NEWS

Majok T. Deng:

The exchange rate is defined as the price of one currency in terms of another currency. In our case, it is the price of the South Sudan pound (SSP) in terms of the United States dollar, or it can be the price of the SSP in terms of the Euro, British pound sterling, Kenya shilling, Uganda shilling, and basket of currencies. According to the central bank website, 1 USD traded at 2,122 SSP as of August 6, 2024.

However, the process of determining an exchange rate has changed over time. For instance, currencies were directly pegged to gold during the gold standard era. According to Wikipedia, the gold standard existed between 1871 and 1914 as an international exchange rate arrangement. For example, the price of the SSP would have been pegged to the dollar, and the same value of the dollar is fixed to a certain ounce of gold.

In addition, the United States dollar (USD) was adopted as a reserve currency, making it convertible to gold at a fixed rate of 35 dollars per ounce of gold, per the Bretton Woods agreement that was signed in 1944 at New Hampshire in the United States of America. This agreement led to the establishment of the World Bank and the International Monetary Fund, and the IMF was given the role of policing the exchange arrangement between countries.

 In such an arrangement, since I have some SSP in my pocket, I would have walked into the Central Bank to offload them for gold equivalence. During this period, governments were constrained not to print more local currencies that were not backed by gold reserves. Unfortunately, the link between local currencies and gold was finally cut by the then-United States President, Richard Nixon, in 1972 due to various reasons among them the heightened demand for gold and the constraints this system had on the US monetary policy. This ushered in a new exchange rate arrangement where currencies are backed by nothing of intrinsic value. These types of currencies are known in economics jargon, as fiat currencies.

Therefore, currencies became very volatile and unstable across the globe. Thus far, some countries have pegged their currencies against the currencies of their major trading partners, such as the United States Dollar and Euro. South Sudan fixed the exchange rate against the USD shortly after independence in 2011. However, the BoSS switched to a market-determined exchange rate in 2015 as it increasingly became impractical to defend the fixed exchange rate regime amidst dwindling international reserves and the subsequent inflationary pressures. Unfortunately, the exchange rate has been very unstable in South Sudan since then, leaving the common man or woman to question who determines the exchange rate between the BoSS and black marketers. Indeed, BoSS doesn’t determine the level of the exchange rate but influences its level using different monetary policy tools such as foreign exchange auctions and the Term Deposit Facility (TDF). In other words, the Apex Bank is not operating on an exchange rate targeting framework. Its ultimate target is to maintain low and stable inflation, making exchange rate stability a secondary objective.

Regarding the foreign exchange auction, it has adopted the Dutch foreign exchange auction system (DFEA). This is the system of foreign exchange auctions that most central banks have employed to stem volatility in the foreign exchange market. According to this system, bidders who bid the rate between the second highest and second lowest bids get the dollars. Thereafter, dollars are allocated to bidders per their respective bid rate, and the weighted average (mean) is calculated by the central bank.

This is the exchange rate that appears on the central bank’s social media handles. It acts as a reference rate for market participants. This rate can move either way following the results of any new foreign exchange auction. The main reason why the central bank has been auctioning dollars to authorized dealers was to ensure that the market has sufficient foreign exchange to cover the import of goods and services. It is against this backdrop that the EAC required its Central Banks to hold forex reserves equivalent to 4.5 months of import cover. Furthermore, foreign exchange auction is the most important tool in BoSS’s toolkit. It is being used by the central bank to mop up excess liquidity in the system.

Another important liquidity management tool for the BoSS is the TDF, which also removes excessive liquidity from the system. In this regard, the bank asks participating commercial banks to deposit amounts up to 12 billion SSP for a period ranging from 28 days to 363 days, and the central bank pays interest rates on the TDF below the central bank policy rate of 15 percent at maturity.

Essentially, the central bank does all these things to contract the money supply in the economy and relieve pressure on the SSP in the foreign exchange market. By so doing, the monetary authority is pursuing what economists call tight or contractionary monetary policy, which is done to rein in inflation.

