The World Bank, United Nations and International Monetary Fund

FRAMEWORK FOR SUSTAINED PEACE, DEVELOPMENT AND POVERTY ERADICATION

THE WORLD BANK, UNITED NATIONS AND INTERNATIONAL MONETARY FUND

STAFF ASSESSMENT OF PROGRESS

FEBRUARY 15, 2006

1 I: Introduction This assessment was prepared by staff of the World Bank, UN and IMF for consideration by the Sudan Consortium as a complement to the report prepared by the Government of National Unity (GNU) and Government of Southern Sudan (GOSS). It is a short note, analogous to the Joint Staff Assessments that Bank and IMF staff routinely prepare for consideration alongside national poverty reduction strategies. The note lays out the views of the staff of these institutions with respect to the implementation of the policies and programs, key constraints, and next steps; and thus covers both achievements through end 2005 against the commitments in the JAM and preliminary recommendations for the coming period. It should be read alongside the GNU/GOSS’s own report and matrix. The World Bank staff has focused on institutional and cross-cutting challenges, and on expenditure allocations, especially transfers and pro-poor expenditures. The IMF staff has focused in particular on the macro-framework and on the budget. The UN contributed, among other things, to the assessment of security and livelihood aspects. The next section presents a review of political and security developments. Section III assesses macro-economic developments and prospects for 2006, followed by an assessment of budget allocations with an emphasis on pro-poor commitments. Section IV highlights systemic constraints and proposed next steps, distinguishing between the GNU and GOSS. The final section reviews (projects) external financing gaps, based on the governments’ requests for support from the international community.

II: Political and security overview Since the Government of Sudan and the Sudan People’s Liberation Movement (SPLM) signed the Comprehensive Peace Agreement (CPA) in January 2005, the parties have been working out the transitional structures to underpin its implementation. These institutions were designed to provide basis for democratic governance, making unity of the Sudan attractive and creating an environment to allow the people of Southern Sudan to exercise their right of self-determination in early 2010. In 2005, progress was made on several fronts of CPA implementation, although there have been delays and troubling areas remain. The most crucial foundations of the State were laid by 9 July, with the approval of the Interim National Constitution (INC) and the swearing-in of the collegial Presidency including the SPLM leader John Garang de Mabior. The INC benefited, albeit belatedly, from inputs of some of the opposition parties in the North, notably the Democratic Unionist Party (DUP) and the other parties to the National Democratic Alliance (NDA). Although other Northern parties, including the Umma Party, have reiterated their opposition stance, the agreement with the NDA paved the way for its participation in the GNU and thereby broadened the support base for the CPA. Further broadening will occur alongside steps towards the democratization of the country and a genuine, all-inclusive approach to rule of law, human rights, fundamental freedoms, civil and political freedoms, decentralization and devolution of powers to the people through the appropriate levels of government. The death of First Vice-President John Garang de Mabior on July 30 was a serious blow. Although nothing suggests anything other than a tragic incident, mistrust and suspicion erupted into days of ethnic riots in Khartoum, Juba and other major towns of Southern Sudan. Yet the swift, joint reaction of the Government and the SPLM, notably

2 with the appointment of Salva Kiir Mayardit as the SPLM Chairman and Garang’s successor and the establishment of a joint commission of inquiry into the incident with international and UN participation, evidenced maturity and statesmanship. Consolidation of progress on the political front is all the more urgent given the ongoing crisis in Darfur. The Government and the two major armed movements, the Sudan Liberation Movement/Army (SLM/A) and the Justice and Equality Movement (JEM), signed a Declaration of Principles (DoP) in Abuja on 5 July under the auspices of the African Union. Several rounds of discussions have been completed in Abuja and the talks have made important progress, especially with respect to wealth sharing arrangements. The participation of the SPLM for the first time in the Darfur peace talks was a welcome development in December 2005 that may help in building confidence and trust as well as broadening commitment to the peace process. The situation on the ground in Darfur remains critical and has created a sense of crisis, not only from a humanitarian perspective, but more generally casting a cloud on the country as a whole, and on regional and international relations. There have been repeated violations of the ceasefire, with attacks on the civil population and humanitarian workers. The number of displaced people has reached 2 million, while 3 million (half the total population of Darfur) are now dependent on international relief for food and other basics. At the same time, many parts of Darfur are becoming too dangerous for relief workers to reach. There has been a welcome shift in international focus from humanitarian relief to grappling with the core political issues, which will need to be sustained by donor commitment to support peace dividends for the people of Darfur once conditions allow. A rapid and successful conclusion of the Abuja peace talks is critical; both to pave the way for full-fledged development efforts in Darfur and to ensure that the benefits of peace more broadly can be fully reaped. Turning to Southern Sudan, the establishment of the Legislative Assembly and the formation of a caretaker GoSS and state governments, underpinned by the Interim Constitution for Southern Sudan (ICSS) provided the basis for the new government. That the SPLM started to reach out to other Southern political forces, and transferred such key ministries as education, agriculture, and industry and mining to other parties appears as a commitment to political pluralism and broadening support for the CPA. The dialogue with other armed groups in the south has started to take clearer shape. Recent focus group work suggests that the current GOSS is perceived by the population as inclusive. However, political stability in Southern Sudan rests not only on implementation of the CPA, but also on the speed with which the SPLM is transformed into a political party able to enrich democratic governance and ensure that significant public resources that the new government manages will benefit the people of Southern Sudan (see below). While there have been some encouraging security developments in Southern Sudan -- including gradual progress in regularization of the SPLA’s military forces, and in the creation of the Joint Integrated Units (JIU), as well as the declaration on unity and integration between the SPLM and the South Sudan Defense Forces (SSDF) on January 8 2006 -- real concerns remain. Foremost are the increasingly evident inter and intra tribal and community tensions, which require that the GOSS, in partnership with civil society, engage in grass roots reconciliation processes. Incorporation of SPLA soldiers into the JIUs needs to accelerate, and delays in the incorporation of Other Armed Groups (OAG) will have to be rapidly overcome. Although established, no meaningful progress

