South Sudan Secession: Modelling the Fiscal Shock and Its Spillover Effects

Abstract

In this article we set up a macroeconomic model designed to describe how a small and open economy endures political uncertainty arising from a country splitting into two independent parts. According to our findings in this paper, stabilization of asset markets in either country at the post-secession era depends on political stability, which will impact on foreign currency inflows to each country. Our model predicts that if political unrest continues after the split, the foreign currency reserves of each other country’s Central Bank will deteriorate over time, possibly leading to domestic depreciation of the local currency in terms of hard currencies. The model also predicts that an expanding budget deficit and declining official reserves will eventually force governments to abandon fixed exchange rate systems in favor of more flexible ones, resulting in further acceleration of both the domestic inflation rate and the domestic money growth rate. As a result, the post-secession period is likely to be characterized by economic instability and political unrest in the two sides unless economic cooperation between the two countries is maintained.