Nevertheless, with all this done, South Sudanese are still wondering why the SSP is still depreciating against the USD despite the amount of effort put in by their central bank. Certainly, some people have often concluded that central bank’s intervention in the foreign exchange market is an ineffective monetary policy tool. However, to my mind, it is the only game in town in South Sudan. The monetary policy rate, which is the traditional tool for central banks, is less active due to the shallow and thin financial market in the country, which makes the transmission of monetary policy decisions to the real economy very weak.

But to explain it further, let us understand how central banks acquire all the dollars they use to sell to commercial banks and forex bureaus. Except for the United States Federal Reserve, which has a printing press of dollars in its basement, other central banks acquire foreign exchange from their governments. In this case, the Bank of South Sudan gets all the dollars it auctions to the authorized dealers from the government of South Sudan, especially oil revenues. Let me also highlight that government’s budget is financed by almost 80% of the oil revenues. Having that said, if the Ministry of Finance and Planning wants to pay the salaries of civil servants and organized forces or some of its discretionary expenditures, it often sells its oil revenues to the central bank. The central bank can use its SSP reserves to pay the National Ministry of Finance and Planning with the equivalent of the dollars it has purchased.

Indeed, as the Finance Ministry pays its discretionary expenditures, it injects liquidity into the economy. The Central Bank would then sell foreign exchange it bought from the government to commercial banks and forex bureaus in exchange for the SSP in order to sterilize unnecessary increases in the monetary base caused by excess liquidity injected into the system by the finance ministry.

Let me use a hypothetical example to explain this point. For ease of argument, let us assume that the Finance Ministry has received one million dollars in its account from the sale of crude oil. Furthermore, let us also assume that the monetary base, which is the central bank’s operational target, is 4 billion SSP. If the Minister of Finance and Planning decides to pay the salaries of the civil and organized forces, but since they are paid in SSP, the ministry would have to sell that one million dollar to the central bank, which is the owner of the SSP.  

Let us use the hypothetical exchange rate of 100 USD, which is equivalent to 200,000 SSP. In this case, the Ministry would receive SSP 2 billion, which it would use to pay its expenditures. Consequentially, the monetary base would increase from 4 billion SSP to 6 billion SSP (M0 of 4 billion + 2 billion injection by the ministry), which would exert pressure on the SSP in the foreign exchange market if the central bank fails to intervene in the market. This will prompt the central bank to auction dollars to mop up the excess liquidity in the system. But it would only manage to buy back only 2 billion SSP, leaving the monetary base unchanged at 4 billion SSP.

 In contrast, if the central bank intervened in the market using the already-built reserves, it would affect the monetary base significantly. For instance, after the government received rapid credit facilities 1 and 2 worth 335 million dollars in 2020, of which 185 million dollars were allocated for the central bank reserves, the SSP had considerably appreciated against the USD in the black market. According to the central bank statistical bulletin (November 2022), the money in circulation declined from 100 billion to about 89 billion SSP after the central bank’s consistent intervention in the foreign exchange market between December 2020 and September 2021. On the other hand, the SSP had appreciated in the parallel market from 60,700 SSP per 100 USD in December 2020 to 40,300 SSP per 100 USD by September 2021.

In summary, the Bank of South Sudan must build substantial forex reserves that it would be using to intervene in the foreign exchange market going forward, if it can significantly impact the monetary aggregates, such as M1 and M2. Another important determinant of the exchange rate is the inflow and outflow of dollars in the economy. For instance, if the outflow exceeds the inflow of dollars, then the currency will depreciate against the foreign currency. Economists called this situation a current account deficit, which can be financed in two ways: either borrowing from abroad or drawing on the central bank’s reserves.

However, if the central bank cannot supply the market with a sufficient amount of foreign exchange, market participants will scramble over a few dollars in the economy, which will lead to the creation of a black market. Indeed, a black market for foreign currency repeatedly emerged as a result of either regulation or the scarcity of foreign exchange in the country fueled by expanding trade deficits and supply shocks.

Majok T. Deng is a South Sudanese economist and a consultant in the communication and public relations department of the Bank of South Sudan. He is reachable via majokthon2014@gmail.com. Disclaimer: The views expressed in this article are his own. These views neither reflect those of the Central Bank management nor its Board.