This paper reviews the request from the São Tomé and Príncipe authorities for a Three-Year Arrangement Under the Poverty Reduction and Growth Facility (PRGF). In 2004, the economy continued to grow at a moderate pace, but inflation increased to 15 percent by year-end, as bank credit to the private sector rose sharply and the government loosened fiscal policy. The proposed program for 2005–07 aims at correcting macroeconomic imbalances and sets the conditions for sustained strong growth. Real GDP growth is envisaged to slow down in 2005 in response to tight financial policies.


This paper reviews the request from the São Tomé and Príncipe authorities for a Three-Year Arrangement Under the Poverty Reduction and Growth Facility (PRGF). In 2004, the economy continued to grow at a moderate pace, but inflation increased to 15 percent by year-end, as bank credit to the private sector rose sharply and the government loosened fiscal policy. The proposed program for 2005–07 aims at correcting macroeconomic imbalances and sets the conditions for sustained strong growth. Real GDP growth is envisaged to slow down in 2005 in response to tight financial policies.

August 1, 2005

On behalf of my Sao Tomean authorities, I would like to express my appreciation to Management and the staff for their assistance and advice to Sao Tome and Principe (STP).

As I indicated in my previous statement on STP, the advent of oil era, while very welcome, as its resources will help to develop the country and reduce poverty, also brings major challenges. These include (i) the avoidance of the so-called “Dutch Disease”, (ii) the adequate responsiveness to political pressures and social expectations and (iii) the building of extensive political consensus for the efficient use of oil resources. Although oil production is not expected before 2012, my authorities have to face these daunting challenges that already loom.

By the time oil effectively starts, Sao Tome and Principe will remain a highly indebted and poor and as such it faces the challenges inherent to this group of countries. While oil bonuses receipts will help the government in its growth-enhancing and poverty-reduction efforts over that transition phase, support from the international community will still be needed.

Recent Economic Developments

Output in STP is estimated to have grown by around 4 percent in 2004, mostly driven by higher public demand. In anticipation of oil bonuses receipts in 2004, and under severe popular pressure, the government raised critical social expenditures aimed at meeting the demand for better conditions of living. However, the oil bonuses did not materialize and the fiscal situation deteriorated with the overall fiscal deficit increasing to 26.3 percent of GDP from 17 percent in 2003. To close the financial gap, the authorities resorted to credit from the central bank and external concessional borrowing from neighboring countries. At the same time, credit to the private sector expanded significantly, which despite the central bank’s efforts to mop-up liquidity in the economy, resulted in consumer prices increasing to 15.2 percent in 2004 from 10.2 percent in 2003. In addition, reliance on intervention in the foreign exchange market to prevent a depreciation of the dobra led to a reduction of NIR.

During the first semester of 2005, macroeconomic policy implementation improved remarkably. Indeed my authorities have tightened their financial policies despite strong pressures to maintain the policy stance adopted in 2004.

Significant progress was made in the implementation of the triggers for reaching the floating completion points, under the HIPC Initiative. A poverty reduction strategy (PRS) elaborated and set out in a PRSP adopted in 2002 had been updated to take into account recent developments, notably regarding the macroeconomic framework.

It should be noted that the relaxation of macroeconomic policies in 2004 did not reduce the authorities’ commitment to reform, improved transparency and governance. In particular, in the oil sector, the institutional framework for developing the national petroleum strategy and to supervise and regulate the sector became operational in the first half of 2004, with the settings of the National Committee on Petroleum (NCP) comprising of representatives of the government, the civil society and the private sector, and the National Petroleum Agency (NPA) which absorbed the small technical petroleum unit already functional since 2002. Furthermore, a public information campaign was started since last year to disseminate basic information on the petroleum industry, notably regarding the management of the petroleum revenues.

Poverty Reduction Strategy

The PRS revolves around five basic pillars that are

  • Accelerated and redistributive growth;

  • Creating opportunities to increase and diversify income;

  • Developing human resources and access to basic social services;

  • Reforming public institutions, capacity building and promotion of good governance; and

  • Mechanisms for monitoring, assessing and updating the strategy.