3 has yet been made in the Ceasefire Political Commission and the Joint Defense Board, Finally but not least, is the need to address SPLA concerns about delayed payments, weak motivation and training. A scale-up of efforts in the transitional areas of Abyei, Southern Kordofan and Blue Nile, where progress on implementation has been even slower than in the South, should be a key priority for the coming year. In Southern Kordofan and Blue Nile, State Governors have been appointed by the Presidency. The interim constitution of Blue Nile State has come into force, paving the way for institutional development in the state in accordance with the CPA; however the failure to thus far finalize the interim constitution of Southern Kordofan has delayed progress there. Abyei remains a flashpoint. The decision of the Abyei Boundary Commission on the geographical boundaries was met with widespread Misiriya dissatisfaction and, therefore, has so far not been implemented by the GNU. The formation of a new administration in Abyei area is a significant challenge. UN agencies have become more engaged in the area and have helped ease tensions. The forthcoming arrival of the SPLA component of the JIU should assist in maintaining security, although this needs to be complemented by Presidential support for processes of peace among local groups, as mandated by the CPA. Also urgently needed is the establishment of the Abyei Area Administration in order to assist in these efforts, as well as in receiving the expected huge influx of returnees to the area. The development needs in Eastern Sudan remain to be addressed in a meaningful way, and the security situation remains tense. The scheduled SPLA re-deployment from the area has been postponed and recent incursions by SAF-supported militias in Hamash Koreib have increased local tensions. UN efforts to promote a peaceful resolution to the crisis are underway, but the planned talks between the National Congress Party and the Eastern Front under the Libyan auspices are facing continuous delays. Moreover, the development needs of the East should be clearly addressed as part of the scale-up of pro-poor efforts assessed below.

III: Macro-economic and fiscal developments For the past six years the national authorities have successfully implemented macroeconomic policies in consultation with IMF staff in the context of successive staff monitored programs (SMPs). The mid-year review of the 2005 SMP was presented to the IMF’s Executive Board in December 2005. The final review of the 2005 SMP is expected to be completed in March-April, and discussions have just been concluded on a new SMP for 2006 between an IMF mission and the authorities. The policy understandings reached by the IMF mission will be presented to the management of the IMF to seek its endorsement. This section presents a preliminary assessment of Sudan’s economic performance and budgetary developments in 2005 and the main policy challenges for 2006. Fund staff will present an update of this assessment including an analysis of macroeconomic policies, the 2006 fiscal framework, and prospects for the year at the Consortium Meeting in Paris. In 2005, overall GDP growth was strong at 8 percent and inflationary pressures were contained. Growth was bolstered by a recovery in agriculture and robust activity in construction and services. Oil production remained virtually unchanged as there was a delay in commencing production from two new fields. Inflation rose earlier in the year but was subsequently contained: for the year as a

4 whole, the average and end-of-period rates of inflation were 8.5 percent and 6 percent respectively. Regarding external balances, the current account worsened in 2005, but the balance of payments was supported by strong capital inflows. Based on preliminary estimates for 2005, oil export revenues rose because of higher oil prices, but imports rose drastically and non-oil exports fell. The latter suffered from transportation bottlenecks (due to delays at the port and inadequate road infrastructure), high domestic demand, and, possibly, real exchange rate appreciation. Nonetheless, a continuation of the strong trend in capital inflows (mainly foreign direct investment into several sectors of the economy) allowed for a further build-up of international reserves from 2 months of imports at end-2004 to 2.6 months at end-2005. Despite healthy economic performance in 2005, the national budget faced new pressures and total expenditures exceeded the budgetary provisions. The main source of pressure was the emergence of a large subsidy on domestic fuels (especially gasoil). These subsidies do not benefit the poor in Sudan, distort the allocation of economic resources, and carry a large fiscal cost that compromises other priority expenditures. However, the authorities have delayed action in this area because of their concern about potential social unrest associated with an increase in fuel prices at a time when the population expects a peace dividend from the implementation of the CPA. A key feature of the 2005 budget was a substantial increase in transfers to the states and to the South specifically, with a corresponding decline in the share of total resources devoted to central government spending (from 91 percent of total spending in 2004 to 74 percent in 2005). The GOSS received transfers equivalent to roughly 3 percent of GDP in 2005, most of which was transferred in the second half of the year. However, the Three Areas received a negligible amount of transfers (see below). While the appropriate definition and calculation of domestic pro poor spending in Sudan are still at a preliminary stage in the context of the ongoing Public Expenditure Review (PER), our analysis suggests modest progress in 2005 relative to 2004. Preliminary analysis of spending through the end of the third quarter of 2005 suggests that pro-poor spending remained at about the same level as in 2004 (around 3 percent of GDP), although this estimate may change as the analysis is further sharpened (see below) and the analysis of 2005 budget outturns is finalized. Overall it appears that other budgeted items, as well as the large domestic fuel subsidy, prevented pro poor spending from increasing as originally envisaged. At the same time, part of the shortfall can also be attributed to lower than expected external financing. A number of the structural reforms envisaged for 2005 were implemented, although there is a need to accelerate improvements in transparency of fiscal expenditures at all levels of government. Key reforms in this area involve the adoption of Government Finance Statistics Methodology (GFSM 2001) and a strengthening of budget procedures. In this regard, we welcome the recent commitment of the National Government to convert the 2006 fiscal framework into GFSM 2001 and begin monthly reporting for 2006 on the same basis by mid-year. The 2006 fiscal framework reflects a large increase in transfers to the states and, according to preliminary analysis, in pro-poor spending, albeit from a

