Michael Malaak Mayen, Juba, South Sudan
December 12, 2016 (SSB) — The effectiveness of official intervention in foreign exchange market is a crucial policy issue for South Sudan. The Bank of South Sudan abolished its fixed exchange rate regime due to gross overvaluation of it currency, the South Sudanese Pound. Since the abandoning of the fixed exchange rate regime and the introduction of a manage float in 2015, the Bank of South Sudan introduced the monthly and sometimes quarterly auctioning of foreign exchange. In the new regime, the Bank instructed commercial banks to report their daily exchange rates.
In the face of the underdeveloped interbank foreign exchange market, the weighted average of commercial banks daily rates, enable the Bank of South Sudan to obtain market-based official exchange rate. The introduction of the auctions was the consequence of the country’s shallow and underdeveloped interbank market for foreign exchange. Intervention in foreign exchange market changes the balance between domestic and foreign currency denominated in the markets, which induces the investors to adjust their portfolio, changing the exchange rate. Furthermore, the information contained in interventions modifies expectations regarding the future spot exchange rate, leading to an immediate adjustment to the current exchange rate.
The auctions supply foreign exchange liquidity in the context of an underdeveloped interbank market and serve as a policy instrument to intervene in the foreign exchange market. The Bank supplies the foreign exchange, which comes from the foreign exchange receipt of the government. Foreign exchange auctions were expected to serve as an intervention instrument enabling the bank of South Sudan to smooth fluctuation in the black market rate.
However, the Bank of South Sudan’s supply of foreign exchange is rather limited at present due to the civil war which has led to closure of some oil wells combining with fall in international oil prices, as oil is the sole provider of foreign exchange for South Sudan.
The relationship between official and black market rates since the introduction of a managed float last year has been rather conflicting. The expectation was that auctions will exert influence on the black market resulting to fall in the black market rate. The sharp depreciation of South Sudanese Pound since the introduction of the new policy implies that the Bank of South Sudan intervention was associated with higher black market rate volatility. The Bank sales of foreign exchange through auctions are associated with depreciation of South Sudanese Pound against the US dollar, rather than appreciation.
Though the auctions have minimal impact on the black market rate, their cost is significantly huge. First, the Bank of South Sudan’s sales of foreign exchange sometimes led to considerable outflows of foreign reserves. Second, the auctions provide windfall gains to the banks that arbitrage between the auctions and the black market.
Therefore, the foreign exchange auctions should be regarded as a transitory arrangement and Bank of South Sudan should put more emphasis on accumulation of its foreign reserves. The auctions ability to function as a means of intervention has been rather modest, whereas they have incurred substantial costs for the Bank of South Sudan in terms of eroding the official foreign reserves. It is a loss on both fronts because the Bank is losing foreign reserves while it is not achieving the goal of stabilizing the market.
A policy target of the Bank of South Sudan has been to align the official rate with the black market rate, closing the gap between official and black market exchange rates. The Bank can be seen as trying to follow the black market rate rather than guiding it. The Bank of South Sudan sought to influence the black market rate using auctions but there seem to be little success.
Regardless of the reforms to the foreign exchange regime, the gap between official rate and black market rate persist and keep widening indicating Bank of South Sudan limited ability to influence the black market. If there was mature interbank market in South Sudan, it would have been possible at least to bridge the gap between official and black market rates but there is no well-established interbank market and unification of official rate with black market rate seem to be unachievable goal due to ever increasing demand for US dollars.
The introduction of managed float, matching expectations then with reality today, did not bring about the much anticipated improvement in South Sudan economy and yielded nothing in the widely claim unification of official and black market rates. As things stand, the whole undertaking has been nothing short of a complete and total failure.
The author, Michael Malaak Mayen, works at the Financial Markets Department, Bank of South Sudan, in Juba, South Sudan. He holds a Bachelor of Commerce (Economics) from the University of Southern Queensland and Master of Economics from Macquarie University, Australia. The views expressed in this article are those of the author and do not necessarily represent those of the Bank of South Sudan or Bank of South Sudan policy. You can reach him at his email: email@example.com
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