The PRS sets as a long term objective the reduction by half of poverty by 2010 and by more than two thirds by 2015. To this end, the PRS develops measures that will reduce the gap in social indicators across all dimensions of poverty (urban and rural populations, gender and geographical locations). Among other measures, the PRS seeks to provide access to basic social services, notably health and education, for the entire population by 2015. In this regard, the health and education sectoral strategies have already been developed and costed.

As noted above, many changes occurred since the adoption of the PRSP in 2002, which called for a revision of its macroeconomic context. Among those changes is the emergence of the oil activity in the islands. My authorities are fully aware that good management of the oil resources will be key to maintain macroeconomic stability and to achieve their poverty reduction objectives. In this regard, the long-discussed and awaited Oil Revenue Management Law (ORML) was adopted by the Parliament in December 2004. As noted in Box 2 of the staff report, the ORML sets the conditions and mechanisms for a transparent use of oil resources. The institutional framework a National Petroleum Agency (ANP) has been set up with the assistance of the World Bank. In addition, my authorities have expressed their interest in participating in the EITI.

The PRS emphasizes that growth should not come from one source as this could be the case with the advent of oil. Therefore, the PRS contemplates alternatives sources of growth through the development of sectors where STP has a comparative advantage and where most of the poorest population is concentrated. These sectors include notably tourism and agriculture. The PRS envisions also a set of actions to improve the business climate. Some of them such as the Auditor General’s Office have been implemented.

Above all, the PRS recognizes the need to maintain macroeconomic stability as condition to reduce poverty. In this regard and in order to achieve their growth and poverty reduction objectives, set in the PRSP, my authorities elaborated with the assistance of Fund staff a three-year economic and development program, for which they are requesting IMF support under the PRGF.

Program for 2005-2007

The program for 2005-07 aims at (i) achieving a GDP growth of 4.3 percent on average per year, (ii) further fiscal consolidation following the rise in current expenditures in late 2003 and 2004, while maintaining pro-poor spending consistently with the PRS objectives, and (iii) bringing back inflation to single digit level.

Fiscal consolidation over the medium-term will be achieved through increasing tax revenue and improving government expenditures. In particular, my authorities intend to reform tax policy and administration, in the context of a tax package to be submitted to the National Assembly. Significant cuts in expenditures will be undertaken over the program period. The wage bill, however, will increase in the first year of the program to reflect augmentation in the civil servants’ minimum wage. No recourse to central bank financing is envisaged over the program period and as reflection of improved budget management, no new domestic or external arrears will be accumulated. As a result of these efforts, the program targets a reduction in the domestic primary deficit from 20.6 percent in 2004 to 7.6 percent in 2007.

Monetary policy will be consistent with the inflation reduction objective, and exchange rate policy will aim at achieving appropriate level of NIR. In particular, to improve liquidity management, the central bank will launch open market operations with central certificates of deposits and allow interest rates to be market-determined, while continuing with its policy of auctioning foreign exchange.

Efforts will be pursued to improve the financial sector reform and particularly the soundness of the banking sector through actions to improve regulation and licensing of new banks and enhance prudential standards. The reform will also strengthen mechanisms to prevent money laundering and financing of terrorism and deter financial crime.

My authorities will continue the reform process consistently with their objectives of improving public expenditure management, promote the development of the private sector and enhance the business climate. Most importantly, my authorities attach a great importance to transparency and governance in the oil sector. They will actively enforce the provisions of the ORML starting with the establishment of the bodies provided in the law.

STP is a highly indebted country and its debt will remain high over the medium-term. This debt situation is an impediment to the growth and poverty reduction strategy. Accordingly, in complement to their efforts to improve debt management, my authorities intend to request a debt rescheduling from the Paris Club in 2005, along with the agreement with the Fund on a PRGF-supported program. However, even after such a debt rescheduling, and further debt relief at the enhanced HIPC initiative completion point, the NPV of debt-to-export ratio is only projected to fall from 450 percent at end-2004 to 402 percent by end-2010, (table 9, page 36) compared with the threshold of 150 percent.

Policies for the Remainder of 2005

The medium-term economic program provides for a frontloading of measures in the first years. Hence, my authorities intend to maintain the policy stance adopted since late 2004.