5 very low base (see Section V below). However, the criteria for transfers (both the total amount and the allocation across states) need to be further clarified, as well as the large size of the “other” expenditure category in the budget. Bank staff will present the results of this analysis at the forthcoming Consortium, which will be expanded during the PER. The GOSS budget for 2005 suffered from delays, and execution reports are still in preparation. The execution report of revenues and expenditures in 2005 is also being prepared and is expected to be finalized and made public in March. The 2006 budget is now being prepared, and it is expected to be passed by the GOSS Parliament in March 2006 and begin on April 1. We also welcome the GOSS commitment to begin monthly reporting and publication along GFS lines in the context of Sudan’s SMP with the IMF. Sectoral ceilings for the 2006 GOSS budget show close correspondence of budget allocations with the priorities that emerged from the JAM (see further below). Some adjustments are needed to allow for new commissions (per the ICSS) and the financing of security needs. A major challenge will be to implement the budget effectively, and ensure transparency and accountability in its execution. In addition, absorptive capacity poses a real challenge, given that the structures of the GOSS are just being established. Looking ahead, the national government is well placed to continue implementing sound macroeconomic policies and intensify reform efforts to ensure sustained high economic growth and reduce poverty. Maintaining stability will require fiscal prudence and improvements in policy coordination at different levels of government. Notwithstanding the ongoing increase in oil revenues, fiscal policy is expected to mobilize non-oil revenues and reorient expenditures toward pro-poor infrastructure and the social sectors. Reforms are needed to further improve transparency of government operations and ensure the success of fiscal decentralization. At the same time, the introduction of the new currency in the second half of 2006 will require careful planning and distribution. The key near term macro and fiscal policy challenges comprise:  Strengthening fiscal performance and reducing economic distortions, including tacking the issue of fuel subsidies and the low level of non-oil revenues by improving administration and rationalizing exemptions.  Ensuring that pro-poor spending increases are in line with the commitments in the JAM. This type of spending is set to rise significantly in the 2006 budget, and will require execution of current plans and possibly reallocations from other types of spending.  Strengthening expenditure management by working on the regulatory and monitoring frameworks of fiscal decentralization and beginning fiscal reporting according to the GFSM 2001.  Ensuring coordination and reporting between the national government, the GOSS, and the central bank on spending and use of funds and on monetary policy.  Moving ahead on reforms to the system of intergovernmental relations, which requires a fully functional FFAMC (Fiscal and Financial Allocation and Monitoring Commission) as envisaged in the INC, and a redesign of the transfer formula consistent with objectives of transparency, simplicity, equity and efficiency; and clarity

6 of roles, in particular for the National State Support Fund, the Ministry of Finance, the ad hoc National Committee of State Governors and Finance Ministers, vis-à-vis the FFAMC.  Improving transparency of the oil sector, including on production, prices, revenue, costs and revenue sharing. In the context of the economic policy framework for 2006, the authorities have committed to implement a series of bold reforms in the aforementioned areas. The budget framework has been modified to include new assumptions about fuel prices, and the authorities intend to conduct a public information campaign to pave the way for the phased elimination of the subsidy and the adoption of an automatic mechanism to adjust domestic prices to changes in international prices. Given the need to increase non-oil revenues, as an immediate step the GNU will cease to extend expired profit tax exemptions. In the next few months, the government intends to finalize a program that will revamp the system of investment incentives in line with best international practice. The program will also address the need to adopt a uniform system of profit tax rates to ensure a level playing field for investors across sectors. Tax administration measures for 2006 include the introduction of self-assessment for large and medium-sized taxpayers and setting up three federal tax offices in major cities in the south. Lastly, planned steps to improve oil sector transparency in 2006 include a GNU commitment to wide dissemination of detailed oil sector data, publication of the 2004 and 2005 audits of Sudapet, and regular transfers of net operating income from state-owned oil companies to the treasury. IV. Systemic constraints and suggested next steps Government of National Unity It is evident from the foregoing that the year 2005 has witnessed important achievements on the part of the National Government – most notably the adoption of the INC and ICSS, which enshrine the key principles of the CPA, the formation of the GNU and GOSS, as well as the establishment of a number of key commissions. On the economic front, and despite some slippages, the overall thrust of macroeconomic policies has been good and performance has continued to be strong, underpinned by past economic reforms, economic stability, and rising oil exports. However, as noted above, the situation in Darfur continues to take its toll on development efforts, not only in the west, but throughout the country in terms of international perceptions, the large need for resources to meet emergency needs and constraints on development assistance, ability to execute the budget, and the resulting lack of focus on CPA implementation. The situation in the East also threatens further instability if issues of marginalization are not meaningfully addressed. While peace in Darfur and in Eastern Sudan will be needed as a foundation for sustainable development throughout the country, there is also the need to establish productive opportunities for individuals in order to alleviate pressure on increasingly scarce land resources. Further efforts are needed to encourage rural and private sector development, trade and financial flows, and reestablishing land use rights. A recurrent problem throughout 2005 was that of delays in meeting key deadlines to implement the CPA. Many important Commissions and bodies on which the

