition, this loss in income happened during Ramadan, when household expenses increase due to seasonal price rises and the additional cost of a richer food basket than normal.

Another complicating factor is the disappearance of the public provision of Iftar (meal to break the fast with) outside mosques and other places that provided food on a non-discriminatory manner to all who wanted it. It is possible that many beneficiaries of these meals do not make it onto government registers used to identify households to be provided with necessities.

What makes the situation more tenuous is the substantial increase in poverty that has happened over the past two years as a result of rampant inflation and depreciation of the Sudanese Pound. The dynamics driving this process have not changed and hence we can expect the process to continue. Inflation will increase should there be a reduction in fuel and food subsidies this year.

A study of poverty in Khartoum, carried out by UNDP and partners in WFP, UNICEF and the African Development Bank in 2018, indicated that urban poverty had increased substantially. The resulting destitution had increased drug addiction, domestic violence and petty crime and strained social solidarity by making it more difficult for people to maintain social obligations.

A further increase in poverty, which will inevitably result from the lockdown, especially if it is extended, is likely to exacerbate the above noted anti-social behaviours. We already see anti-government agitation and opposition to measures taken being exploited by those threatened by a successful transition to peace and democracy.

The need for structural change to rebuild better

It is critical for Sudan’s international friends to provide much needed financial support. This would allow the country to engage in needed structural reforms to get the economy moving by initially stopping the haemorrhage of rising poverty through stabilising the exchange rate and bringing inflation under control. The state must simultaneously address its trade and fiscal deficits. The two are intertwined and must be dealt with holistically.

The fiscal system in Sudan is fundamentally flawed. It does not perform the core functions of funding public service provision and reducing income and wealth inequality.

On the expenditure side, the entire federal wage bill only accounts for 2.9% of GDP. The bulk of the 1.7% of GDP that is allocated to transfers to states is spent on wages, taking the total public sector wage bill to around 4.5% of GDP, well below the average for Africa and the Arab region.

The tax share of around 6% of GDP is over 90% dependent on regressive indirect taxes. Effectively, there is no meaningful taxation of personal income or wealth.

In this context the three major fiscal challenges the government should address are:

  • The bloated share of subsidies and military and security expenditures.
  • The negligible share of progressive direct taxation.
  • The insufficient allocation of resources to basic social services.

The implied deficit due to subsidies is being reduced as a result of the fall in international oil prices. The government has also taken measures to reduce it further by establishing a two-tier pricing system, with the introduction of a commercial rate, which is four times the subsidised price for both benzene and diesel.

It can be reduced further through immediate reform of electricity household tariffs to bring them in line with cost of production. Given that the bulk of electricity is used by the household sector, this reform can assist the productive sectors by reducing household demand.

The government has also raised the price of subsidised bread in Khartoum state. The foreign exchange cost of wheat subsidies can be reduced by increasing local production and mixing local cereals with imported wheat to increase the local content of bread.

The transitional government has already taken measures to contain the military and security sector budget. Measures taken have already created some unease within the security sector. The pending incorporation of rebel armies into the national military as a result of peace negotiations is likely to increase the salary component of the military budget.

Thus, the best one can hope for is containing the total budget, if one is to maintain the fragile civilian-military power sharing arrangement during the transitional period. Only once a government assumes power through elections planned for 2022 can the issue of the role and size of military forces be handled head on.

The other fiscal problem that causes the deficit is the limited fiscal effort, with tax revenues at 6% of GDP. Here, the solution is to institute progressive property taxation on residential properties and vehicles in Khartoum and major urban areas. This tax can easily more than double the tax intake to the 15% of GDP threshold below which IMF considers the country fiscally fragile. Such a tax is difficult to avoid and has low collection costs.

The other side of the coin is what the government is already focused on in terms of reducing exemptions against existing taxes. Temptation to increase the rate of sales taxes, except on luxuries, should be avoided due to its regressive nature.

The third area that needs attention on the fiscal side is increasing the dismal allocations to basic social services, particularly healthcare and education. This would help build a more resilient society against possible future pandemics.

The transitional government has already taken some steps to increase the allocation to basic services and reforming civil service pay, as part of the 2020 budget. Increased fiscal effort and a reduction in the size of subsidies should allow the government to further increase allocation to basic services.

The closing of the trade deficit and maintaining the value of the Sudanese Pound requires a lot of external support. The government can take measures like restricting imports of luxury goods, but efforts to increase exports and substitute for imports require external support.

Due to the neglect of Sudan’s productive infrastructure for decades, the cost of transporting goods to and from Sudan is sky high, making it difficult for Sudan to enter competitive export activities. Sudan has blanket preferential tariffs in the EU market but does not have links with major customers there.

The transport infrastructure will take a long time and a lot of money to build up hence it makes sense to initially focus on local transformation of products like gum Arabic. This would mean a focus on producing higher value items for which the relative cost of transport will be less of an issue.

Moreover, jobs will also be created in processing industries. But for this to happen there is need for foreign direct investment to bring in technology and management knowhow. Within the transport sector, rehabilitation of Sudan’s rail network should be possible with the right injection of modern know how and investment. Port Sudan can also be modernised, thus reducing the cost of shipping substantially.

New niche export markets should also be found in areas like organic agriculture to compensate for the high cost of transport and create jobs for educated youth. The specific products to focus on should be identified and required steps for getting certified organic designation followed. Just exporting more commodities will not close the trade gap; neither will it create the high productivity/wage jobs that an increasingly educated labour force demands.

On the import side, there is need for a careful study of the demand structure and identification of items that are for mass consumption and those that only cater to the rich. It would then make sense to limit to the extent possible imports of luxury goods in order to reduce demand for scarce foreign exchange.

There is also need for identification of sectors in which domestic demand is sufficiently high to justify import substitution industrialisation. While these ideas were out of fashion up to a few months ago, the Covid-19 pandemic has taught many countries the value of self-sufficiency. High transport costs in Sudan add an extra argument for maximal production for the local market.

Controlling the slide in the currency and bringing inflation under control is contingent on the twin trade and fiscal deficits coming under control. Sudan cannot afford to take for granted the low price elasticity of its imports and exports. Hence, it is vital to explore options for making exports and imports more responsive to incentives.

Adopting the right mix of fiscal and active trade policies will allow Sudan to move out of the vicious cycle of poverty it currently is in. Adopting the bold yet practical reforms suggested above can help Sudan move to a virtuous cycle of rising productivity and incomes, and hence sustained reduction in poverty.

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