I - Recent Economic Developments

Macroeconomic performance has been satisfactory in 2005. Output is estimated to have grown by 3.8 percent last year, mostly driven by strong demand, despite an adverse external environment. Inflation, however, rose on account of higher international oil prices and the depreciation of the dobra. Indeed, it should be noted that over the last year, my authorities adjusted local petroleum prices to reflect changes in international oil prices. Consequently, the electrical company EMAE, which petroleum product is an intermediate good for the production of electricity, also raised its tariffs to cover the additional costs. As a result, inflation was above the program target by 2 percentage points, at 17 percent in December 2005.

Fiscal policy implementation has also improved, as the authorities pursued their fiscal consolidation policy over the course of 2005, despite strong social demands, and they managed to achieve the fiscal objectives set for 2005. In particular, large cuts were made in domestic primary spending to cope with the shortfalls in tax revenues and the increase in the minimum monthly salary in the public sector from US$ 31 to US$ 40. As a result of spending restraint, the fiscal deficit was slightly lower-than-programmed. Fiscal reforms progressed well as all draft new codes on personal income, corporate taxation and tax tribunals (structural performance criteria) as well as the new guidelines on urban property taxation and the new legislation on inheritance taxes (benchmark criteria) have been submitted to the National Assembly for approval. Public expenditure and external debt management are being improved with the assistance of the World Bank.

Monetary policy aimed at controlling the inflation surge, with notably increases in the bank reference rate and banks’ reserve requirements. Preliminary information indicates that this move has been successful in lowering bank credit to the economy. The dobra depreciation occurred following the technical changes to the central bank foreign exchange auction in the last quarter of 2005. Reforms to improve the operations of the central bank and the conduct of monetary policy advanced well, with the assistance of the Fund. The BCSTP has posted on its internet website the external audit of its 2003 and 2004 financial statements, as agreed in the context of the safeguards assessment of the BCSTP conducted by the Fund’s Finance Department in early 2004. Publication of the audited financial statements will become the norm for the central bank from now on.

The resumption of the tourism activity, after a period of sluggishness in the aftermath of the Coup in 2003, as well as lower payments for technical assistance contributed to offset the deterioration of the trade balance, thus keeping the current account balance (excluding official transfers) in 2005 at the same level as that of 2004, at around 59 percent of GDP. The overall external balance, however, is estimated to improve due mainly to the receipt of oil signature bonuses, which are held in an account, the National Oil Account (NOA), at the central bank. The latter’s gross international reserves, excluding the above-mentioned account, remained at around 3.5 months of imports by end-2005.

For years now, São Tomé and Príncipe has embarked in a wide range of structural reforms aiming at promoting private sector and strengthening the business environment. A new investment code that provides for equal treatment of domestic and foreign investors, which is consistent with the new code on corporate taxation is before the National Assembly for examination. There has been substantial progress in the public enterprise and judicial sectors reform. A comprehensive strategy has been launched to fundamentally improve the financial position of the water and electricity company (EMAE). To this end, in addition to the tariffs above-mentioned, a timetable for the reduction of outstanding payments arrears to EMAE has been established. In consultation with the World Bank, work is progressing regarding the preparation of terms of reference for the conduct of feasibility studies on the public enterprises that administer the airports (ENASA) and seaports (ENAPORT). The long-lasting non-tariff barrier related to the privately-managed telecommunications company (CST) has been eliminated in December 2005, thus opening the sector to new operators. Regulations for an effective functioning of the telecom sector are being finalized, which will allow for the launching of bidding rounds for different telecommunications services. The submission to the National Assembly of a legislation criminalizing money laundering and the financing of terrorism has been delayed, due to the need to update related pieces of legislation. With the assistance of Fund’s LEG and MFD, the government intends to continue a review of these pieces of legislation and will submit this legislation in the course of the year.

Turning to the debt situation, São Tomé and Príncipe is current with its obligations vis-à-vis the multilateral creditors and has cleared its arrears with Paris Club creditors as part of the Paris Club debt rescheduling agreement reached in September 2005. The authorities are currently in the process of reconciling debt records with Paris Club creditors, with the expectation of signing bilateral agreements by April 1, 2006.

Concerning the oil sector, as I stated in my Buff statement in August 2005, the institutional framework for developing the national petroleum strategy and for the supervision and regulation of the sector became operational in the first half of 2004, with the settings of National Petroleum Council (NPC) and the National Petroleum Agency (NPA) as well as the adoption of an Oil Revenue Management Law (ORML). The NPA is receiving technical assistance to develop advisory capacity and has launched its internet website in December 2005. Public information campaigns on oil-related issues took place through national forums with the civil society in 2005. An overall strategy to develop the oil sector has been completed in mid-2005 and is to be submitted to the National Assembly.

My authorities remain committed to ensuring transparency and good governance in the management of the oil sector. Following the recent disclosure by the Attorney General’s Office of São Tomé and Príncipe of irregularities in the awarding of oil Blocks 2–6, my authorities have stated that they will support the Attorney General’s Office in conducting further investigations and needed legal actions on this issue. In addition, they will propose that the Attorney General’s recommendations regarding the implementation of international standards be applied to future oil bidding rounds while working towards the implementation of Extractive Industries Transparency Initiative (EITI) principles.

Performance under the PRGF has been satisfactory, as all eight quantitative performance criteria set for end-September 2005 and all structural performance criteria set for end-July 2005 were met. In addition, all structural benchmarks for end-September 2005 have been met, with the exception of the one on AML/CFT. In light of this satisfactory performance, my authorities request the completion of the first review under the PRGF.