7 effectiveness of the transition to peace depends are yet to be established, including the National Electoral Commission and the National Land Commission. Among those which have been announced, some, including the Ceasefire Political Commission, the National Constitutional Review Commission (NCRC), the NPC and FFAMC, are yet to function effectively. Other key commissions faced significant delays in establishment and composition, including that related to assessment and evaluation of the CPA (AEC), petroleum (NPC) and intergovernmental fiscal relations (FFAMC), although these were announced by the end of 2005. The authorities need to press ahead with the implementation of the CPA. Seeing through key aspects of Chapter II of the CPA (on Wealth Sharing) including the realization of pro-poor commitments and fiscal decentralization in the national budget, and transfer of revenues to Southern Sudan, will be particularly important to demonstrate the commitment of the new Government to the CPA and to the JAM. In this regard, it is very important that the National DDR Coordination Council as well as the Northern and Southern Sudan DDR commissions be established as soon as possible. Overall progress in the Three Areas (Abyei, Southern Kordofan and Blue Nile), which were accorded special status in the CPA, was slower than expected, due mainly to the lack of progress on CPA implementation overall. Lack of institutional development contributed to national budgetary support for these areas in 2005 running at far below the levels which had been committed. Given recent improvements in the security and political situation, increased efforts are urgently needed to get progress on track, including with respect to the reformed governance structures, security arrangements and local reconciliation. A number of areas warrant attention by the GNU in the coming period, in particular: 1. Enabling full establishment of the key institutions associated with the CPA and INC, including in particular those Commissions and bodies which have yet to become properly functional. In a number of cases, including with respect to petroleum and intergovernmental fiscal relations, the terms of reference need to be clarified consistent with the CPA and INC, and associated reforms are needed to ensure smooth and efficient arrangements and inter-ministerial/agency relations within the overall institutional set-up for the GNU. 2. The commitment by the GNU to concrete actions to improve governance and transparency is welcome – including through steps on budget classifications and fiscal reporting. The full functioning of the NPC and formation of joint oil sector committees (oil production system and oil revenue allocation) as provided for in the CPA, are a precondition for greater transparency in this important sector, as well as the steps mentioned above to publish detailed oil sector data, ensure regular transfers of profits from oil companies to the treasury, and audits of Sudapet. The governance arrangements for the Sudan are already quite complex and for many, appear to be opaque – it is especially important in this context to ensure a clear and effective role for the new CPA institutions. 3. Increasing development efforts in marginalized parts of the country in line with the decentralization agenda. The recent establishment of the FFAMC is a welcome step forward; the GNU now needs to make the agency function consistently with the INC. The key is to establish an appropriate level of total transfers, as well as equitable allocations across states and, just as importantly, to strengthen local and national government capacities for policy development and service delivery.

8 4. More rapid and concrete progress is needed on rural reforms, consistent with the pro-poor objectives of the GNU. This requires actions that build on the Gezira Act, to reform marketing arrangements for gum Arabic, and refocus development efforts on rain-fed areas and micro and small scale activities. Failure to move on gum arabic marketing effectively imposes a substantial tax on millions of the poorest households in Sudan. 5. Improvements in the regulatory framework are needed to enable private sector participation in reconstruction efforts and to increase trade and financial flows. Strengthened efforts are needed to diversify the economy through market mechanisms and structural reforms to prevent the emergence of the “Dutch disease” and to support private investments in disadvantaged regions. 6. The GNU needs to operationalize the results focus that was laid out in the JAM Framework. The staffs welcome the Presidency’s commitment to use the JAM framework as a roadmap and basis for development planning and project implementation, and as a tool for monitoring and reporting on progress and allocating donor funding. It encourages the authorities to specify the arrangements for monitoring. 7. More efforts are needed to promote democratic governance and ensure the conduct of general elections by the end of the fourth year of the Interim Period, as provided for in the CPA and INC. While the establishment of the National Population Census Council is welcome, there is a concern that inadequate resources were allocated in the 2006 Budget (see below). Commitments across all of these areas were made by the Government in the JAM Framework, so to a significant extent the challenge is now one of implementation and progress against these benchmarks. The need to ensure increased allocations to meet pro-poor needs is an area of particular concern that should be closely monitored over the coming period. Government of Southern Sudan In Southern Sudan, the development needs remain as vast as was documented in the JAM presented in Oslo in April 2005. Staff recognize the major achievements in the appointment of the GOSS cabinet and establishment of the government in Juba, setting up the organs of representative government in the Assembly, and the drafting and passage of the ICSS which provide the framework for governmental powers, and for basic human rights. While there has been progress in implementation of the CPA, the last year has been marked by significant delays, most notably in the establishment and operationalization of the structures of government and in the reporting of revenues and their allocation. Even with the GOSS now in place, getting the basic structure functioning is taking time. While this was impeded by very weak infrastructure and communications on the ground, delays in key decisions and very limited capacity have prevented basic government functions and institutions from becoming operational. For 2006, many of the key elements are now in place and the GOSS needs to press ahead. Challenges can be seen at several levels, which require key decisions and concerted efforts to deliver on the expected peace dividend. 1. At the GOSS level, there are several priorities which should be tackled as a matter of urgency:

9  The establishment of the public service, which includes the adoption and implementation of a recruitment policy and development of a payroll.  Better coordination of development planning, implementation and monitoring across agencies, several of which have related mandates (eg rural, agriculture, animal resources, etc), where roles and responsibilities need to be clarified.  Build capacity for fiscal and development policy-making, including prioritizing among expenditure programs and monitor results. This could include practical efforts to ensure synergies across programs – for example on civil works, where locations for different activities (schools, health care, marketplaces and so on) could be selected in a coordinated manner.  Arresting illegitimate taxation and charges on trade.  Establish a program to prevent the risk of corruption emerging, through operationalising the relevant provisions in the ICSS.  A cross-cutting issue relates to the need for capacity building to establish core capacities within key line agencies, and at lower levels of government. To be effectively addressed, these issues need to be coordinated at the appropriate level of government. 2. The importance of sound public financial management to the GOSS cannot be over-emphasized. So far, overall progress on this front has been modest. Consistent with the GOSS commitment of transparency and sound public financial management, decisions have been made to engage a procurement agent (and a tender is underway), a project accounting agent, and to contract an external auditor. A donor- supported IFMIS needs assessment is ongoing and the GOSS is planning to undertake an internal evaluation of existing systems and identify weaknesses and gaps. As a stop gap measure while the project accounting agent is recruited through international bidding, GOSS is contracting in the services of KPMG for MDTF and GOSS pooled funds (which would cover up to about 28 percent of the total budget). As noted above, MOFEP has committed, in the context of a possible 2006 IMF SMP for the Sudan, to publish its budget as well as monthly expenditure and revenue reports consistent with international best practice. However significant risks remain to be addressed in three main areas: o Clarifying the processes and controls that govern GOSS core Treasury operations for (the non-pooled component of) its budget, including commitment control procedures to prevent possible misallocation of resources and expenditure overruns. o The urgent need to develop a roadmap and put in place financial management capacity and systems at the sub-national level, including capacity for making payments across Southern Sudan. o Putting in place transparent procedures for revenue management, including to ensure that the savings are appropriately invested There is a real risk now that failure to make key decisions on public financial management will slow down the whole development program, both in terms of staffing as well as capital spending. Staff recommend that urgent decisions be made to ensure that appropriate systems and capacity be put in place. 3. GOSS-lower level linkages need to be fleshed out and implemented.

10  The ICSS frames a significantly decentralized system but there is not yet clarity on expenditure and revenue assignments, on links between central line agencies and the lower levels of government, or on decentralization of the public service.  There is a provision for significant transfers to state governments in the 2006 budget plan. However a system of intergovernmental transfers remains to be established. The provision for a southern FFAMC is welcome but key decisions and technical support will be important to help operationalize the aims of the GOSS on fiscal decentralization through work on the formula/ criteria for transfers, implementation and monitoring arrangements.  Support to the states is an urgent priority to get functioning institutions established – including basic equipment, support for core functions (in particular public financial management) and training for core staff. It is likely that a fully decentralized system cannot be implemented immediately, and that interim arrangements are put in place to help strengthen local capacity while service delivery takes place outside of the government realm. 4. The role of the public sector in Southern Sudan needs to be carefully considered, as well as measures to support and enable private sector to prosper. There is a temptation when planning for a new era for the nascent GOSS agencies to evolve towards a system with too much government involvement in the economy and in service provision. This, however, needs to be avoided, as the private sector is, in many cases, a more efficient agent to deliver on service provision. The following recommendations seem to apply:  Exploit the potential of the private sector in service delivery, including through public-private partnerships;  Develop relations with NGOs, building on the emerging approach in education and health, and strengthening GOSS capacity to engage and supervise contracts with NGOs;  Scrutinize current and emerging administrative arrangements to remove obstacles – e.g. multiple taxation on goods; and  Establish a regulatory and legal framework for private sector development to encourage the emergence of a local entrepreneurial class and foreign investors, and encourage micro credit schemes. One important issue for the south is to improve security on the ground. This has several aspects which influence progress on the development agenda, and that need to be addressed urgently. On the one hand, security is a precondition for a major scale-up in the development efforts, in particular larger infrastructure projects with a high peace dividend. At the same time, there is a need to ensure a level of financing for the armed forces which is appropriate, and based on a size approved by the Southern Sudan Legislative Assembly, while at the same time avoiding a squeeze of the development budgets. The preparedness of the SPLA to work with technical experts from the region on fiscal planning, procurement and related issues is welcome. For the GOSS, like the GNU, operationalizing the focus on monitoring actions and results that was laid out in the JAM Framework requires further attention. Transparency and accountability will be promoted by the GOSS’s commitment to use the JAM framework as the basis for development planning and project implementations, and as a tool for monitoring and reporting on progress and allocating donor funding.

11 However capacity needs to be built and institutional responsibilities clarified in order for this to happen. V: Assessment of Development Financing This final section reviews recent trends in donor assistance and assesses the requests of the GNU and GOSS for external support in 2006, against performance in 2005 and expected progress this year. A. Recent Trends in Donor Assistance to the Sudan Almost a year after the Oslo’s Donors’ Conference, a stock-take of the level and composition of external assistance shows a positive trend. A broad regional disaggregation reveals three main developments during the period 2003-5 (Table 1). First, that overall reported assistance has increased significantly, from US$ 383 million in 2003 to about 1.4 billion in 2005. Second, this was significantly driven by increased humanitarian assistance to Darfur, which peaked at US$890 million in 2004. Third, assistance to Southern Sudan almost doubled in 2005, to US$563 million, following the signing of the CPA, with large shares of humanitarian and recovery support, alongside an increase in development assistance.

Table 1: Total reported donor assistance committed to Sudan by region, 2003-05 (US$ million) 2003 20041 20052 Darfur -- 890.2 663.5 Southern Sudan 70.2 229.83 563.2 Rest of Sudan -- -- 98.5 National/Unspecified 313.1 -- 82.9 Total 383.4 1,120.0 1,408.1 1/ Estimated figures based on FTS Geneva and Darfur Funding Overview 2/ All funding recorded by UN for 2005, MDTF contributions, and US and EC reports 3/ Assuming that Southern Sudan received all non-Darfur funding for 2004

The major focus of donor support continues to be humanitarian activities associated with Darfur. In 2005, humanitarian assistance amounted to almost US$1.1 billion, 76 percent of total recorded assistance. Assistance to Darfur nonetheless decreased in both absolute and relative terms between 2004 and 2005: from US$890 million to US$664 million; and as a share of total reported assistance, to about 47 percent in 2005 (table 2).

