Tryaksh International Journal of Business & Management


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Volume-1 Issue-1, 2021


Impact of Foreign Reserves on Exchange Rate Fluctuations in Sudan from 1978 to 2019

Dr. Ayoub Taha Sidahmed Taha

Associate Professor of Economics-SIU- Sudan.

Suggested Citation :

Dr. Ayoub Taha Sidahmed Taha, Bakheeta Mohamed Mahmud Hag Altahir. Impact of Foreign Reserves on Exchange Rate Fluctuations in Sudanfrom 1978 to 2019, Tryaksh International Journal of Business & Management (TIJBM), Volume 1 Issue 1: Tryaksh. 1(1): 1-12.

Abstract

This study has been carried out to investigate the effect of foreign exchange reserves on managing the fluctuations of the exchange rate in Sudan,during the period from 1978 to 2019. The study adopted the historical approach to find out the development of both foreign currency reserves and the exchange rate; and then the study used the econometrical analytical approach to explain the relationship between the size of foreign currency reserves as an explanatory variable and the exchange rate as a dependent variable. The study found that the local currency exchange rate continued to deteriorate against the dollar by more than one hundred and eighty thousand times during the study period. In contrast, the size of foreign reserves in Sudan remained small and low, except for the period of oil production(2000-2011). The study confirmed that the size of the reserve fell short of covering 50% or even33% of the country’s annual needs for imports, as its coverage rate for imports reached 17%, and for foreign debt was only 3%. The study proved that there is a positive relationship between the foreign exchange reserves and the foreign currency exchange rate, where the correlation coefficient reached about 0.93. This was demonstrated when the study period was divided into four stages, excluding the oil production phase from 2001 to 2011, which confirms that the nature of the policies adopted did not improve the local currency exchange rate against the dollar. These results showed that foreign currency reserve, despite its weak size and its fluctuations, has increased the value of the foreign exchange rate, which indicates that the foreign exchange reserves were obtained from unreal resources that led to the weakness of the local currency and the escalation of foreign currency values such as the dollar, in addition to the lack of appropriate policies to manage money supply. The study indicated that export revenues did not cover imports, and the remittances of expatriates abroad remained very low. All this made foreign currencies a source of speculation through local currency, which increased in supply and decreased in value. The study recommended encouraging exports, especially value-added products, with the need to rationalize imports and public spending, review foreign exchange policy to the extent that it provides conditions conducive to foreign currency and alters the continuous devaluation of the local currency., And then the need to follow an appropriate mechanism to manage the money supply of local currency.
Keywords: Foreign Reserve, Exchange Rate, Reserve Adequacy, Exchange rate policies. Exports, Imports

Full Text

The foreign exchange reserves in Sudan witnessed great fluctuations during the study period. On the other hand, several policies and procedures were followed to correct the exchange rate, so the study came to stand on the effect of foreign exchange reserves on the exchange rate. Hence the problem of the study was raised in the following question: To what extent did the foreign exchange reserves affect the exchange rate in Sudan during the period 1978 - 2019? 

This question, in turn, leads to the following sub-questions:- What is the level of correlation between foreign exchange reserves and the exchange rate? What is the level of correlation between the size of the money supply and the exchange rate?

What is the appropriate level of foreign exchange reserves to stop the deterioration of the local currency against foreign currencies in Sudan?

Importance of the Study Sudan has been suffering for a long time from weak foreign exchange reserves for several reasons that contributed to the decline in foreign exchange inflows, which caused fluctuations in the local currency exchange rate against other foreign currencies. The economic situation worsened after the secession of South Sudan in 2011, and Sudan lost 75% of oil revenues, as this greatly affected foreign currency reserves and negatively affected most of the economic gains that were relatively achieved during many years prior to the secession process and cast a negative shadow over the entirety Economic performance, although the country has adopted several policies to improve foreign exchange flows to control exchange rate fluctuations. This study followed the historical approach to extrapolate developments in foreign exchange reserves as well as the exchange rate in Sudan during the period from 1987 to 2019,. This is in addition to applying the econometrical method to study the correlation between the foreign reserve and the exchange rate, which confirmed the existence of a positive relationship,reflecting that the foreign exchange reserves did not contribute to strengthening the local currency against a foreign currency, such as the dollar. Therefore, the result indicates several aspects, including that the reserve was not used in managing the exchange rate, also the foreign exchange policies adopted during the study period contributed to the devaluation of the local currency

Study Hypotheses To answer the study’s questions, the study proposes the following hypothesis:- There is a positive correlation between the foreign exchange reserves and the foreign exchange rate in Sudan.

Study Objectives: this study aims to (1) Explain the implications of the exchange rate and foreign exchange policy in Sudan. (2) Clarify the effect of the foreign exchange reserves in Sudan on the exchange rate.

Study Period The time span of the study was chosen from 1978 because this year was the beginning of the liberalization of the exchange rate in Sudan with the aim of moving the export sector and supporting the country’s foreign exchange reserves, and From that date and throughout the period of study extending for 40 years until 2019, foreign exchange reserves witnessed remarkable changes as a result of economic conditions in the country, which necessitated adopting several policies
towards the exchange rate.

