Democratic Republic of São Tomé and Príncipe
Fifth Review Under the Three-Year Arrangement under the Poverty Reduction and Growth Facility, and Request for Waiver of Performance Criterion: Staff Report; Press Release on the Executive Board Discussion; and Statement by the Executive Director for the Democratic Republic of São Tomé and Príncipe
Author: International Monetary Fund
Publication Date:
07 Mar 2008
eISBN:
9781451835144
Language:
English
Keywords:
ISCR; CR; HIPC topping-up assistance disbursement; disbursement of topping-up HIPC assistance of SDR; PRGF review; assistance; PRGF arrangement; topping up; US$ million; enrolment ratio; oil bonus; São Tomé and Príncipe authorities; oil signature bonus; Bonuses; Global; net of valuation
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Economic activity continues to be robust in 2007, driven by foreign investment in tourism-related construction and services. The central bank (BCSTP) strengthened its efforts to control liquidity growth. Progress on structural reforms has been mixed. The authorities intend to accelerate public financial management reform. The authorities and IMF staff shared the view that the country’s fiscal and external financing strategies need to adjust to the uncertain oil revenue prospects. The BCSTP is committed to deepening foreign exchange market reform.

Abstract

Economic activity continues to be robust in 2007, driven by foreign investment in tourism-related construction and services. The central bank (BCSTP) strengthened its efforts to control liquidity growth. Progress on structural reforms has been mixed. The authorities intend to accelerate public financial management reform. The authorities and IMF staff shared the view that the country’s fiscal and external financing strategies need to adjust to the uncertain oil revenue prospects. The BCSTP is committed to deepening foreign exchange market reform.

I. Background

1. São Tomé and Príncipe has a very narrow production and export base. The once-dominant cocoa sector has declined in the last three decades. Tourism is relatively small and brings in little net foreign exchange receipts because it relies heavily on imported goods and services. The large external current account deficit has been financed by official transfers, private inflows, and in recent years oil signature bonuses. Exploratory drilling so far has not yet confirmed the existence of commercially extractable oil reserves.

2. São Tomé and Príncipe reached the completion point under the enhanced HIPC Initiative in March 2007. By September 2007, creditors representing over 80 percent of the country’s external debt at the completion point had agreed to deliver HIPC relief, enabling the Fund to disburse its share of topping up assistance. 1

II. Performance Under the Arrangement

3. Economic activity continues to be robust in 2007, driven by foreign investment in tourism-related construction and services. Real GDP is projected to grow at 6 percent, somewhat slower than in 2006, reflecting lower public expenditure and imports financed by oil bonuses (Figure 1 and Table 1).

Figure 1.
Figure 1.

Recent Macroeconomic Developments, 2003–07

Citation: IMF Staff Country Reports 2008, 095; 10.5089/9781451835144.002.A001

Sources: São Tome and Príncipe authorities; and IMF staff estimates and projections.1 There is a break in the GDP data series between 2003 and 2004.
Table 1.

São Tomé and Príncipe: Selected Economic Indicators, 2005–20101

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Sources: São Tomé and Príncipe authorities; and IMF staff estimates and projections.

Based on 2001 census and survey-based GDP series unless otherwise specified.

Due to the revision of balance of payment data, the data of Country Report No. 07/267 and revised program are not comparable.

Central bank buying rate.

Includes HIPC and MDRI debt relief and oil signature bonuses.

Excluding oil revenue, grants, interest earned, and scheduled interest payments, foreign-financed scholarships, and foreign-financed capital outlays.

Percent of exports of goods and nonfactor services. The difference between debt service before and after HIPC relief is larger than debt service saving in cash terms because this table is on an accrual basis.

Gross reserves exclude the National Oil Account and guarantee deposits placed at the BCSTP by financial institutions waiting for operating licenses.

4. Inflation declined to 14 percent (year-on-year) by the end of June 2007. The deceleration in the first half of 2007 reflected the authorities’ efforts to reduce fiscal imbalances in the 2007 budget, and to curb liquidity growth. The dobra depreciated in real effective terms during the period, partially offsetting last year’s real appreciation. In early September 2007, the government raised domestic prices of petroleum products by 14–25 percent, and electricity and water by 40–60 percent, as international oil prices increased.

5. All quantitative performance criteria for end-June 2007 were met. Domestic revenue fell short of the program target for the first half of the year, mainly because import duties and nontax revenue were lower than expected. The government met the performance criterion on the domestic primary deficit mainly by compressing capital expenditure. In addition, the wage bill was less than projected because a general wage increase of 18 percent did not take place at the beginning of the year as expected. The end-June structural performance criterion related to the issuance of prudential regulations was not met. However, all four required regulations were issued by mid-November 2007 (Appendix I, Attachment I, Table I.2).

