November 20, 2013 (SSNA) — For the starters, Central Bank of South Sudan issued a circular entitled “Exchange Rate Reforms” on 11 November 2013 to devalue its currency from about 3.16SSP/$1 to 4.5SSP/$1 with goal of unifying the official and black market exchange rates, thereby achieving its immediate target of lowering “short-term exchange rate volatility” and clamping down on “rent-seeking behavior” as well as stimulating the economy. This policy proved unsuccessful, and provoked public outcry over fuel shortage and price hikes of other consumer goods. This train of events compelled the National Legislative Assembly to intervene and order the reversal of the devaluation. The CBSS leadership has diffidently obliged.
First, was unification of the official and parallel market overdue and a worthy goal? The answer is absolutely affirmative.
Second, economics theory is nicer to any currency devaluation save its unintended consequences in an open economy setting. Currency devaluation of domestic currency is theorized to improve the balance of payments as well as boosting economic activity. Devaluation is likened to increase in money supply which makes local currency cheaper relative to foreign currency. It is hypothesized to disfavor imports and positively impact exports. This chain of monetary reactions is posited to bring about positive net exports which bear positively on the gross domestic product.
Third, price stability is one of the goals of the central bank. So, if the central bank’s independence over management of the monetary policy and achieving price stability is not in question and the theory predicts that currency devaluation is a good thing for the economy in the long run, then what is all this fuss about, especially the public outcry shattering the airwaves and the “corridors of powers” in Juba?
I would argue that the public outcry is justified and that the CBSS has erred in its approach to carrying out currency devaluation.
I. Approach to Devaluation: Shock Therapy Vs Gradualism?
While everyone would agree with the goal of unifying the two rates, the application of the “shock therapy” overnight was ill-advised because rapid devaluation can produce economic shocks. What CBSS did in essence was to decrease the original currency value by 150% from 3SSP/$ to 4.5SSP/$1. This is a huge change bearing in mind that South Sudan is, generally speaking, an importing economy. Second, it was unwise to “blindly follow” the black market rates. If the black market rate is 4.5SSP/$1 today, what would prevent it from reaching 10SSP/$1 the day after or next week? Have they thought about the consequences of the disequilibrium in the currency markets and how that may lead to price instability, something they were trying to avoid in the first place? Quite frankly, such abrupt devaluation was destined to choke off the import market since it will now be prohibitive to import from East Africa. One does not have to be a rocket scientist to figure out that such devaluation is going to be painful to many people; inevitably they will rise up in arms. They surely did!
If history is anything to go by, CBSS should have approached this by taking a leaf from other countries. While some people see the case of Poland as vindication of “shock therapy”, good and reasonable people also believe that sudden currency devaluation can have catastrophic effects. It was what largely got Mexico into currency crisis in 1994.
Therefore, the CBSS should know or should have known that large and sudden devaluation would negatively reverberate in the economy and as thus, they should have devalued the currency gradually by few percentage points, one at a time.
II. Nonexistence of Export Sector in South Sudan
CBSS was bold in believing that devaluation would improve the balance of payments manifolds and stimulate the economy but they failed to account for the fact that South Sudan has no export sector. That South Sudan has no export sector to compensate for the loss in imports should have given the CBSS pause before abruptly devaluing the currency. The gradualist approach would have not backfired as the “big bang” approach just did.
III. Lack of Clarity in Communicating Monetary Policy to the Public
So while unifying the two exchange rates was necessary, the manner in which it was done was ill-considered. Gradualism as opposed to shock therapy would have taken South Sudan a more prudent path toward the unity of the two markets. Secondly, CBSS fumbled the message and failed to communicate clearly to the oversight body and the public. Sadly, with the reversal, CBSS is more bruised than before or its credibility has been dented, dare I say? This lack of clarity is a bad PR and it does not augur well with the tenets of central independence in matters of monetary policy.
IV. Existence of Questionable Currency Exchange Bureaus
Finally, this policy prescription was not going to work. In fact, it was destined to die on arrival because of the “currency quota” factor. As long as CBSS continues to allocate dollars to foreign exchange bureaus whose aim is to flood the black market with those dollars, this “devaluation” was an exercise in futility. A story is in order. Some months after the independence, those who were trading in dollars on the street were asked to register or get arrested. But like everything else in south Sudan, this policy was never enforced. The black market is proving lucrative to some people in power and who concoct up stories to get dollars at the official rate only to turn around and sell them at black market rates.
What is to be done?
Generally speaking, it is good to recognize that monetary policy does operate in an environment where politics, economics and other factors interact to impose certain constraints on economic actors. A prudent policy maker must try to anticipate some of these countervailing factors.
Second, in least developed countries where the economic fundamentals are usually weak, including high inflation rate such as the case in South Sudan; where there is a fixed exchange regime with local currency artificially pegged to US dollars; and where citizens lack confidence in the national currency due to exchange rate volatility, currency black markets are a typical regularity. They form part of what is referred to as “underground economy” because the latter falls outside the purview of regulatory agencies such as central banks.
Therefore, knowing that black markets do exist in countries such as South Sudan, it would have been prudent for the central bank to come up with practical monetary policy that aims to instill confidence in the local currency as well as making sure that spot trading in foreign currencies is brought under control. It is an eyesore to see just anyone on the street at Customs market or Jubek Memorial market carrying dollars, pounds or both waiting to dump them whenever they hear the wind of dollars falling.
What Should CBSS Do Fast Forward?
The CBSS should not call it quits but continue to innovate and work harder to unify the two exchange rates through:
In summary, the CBSS was justified in endeavoring to unify the official and parallel market rates. However, the application of shock therapy without thinking about how the consequences of devaluation would play out, and failing to clearly communicate the policy intervention to the public have, in my view, bruised the credibility of the CBSS. It remains to be seen whether CBSS has learned from this experience. Else it would have been the story of yet another crisis gone to waste.
James Garang is reachable at [email protected]