More specifically, on the fiscal front, most of the enhancing-revenue measures related to changes in tax procedural code, coverage and rates will be implemented during this year and are expected to raise revenue by 2.1 percent of GDP in 2005. In addition, the draft new tax codes will be submitted to the National Assembly during this quarter, with the new tax regimes entering into effect in January 2006. On the expenditure side, cuts will be operated essentially in goods and services, including telecommunications, water and electricity and official travel items, and in domestically-financed investment expenditures, while ensuring that pro-poor spending is not affected. Both expenditure items will decrease by 11.5 percent of GDP.

As regards fiscal-related reforms, the government is developing a fully integrated, computerized budget and public expenditure management system with the assistance of the World Bank and FAD. It should be operational by mid-2006. The Auditor General’s Office is expected to complete the review of the 2004 financial accounts of central government during this quarter. The government will start implementing recommendations of this review in the last quarter of this year. The government is committed to improve the system of public procurement during the next three years, with the assistance of the World Bank. The new procurement practices are expected to be in place by end-2005. A PRSP unit has been set up at the Ministry of Planning and Finance, with the objective of ensuring the implementation and monitoring of the PRSP. This unit will issue a report on the status of implementation by September 2005. My authorities will also undertake the revision of its payment of wages and salaries, and develop a public employee’s register with the assistance of UNDP. By September 2005, a computerized registry of public servants, among others, will be developed.

Along with fiscal adjustment, my authorities will maintain a tight monetary policy stance in order to achieve their inflation reduction objective set at 15 percent this year. In particular, private sector credit growth will be reduced from 116 percent in 2004 to 19 percent in 2005. The central bank will also continue to work closely with MFD regarding the implementation of indirect monetary instruments such as certificates of deposit and the special liquidity facility. The central bank is committed to the continuation of a flexible exchange rate arrangement, as already signaled by the recent introduction of foreign exchange auctions in late 2004.

As regard bank supervision and prudential regulations in the financial sector, the central bank intends to implement a consolidated reporting mechanism on financial conditions to be submitted by banks to the central bank by September 2005 and to establish a Credit Risk Bureau during the third quarter of 2005. With the assistance of LEG, a legislation to criminalize money laundering and the financing of terrorism is being elaborated and is expected to be submitted by September 2005.

Other Structural reforms in 2005 will aim at developing and sustaining economic activity through the improvement of the business environment, the divestment of public enterprises and the strengthening of the governance, notably in the oil sector. Specifically, my authorities intend to submit to the National Assembly in the third quarter of 2005 a new investment code and adopt by end-September 2005 an action plan for streamlining the process of establishing businesses. The idea of a land reform is progressing with the elaboration of terms of reference for a study on land tenure by end-2005. With the support of the World Bank, my authorities will seek to address the most urgent needs for institutional reform and technical capacity building of the judicial system over the program period.

The restructuring of the public enterprises is progressing. To avoid further consumer debt accumulation, EMAE will introduce soon a prepayment system through electricity metering keypads for residential and commercial users. EMAE and the government agreed on a performance contract under which the government will grant a guarantee to a bank loan to EMAE for the implementation this system on the condition that EMAE develops a broader financial strategy to address its weak financial position. A first step of this strategy will be the elaboration of a timetable for the reduction of outstanding payments arrears by customers during this quarter. My authorities are also considering the divestment of other public enterprises. In particular, they intend to complete feasibility studies on the privatization of public enterprises administering airports (ENASA) and seaports (ENAPORT) by end-2005.

As regards transparency and governance in the oil sector, my authorities will finalize by the end-September 2005 an overall strategy for the oil sector development, with the assistance of the World Bank and UNDP. In particular, the strategy will address options for institutional settings regarding the development of the country’s Exclusive Development Zone (EDZ) and the country’s possible participation in petroleum exploration and development activities. In accordance with the Abuja Declaration, my authorities intend to foster the production, and dissemination of oil-related information.


My STP authorities view this string and ambitious medium-term program for which they are requesting Fund’s assistance under a PRGF arrangement as being able to help them meet the objectives of growth and poverty reduction. The program will also contribute to strengthen the institutions of the country and help put in place the reforms that will improve economic performance and establish a strong foundation in preparation of the oil era. In their efforts my STP authorities are hopeful that they can continue to rely on the full support of the international community. In this regard, I would appreciate Directors’ support for their request for a PRGF arrangement.