Study Methodology The study followed the historical method to find out the development of both foreign currency reserves and the exchange rate, and then the study used the econometrical analytical method to explain the relationship between the size of foreign currency reserves as an explanatory variable and the exchange rate as a dependent variable through the following functional relationship: (FER) = α + β (EXR) + ℮I, where (FER: Foreign Exchange Reserve ،،،EXR: The exchange rate &EI: the random limit.)

Literature Review
Foreign Exchange Reserves

Financial and economic analysts frequently use the term foreign exchange reserves, because of its great importance in the monetary and financial system in each country, and its great link to economic activity and import and export operations, in this is addition to determining the value of the local currency for each country. Many have dealt with the concept of foreign reserves instead of the foreign exchange reserves;. However, studies differed about establishing an accurate and comprehensive concept of foreign reserves, due to the disagreement about the elements that make up the reserve. The definition of the fifth editionof (Balance of Payments Guide) states that “these reserves, are external assets that are readily available to the authorities for direct financing of payment imbalances and indirect regulation by interfering in the exchange markets to influence the currency exchange rate ) (N, E, Custer 2000, p. 49).Andsince the concept The foreign reserve is a broad concept and includes all foreign assets of foreign currency and gold balance, in addition to treasury bills and bonds, special drawing rights units and net reserve position at the International Monetary Fund, hence this study focused on foreign exchange reserves because it is the most liquid assetof these assets at the disposal of the central bank to use when necessary. Number of researchers have pointed out the importance of thisapproach in dealing with the composition of foreign reserves and the feasibility of using them, (foreign reserves should be liquid or close to liquidity in order to be ready to resort to when necessary and at the required speed, Jocelyn Landel, Mills 1989, p. 17).

Adequacy of Foreign Exchange Reserves
Maintaining a large foreign exchange reserve may entail its cost in sacrificing alternative opportunities that would have yielded socio-economic returns if these resources were used. At the same time, diminishing reserves will affect the state’s ability to cover its imports for a future period as well as financing its productive sectors and preserving on the value of the local currency at a fixed and stable rate. Whenever the balance of foreign currency reserves is abundant in the central bank, this gives foreign and local investors a sense of confidence and security, especially in times of crisis. Foreign reserves are always needed to ensure that the state will fulfill its external obligations, including
sovereign and commercial debts, and include the ability to absorb any unexpected capital movements. Many studies have looked at the optimal level of reserves that
make the country in a safe position against external shocks that could be exposed to the balance of payments as a result of the high cost of imports, low export earnings and the difficulty of external borrowing, Consequently countries do not resort to adopting policies that lead to the deterioration of the value of the local currency and deterioration of economic conditions.

It was stated in the report of the International Monetary Fund (the adequacy of reserves should be considered through their ratio to imports in order for this to ensure that the country has the flow of its necessary imports, (IMF Report 1970).Some studies have gone to determine the acceptable percentage of the reserve’s coverage for imports (the ratio of reserves to imports should range between 30 to 40%,( John William Sun pp. 196, 1988 CE), and this does not apply to many countries .In Sudan and throughout the study period (1978 - 2019), the coverage ratio of the imports reserve did not exceed 17% at its best. Many interested people have argued that increasing imports may be a catalyst for increasing reserves, but this may not be effective in many countries. In Sudan, despite the growth in the volume of imports during the study period six folds (from 0.03 billion to 0.18 billion), this, resulted in the reserve doubling just twice(From 1.3 billion to 2.6 billion) and the economy has not been able to create safety reserves, which confirms that the majority of Sudan’s imports are consumerstyle, (It notes that Sudan’s imports of productive elements decreased significantly, and in contrast, imports of consumer goods increased by a rate of 66%, Ahmed, Al-Omari, and Ayoub 2018.In contrast, the majority of Sudan’s exports of raw Materials. (it is noted that the proportion of Sudan’s exports of Raw materials are about 100%, Ahmed, Al-Omari, and Ayoub 2018).This inverted image made the balance of trade in a state of continuous deficit, which reflected negatively on the foreign exchange reserves. Precautions are always used to face the deficit in the trade balance due to the deterioration of export earnings, the increase in import prices, or the deterioration of the terms of exchange. (Reserves are an asset to meet the deficit, and to avoid the state from entering into undesirable policies as a precaution. J. Niehans ،IMF, 1970).A number of researchers have used the foreign exchange reserve ratio to offer money in its broad sense (currency with the public + demand deposits and quasi-money (M2) to find out the effect of increasing money supply on foreign exchange reserves.If the ratio is low, it means capital outflow (if the money balance is M2 compared to reserves) Significantly, this confirms the existence of a huge amount of capital, and this percentage is important for countries in which the banking system is characterized by weakness (Muhammadi, Al-Tayyib M’hamed 2008, p.92).
 


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