Table 2: Reported Donor Assistance to Sudan by Category and Region, 2005 (US$ million) National Darfur Southern Sudan Total % share Recovery 31.6 5.6 128.0 165.2 12% Unspecified 12 2.3 1.8 16.1 1% Development 54.5 0.5 103.1 158.1 11% Humanitarian 83.3 655.5 330.3 1,069.1 76% Total 181.3 663.5 563.2 1408.1 % share of total 13% 47% 40% Source: Staff estimates based on all funding recorded by UN for 2005, MDTF contributions, and reporting by US and EC. Note: MDTF commitments are included under Development. The doubling of total reported assistance to Southern Sudan since Oslo is welcome evidence of donor commitment. Indeed, alongside the massive donor response to Darfur, the CPA appears to have been associated with an increase in the

12 relative share of the South in total assistance to the Sudan, which rose from 20 percent in 2004 to about 40 percent in 2005. Moreover in 2005, an increased share of assistance to the South could be classified as recovery or development, which is consistent with the shift in focus in the agenda laid out in the JAM. The new mechanisms to channel and harmonize development funding through the MDTFs became operational in 2005. During the past year, the MDTFs received US$49.9 and US$100.7 million of actual donor commitments for the North and South respectively. Out of the existing funds, both the MDTF-N and the MDTF-S have been nearly fully committed, in the sense of having approved full program proposals by the time of the Sudan Consortium. Hence replenishments are needed in order to support programs in 2006 and beyond.

13 Overall donor commitments thus far against the promises made in Oslo to support phase 1 of the Interim Period (though end 2007) appear to be on-track (Table 3). Out of a total of US$4.5 billion through 2007, about 31 percent has so far been reported. An encouraging picture is also revealed in the commitments of development assistance through the two MDTFs: US$ 558.5 million was pledged in Oslo, and about US$150 million - 26 percent - has so far been disbursed into the MDTFs. With approximately one- third of phase one behind us, this is good news, but also calls for continued commitments on behalf of the donor community to support Sudan’s development agenda.

Table 3: Donor pledges to Sudan relative to actual contributions (US$ million) Donor Pledged in Oslo Total % of Of which MDTF Phase 1 (2005 – 2007) recorded total Total of which MDTF funding pledge North South Total Development in 2005 Norway 250 -- 100 56.3 23% 11.2 20.3 31.5 Sweden 110 40 28.6 38.4 35% 3.4 6.3 9.7 Germany 165 8 26 29.9 18% ------Netherlands 227 33.5 195 115.7 51% 23.4 23.4 46.8 Italy 78 2.6 5.2 14.8 19% ------EC 767 400 45.5 164.2 21% -- 28.2 28.2 Denmark 91 -- 15 14.3 16% -- 6.2 6.2 UK 545 464.5 80.7 164.1 30% 11.8 11.8 23.6 Japan 100 -- - 58.7 59% ------US 1700 430 - 601.4 35% ------Canada 73 -- - 27.5 38% ------Finland 16 -- 16 4.4 28% -- 4.4 4.4 France 40 40 - 6.7 17% ------Arab 200 200 50 NA ------League Australia 10 -- -- 10 100% ------Other 180 13.9 12.5 1001.6 58% 0.1 0.1 0.2 Total 4,552 1,632.5 574.5 1,408.00 31% 49.9 100.7 150.5 Source: Staff estimates. Note: Reporting as of December 2005. Yet while total donor commitments over the past year have been significant, increased efforts are needed to deliver on the reconstruction and development agenda laid out in the JAM. So far, out of the Oslo pledges of about US$1.63 billion to support the development agenda in phase 1, only US$323.3 million (almost 20 percent) has so far been confirmed. This slow rate of progress is true both for the south, as well as for programs in Northern Sudan, and is of course related to the various difficulties of getting started that have been outline above. The rate of commitments and disbursements should accelerate in 2006 – and more importantly increased efforts are needed to ensure that commitments are transformed into disbursements in order to make a difference on the ground.

B. Assessment of Financing Needs and Requests Staff concurs with the conclusion of the GNU and GOSS that the financing needs for development assistance in 2006 are large. The staff also supports the recommendation by the GNU and GOSS that more financing be directed through the MDTFs as this would allow for maximum ownership of program design and implementation, and for strengthened links with the domestic budgets. This section

14 reviews financing needs for 2006 in light of the requests presented by the GNU and GOSS to the Sudan Consortium, and domestic pro-poor efforts. The fiscal and GDP estimates presented here reflect the revised macroeconomic framework of the GNU discussed with IMF staff in February 2006 in the context of a new Staff-Monitored Program. As such, these figures differ somewhat from the ones in the budget document and in the government report. While the trends and conclusions drawn from the original figures are still relevant, any future analysis will be based on the revised fiscal framework. The authorities are expected to communicate to Parliament the revised macroeconomic framework in due course. A key interest lies in recent and projected trends in GNU budget allocations for pro-poor spending against the JAM commitments (see Volume I, Tables 4 and 8). For working purposes, building on what was agreed during the JAM, we defined GNU poverty-reducing expenditures as including: i) locally financed national development spending on pro-poor projects; ii) national social subsidies; iii) one-half of current national transfers to Northern states; iv) locally financed regional development spending; and v) transfers to the Three Areas. Regarding (i), the national development budget was carefully reviewed to determine what could be considered pro-poor: all education, health services and drinking water and sanitation, part of agriculture, most of basic infrastructure (e.g. all power & electricity, and selected roads and bridges), and projects for family micro-productive and income earning opportunities were counted as such. We excluded, among other things, wages and salaries for national government employees, debt repayments, on-lending and capital contributions, the Merowe Dam and major industrial projects. With respect to current transfers to Northern states and regional development spending, we have obviously adopted a crude approach based on currently available information about the distribution across states and across government functions. Further analysis is being undertaken in the PER, through detailed case studies, to review the extent to which the allocations really benefit disadvantaged states and localities, linking back to the decentralization reform agenda that was assessed above.