II - Program for the Medium-Term and Policies for 2006

The medium-term macroeconomic outlook for São Tomé and Príncipe is favorable, following particularly the recent developments in the oil sector. Real GDP is expected to increase by at least 5 percent on average over the next three years, on account of higher investment in several sectors in anticipation of the oil era. However, as I stated in previous meetings, São Tomé and Príncipe is not an oil-producing country yet and, therefore, it will very likely remain a low-income country at least until oil production starts, which is expected in 2012. Thus, São Tomé and Príncipe, as any other low-income country, is still facing – and will continue to face in the near to medium term - daunting challenges. These include among others, consolidating macroeconomic stability, while addressing pressing social needs, as highlighted by the recent cholera outbreak in the archipelago. My authorities are of the view that part of oil bonuses from the awarding of oil blocks could be used to complement foreign assistance in satisfying these needs, consistent with the PRSP. They do not lose sight of the need to avoid Dutch disease and, accordingly, they remain committed to a proper and transparent use of these resources.

In 2006, the economic activity is expected to grow by 4.5 percent and inflation to decline to 13 percent from 17 percent in 2005, owing to a prudent monetary policy. Overall, my authorities intend to pursue their prudent macroeconomic and structural policies.

Fiscal policy takes into account recent developments in the local oil sector and in the tax reform, and gives more weight to pro-poor spending. Specifically, revenues (excluding oil bonuses) are expected to increase by 2 percentage points of GDP with the coming into effect of several revenue-enhancing measures adopted last year. Expenditures will increase by 5 percentage points, reflecting mainly higher investment spending in agriculture and fisheries, and greater outlays in social sectors on one hand, and continued control of the wage bill on the other hand. On the wage bill, my authorities will enforce a strict management of the payroll through the activation of the civil servants’ register that has been recently developed with the UNDP. Further increase in the wage bill will be implemented once a new government is appointed following the holding of parliamentary, regional and presidential elections scheduled this year. As noted above, the larger fiscal deficit expected in 2006 will be financed by part of the oil bonuses and foreign assistance.

In order to improve public finance management, a fully integrated, computerized budget and public expenditure management system (SIGFE), developed with assistance of the World Bank is slated to replace the existing system by end-December 2006 (performance criterion). My authorities also intend to launch a thorough reform of the Inspectorate-General of Finance. They will amend internal control laws and administrative regulations governing the IGF’s actions by end-March 2006 (structural benchmark), with the aim of increasing the IGF’s powers regarding the oversight and auditing of the financial operations of the central government, public enterprises, and local governments. By end-June 2006, the government will establish a database to record and monitor follow-up actions addressing problems identified by the IGF in each inspected sector, including the applicable sanctions and penalties (structural benchmark).

Monetary policy will aim at bringing inflation to a lower level by end-2006, through notably ceilings on the expansion of the central bank’s domestic assets and banking sector credit to the government. Nevertheless, the central bank (BCSTP) stands ready to reassess its monetary policy stance whenever it deems necessary. In particular, the central bank will keep its reference interest rate above the inflation rate and will use its available instruments to address liquidity concerns. The BCSTP will pursue the strengthening of its operational capacities, with technical assistance from Fund’s MFD on the development of additional instruments, in the areas of banking supervision, development of interbank money markets, and foreign exchange auctions. The BCSTP remains committed to the continuation of the existing managed float exchange rate arrangement, which has allowed the monetary authority to appropriately address the volatility of external inflows and outflows.

My authorities intend to pursue their structural reforms aiming at improving the business climate and supporting private sector entrepreneurship. In particular, in order to alleviate administrative burdens on start-ups, my Saotomean authorities, along with the IFC advice and assistance, plan to address ways to modernize the business registration process, through notably the establishment of a one-stop shop. A deadline for the completion of the feasibility studies of ENASA and ENAPORT will be set this year in consultation with the Fund and World Bank staffs.

My authorities also intend to pursue efforts to increase transparency. In the oil sector, they will ensure a regular updating of the newly-established internet website of the NPA. In addition, in cooperation with the World Bank, they are developing an implementation manual/handbook of the oil revenue management law that will be posted on the websites of the National Assembly and the NPA by the end of the first quarter of 2006.

Regarding poverty reduction, my authorities have recently submitted the first PRSP annual progress report to the Fund and the World Bank, which has been prepared in a participatory process, in collaboration with the country’s main donors and civil society. The preparation of the PRSP annual report constitutes one of the floating completion point triggers specified under in the HIPC Decision Point Document of December 2000. The completion point is expected to be reached in mid-2006.

III - Conclusion

My Saotomean authorities have demonstrated great degree of ownership of their program, and they are resolved to pursue prudent macroeconomic policies and sound structural reforms over the medium-term. In particular, with the advent of the oil era, work is being done to ensure that the regulatory framework for a proper development of the oil sector and an efficient management of oil resources is in place. Nevertheless, São Tomé and Príncipe remains a low-income country, at least until oil revenue flow into its economy, and it is still facing challenges inherent to this group of countries. Addressing these obstacles during this transition phase toward the oil era will require continuous support from the international community. My authorities are particularly grateful to the latter for its support so far through notably the debt rescheduling agreement with the Paris Club in September 2005 and the pledges for the Priority Actions Program at the recent roundtable meeting with donors that took place in Brussels last December. They look forward to the completion point under the HIPC Initiative and, subsequently, to immediate debt reduction under the MDRI this year. My authorities are of the view that all these actions will be critical to a successful implementation of their growth-enhancing and poverty reduction strategy.