Our preliminary assessment is that progress is being made by the GNU in meeting the key JAM commitment of increasing pro-poor spending over time (Table 4). This requires a combination of budgetary reallocations and appropriate utilisation of increased revenues. For 2005, we observe that the GNU’s expenditure commitment in the JAM appears to have been met by a small margin, with pro-poor spending reaching nearly 3 percent of GDP. For 2006, the JAM programmed a rapid year-on-year increase in pro- poor spending, to nearly 6 percent of GDP. There are indeed significant planned increases in pro-poor spending in the 2006 fiscal framework; and these efforts appear to be approaching JAM commitments in the context of significant increases in national income overall. For example, pro-poor as a share of non-south expenditure almost doubled between 2005 and 2006, from 12 to 22 percent. Indeed the absolute amount of pro-poor spending – based on our preliminary analysis and excluding transfers to the GOSS – is programmed to more than double between 2005 and 2006, bearing in mind at the same time that the expansion is from a very low base. How this relates to the development financing request is assessed below.

15 Table 4: Recent and Projected Trends in GNU Budget Allocations (% of GDP) 2005 2006 JAM Actual JAM Revised fiscal framework Total Revenue 22.6 21.8 25.4 24.0 of which from oil 13.0 13.3 15.9 14.3 Total Expenditures 24.3 23.6 27.6 24.9 GNU Poverty Reducing 2.7 2.9 5.9 5.1 Transfer to GOSS 4.6 2.8 5.6 4.0 Other (including other capital expenditures) 17.0 17.9 16.1 15.8 MEMO ITEMS Total GNU Pro-Poor Spending ($ millions) 645 731 1,721 1,791 Pro-poor /Non-South expenditure (%) 13.7 14.9 26.8 22.8

Source: MOFNE, IMF and Bank staff estimates; JAM Volume I. Notes: JAM expenditure in 2005 for six months only; see text above for definition of pro-poor; 2005 actual figures are for nine months only. See Table 6 below for further detail on development financing request. While there has been overall progress in increasing pro-poor budget allocations, a particularly disappointing result in 2005 was the lack of financing support for development directed to the Three Areas, from GNU resources, as well as from donors. The Three Areas represented almost one-fourth of the total costs presented in the JAM for the GNU, reflecting needs in basic services, support to rural development and livelihoods, and the significant costs of building new infrastructure – in particular, roads and a connection to the northern power grid (Table 5). As noted above however, a major challenge here is to develop the institutional structures and capacities to implement priority programmes.1

Table 5: Phase I: JAM costs for Three Areas, and reported financing (US $ millions) 2005* 2006 JAM Budget JAM Budget Actual Plan Total 101 270 Domestic 0.17 71.7 External Financing NA NA Notes: *For 2005, JAM estimates are for July-December only.

For the purposes of assessing the appropriate level of external financing in 2006, staff recommends that the JAM approach be maintained: the focus is on the GNU and GOSS efforts both in terms of their own pro-poor spending efforts as well as progress in implementation of sound economic policies and the institutional and structural reforms laid out in the matrix. This has the advantage of ensuring continued focus on domestic efforts to implement pro-poor reforms and increase pro-poor spending as a basis for improved partnerships with the development community.

1A more specific concern on GNU budget, noted above, is the limited budget allocation for census preparations (US$4.4 million in 2006); while the MDTFs could co-finance these activities (up to US$8.5 million in 2006), in total this would cover less than 40 percent of the estimated cost.

16 The financing request of the GNU is assessed in terms of the government’s budget and estimates that were made in the JAM. This is presented in Table 6, alongside several reference points: what had been estimated in the JAM as the external financing needs, total GNU poverty reducing spending, and the projected foreign financing component. The figures for 2005 are based on actual reports, while the 2006 figures are based on the macro and budget framework discussed with the IMF and Bank staff. By way of explanation of the estimates for 2006, the US$745.9 million is the foreign financing assumption in the GNU’s budget, and includes grants and loans for projects and other activities, some of which has been secured already. This figure does not include the costs of humanitarian assistance (which are much larger, as shown in the UN Workplan request of US$956.8 million). Within the amount that the GNU has budgeted as foreign financing, a share would co-finance projects that have been classified by Bank staff as pro-poor projects – as noted above, this estimate is based on a careful project- by-project review of the national public investment program and the regional development program (see above). The foreign financing needs for this pro-poor share amounts to US$ 386 million, and is referred to in Table 6 as the “foreign component of pro-poor programs” in the Explanatory Note for 2006 Budget issued by MOFNE. (Note that the associated domestic financing for the same projects is US$833.7 million; see the GNU/GOSS report, Table 5.) Finally, as part of the pro-poor financing needs, is the request for “external financing of government projects and programs”, which is done via the MDTF-N. This is shown in the 2006 GNU budget to amount to US$173.2 million.

Table 6: GNU External Development Financing Trends and Plans, 2005-2006 (US$ millions unless otherwise noted) 2005 2006 JAM estimated external financing needs 262 575 Foreign financing assumptions, as per GNU 2006 fiscal 745.9 framework Of which : Foreign component of pro-poor programs 386 External co-financing of govt projects/ programs 1 49.9 173.2 Memo Items: GNU poverty reducing expenditure (staff estimate) 731 1,791 Share of pro-poor spending financed externally (%) JAM estimate 40 36 Revised estimate 12 22 External Development Financing Request (% GDP) JAM Estimate 0.9 2.1 Revised Estimate 1.1 UN Work plan/humanitarian, of which 844.9 956.8 Darfur 663.5 648 UN workplan development and recovery 88.1 123.92 Source: As reported in UN Resource Tracking System (RTS) and estimated by Bank staff Notes: 1/ Via Multi-Donor Trust Fund. 2/ This figure reflects funding which has been 30% secured, and as such does not reflect the full spectrum of planned recovery and development programming in 2006 included in the Workplan.

17 Given the performance in 2005, the 2006 macroeconomic framework and proposed policy and institutional reforms, coupled with the pro-poor efforts reflected in the GNU budget for 2006, the Government’s financing request of US$ 386 million in 2006 is appropriate on a commitment basis. Assuming that this request is fully met, and the pro-poor GNU budget of US$1.8 billion fully executed, then the externally financed share of pro-poor needs would approximate 22 percent, which is somewhat lower than the 36 percent share that was estimated in the JAM. However it should also be noted that the lack of access to grants and concessional finance have led the GNU to incur and plan for non-concessional loans. One example is the planned rehabilitation of the railway connecting the north and south. For the GOSS, like the GNU, the budget is critical, not only as a means of actually financing priority programs. In a broader sense, the budget serves as a concrete indication of GOSS priorities, for the population, which should be subject to debate and scrutiny, and the key signal to inform donor choices across sectors, and as a basis for partnership with donors. The broad composition of the 2006 GOSS budget shows a commitment to implementation of the JAM priorities. The major expenditure priorities are for infrastructure, education and health services, and pro-poor spending comprises about 76 percent of total expenditure (Table 7). Since the JAM has been used to help guide the budget process, the relative shares are close to the commitments that were made at that time adjusted appropriately to address emerging needs in the spirit of the JAM being a “live” document including, for example, increased transfers to lower levels of government consistent with the constitutional arrangements that have since then been developed. Given the breadth of needs in the south, and the strong development and pro-poor focus of the emerging sector programs, the definition of “pro-poor’ for the GOSS budget is broad, although excluding security and some core functions that arguably do not directly benefit the poor. Table 7: Sectoral Shares of the 2006 GOSS Budget Sector Allocation Budget Expenditure JAM share (US$ millions) Share (%) Share (%) (%) Accountability 15.6 1.2 1.5 2.9 Economic Functions 15.0 1.2 1.4 3.6 Education 140.0 10.8 13.3 20.1 Health 110.0 8.5 10.5 10.5 Infrastructure 305.0 23.4 29.1 21.7 Justice, Law and Order 68.6 5.3 6.5 3.0 Natural Resources & 61.2 4.7 5.8 7.8 Rural Development Public Administration 12.1 0.9 1.2 3.9 Security 220.0 16.9 21.0 6.1 Targeted Services* 9.0 0.7 0.9 7.7 Transfers 92.5 7.1 8.8 12.6 Reserves 252.4 19.4 Total 1,301 100 100 100 Source: GOSS Ministry of Finance & Economic Planning, Budget Call Circular for 2006, February 8, 2006 Note: JAM total estimate of pro-poor needs for 2006 was US$1,288,900,000. * Targeted services includes allocations for gender, youth, disadvantaged groups, and IDPs.

18 Finally, we assess the recent and expected evolution of financing for development in Southern Sudan, both from GOSS own sources and external financing, as was done for the GNU. The GOSS figures for 2005 are based on the four month budget that was approved by the Southern Sudan Legislative Assembly, while the 2006 estimates are based on the above-mentioned Budget Circular (see Table 7). Whereas the external development financing needs for 2006 were estimated in the JAM at about US$530 million, the request put forth to donors at the Sudan Consortium has been revised downward to take into account both existing and expected program commitments through the MDTF and USAID2, as well as experience to date on implementation. Based on the emerging program for 2006 and the strong pro-poor efforts evidenced in the budget, the GOSS’s financing request of US$300 million is appropriate, but again, on a commitment basis. Assuming full execution of the GOSS poverty reducing efforts as per the budget plan and donor commitments of the order of US$300 million, the external share would amount to about 37 percent, which is close to the share agreed during the JAM.

Table 8: GOSS External Development Financing Trends and Plans, 2005-2006 (US$ millions unless otherwise noted) 2005 2006 JAM estimated external financing needs 263 530 Externally financed recovery/development assistance1, of which 286.7 300 Cofinancing of govt projects/ programs 2 70 200 Work Plan: Humanitarian component 328.3 562.95 Memo items: GOSS poverty reducing expenditure 106.7 792.9 Pro-poor as percent of total domestic expenditure (%) 75.6 Development and recovery through the UN work plan 3 78.3 76.5 JAM estimate of share of pro-poor needs financed externally (%) 43 41 Total JAM needs ($ millions) 608 1,290 Notes: 1/ As reported in UN Resource Tracking System (RTS), and including US. 2/ Co-financing via MDTF-S, on a commitment basis. 3/ The 2006 figure reflects funding which has been 30% secured, and as such does not reflect the full spectrum of planned recovery and development programming included in the Workplan.

It bears repeating that the effectiveness of public resource use in Southern Sudan is conditional upon sound public financial management. This is true both for domestic and foreign sources of funds. Hence the recommendations made above regarding public financial management are critical. Consistent with the CPA and the desire of the Government as well as development partners to harmonise assistance, it is recommended that the resources for development assistance be directed, as much as possible, through the MDTFs. This will help to ensure prioritised use of resources, consistent with the JAM, and well linked to the GNU budget. The expected financing through the MDTF is shown in the GNU budget, as so-called “JAM grants” and amounts in 2006 to about US$ 83 million. For the GOSS, the expected MDTF financing is shown as US$200 million, again on a commitment basis.

2 This estimate is informed by the existing MDTF-S pipeline needs for 2006, which is US$173 million for 2006, and US Government commitments for the current fiscal year (through October) of about US$ 80 million, and additional programmatic financing needs (including for rural development and HIV AIDS).