6. Fiscal developments since July 2007 have complicated program implementation. Protracted negotiations with trade unions led to a 35 percent general wage increase effective from July 2007. More overtime payments were also made to teachers and health workers. The wage bill is thus projected at 9.1 percent of GDP for the year, rather than 8.2 percent under the program (Table 2). Moreover, domestic revenue for the year is expected to be lower than programmed by about 1 percent of GDP, in part due to an unexpected shortfall in the oil-related grant. Higher public expenditure in the third quarter and the petroleum price increase put pressure on inflation and exchange rate depreciation.

Table 2.

São Tomé and Príncipe: Financial Operations of the Central Government, 2005–2008

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Sources: São Tomé and Príncipe authorities; and IMF staff estimates and projections.

Based on 2001 census and survey-based GDP series.

For 2007, includes IDA and AfDB MDRI debt relief as a stock of debt reduction.

For 2007, includes the repayment of three $5 million loans disbursed by Nigeria in 2002–04 upon receipt of oil signature bonuses for Blocks 2–4 in the Joint Development Zone.

Excluding oil revenue, grants, interest earned, scheduled interest payments, foreign-financed scholarships, and foreign-financed capital outlays.

For 2006, refers to a temporary accumulation of technical arrears with bilateral creditors, pending reconciliation of debt records.

For 2005, reflects impact of Paris Club rescheduling in the last quarter of 2005.

For 2007, assumes rescheduling agreement with non-Paris Club bilateral creditors for current maturities and stock of arrears.

Net of valuation changes. For 2007, includes IMF MDRI debt relief as a stock of debt reduction.

7. The central bank (BCSTP) strengthened its efforts to control liquidity growth. It continued to sterilize the budgetary use of oil bonuses and HIPC savings through foreign exchange sales. As a result, the 12-month base money growth declined from over 110 percent in mid-2006 to about 20 percent in mid-2007 (Table 3). Since then, the dobra component of base money grew by about 20 percent, excluding base money changes due to a surge in foreign currency bank reserves at the BCSTP. The velocity of money remained broadly unchanged.

Table 3.

São Tomé and Príncipe: Summary Accounts of the Central Bank, 2006–08

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Sources: São Tomé and Príncipe authorities; and IMF staff estimates and projections.

Includes guarantee deposits by prospective financial institutions waiting for operating licenses.

Oil signature bonuses for Blocks 5 and 6 in JDZ, totalling US$26.1 million, originally assumed for 2007, are now projected for 2008.

Includes prospective disbursements under PRGF arrangement and MDRI assistance from the IMF as debt reduction totalling SDR1.6 million, assumed in the first quarter of 2007.

8. Progress on structural reforms has been mixed (MEFP Table I.2). The authorities have been preparing monthly budget execution reports using the pilot budget preparation and execution program (SAFINHO). Agreement was reached with the U.S. Millennium Challenge Corporation (MCC) on a threshold program for technical assistance to strengthen revenue administration. However, final approval by the National Assembly (NA) of the corporate income tax law, along with the remainder of the tax reform package, awaits the submission of a revised draft of the personal income tax law. Regulations to implement the anti-money laundering law have not been issued because the NA has not yet given the law its final approval. The Oil Resource Management Law (ORML) Handbook is under a government review before its publication. Finally, some progress has been made by EMAE, the utility company, in installing the prepaid electricity meter systems, which reached about 1,000 meters in September 2007.

III. Policies for the Remainder of 2007

9. The authorities remain committed to reducing the domestic primary deficit to 7 percent of GDP. The recent adjustments of fuel and utility prices are expected to enable ENCO, the fuel importer, to clear its tax arrears of about 0.9 percent of GDP. The government also intends to reduce nonwage spending by about 1–2 percent of GDP from budgeted amounts, while protecting HIPC-related social spending. Expenditure commitments will be strictly controlled to prevent any build up of payment arrears (MEFP paras. 9, 10). To protect the poorest segments of the population, electricity and water tariffs have been linked to the level of consumption since October 2007.

Financing of the Domestic Primary Deficit

(Percent of GDP)

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Sources: São Tomé and Príncipe authorities; and IMF staff estimates and projections.

Excludes receipts of oil signature bonuses.

Includes goods and services, non-essential current spending, domestically financed capital expenditure, and HIPC-related spending.

World Bank Development Policy Operation grants.

Includes debt relief of about US $1.5 million.

10. The BCSTP will maintain a tight monetary policy to counter the pressures from higher energy costs (MEFP para. 12). Since weak financial intermediation is limiting the effectiveness of monetary policy instruments, the authorities have to rely primarily on fiscal restraint and foreign exchange sales to contain pressures on domestic prices. Recognizing the tradeoff between NIR accumulation and sales of foreign exchange to mop up excess liquidity, they agreed that a proactive monetary policy needs to be supported by continued fiscal adjustment in order to bring annual inflation as close as possible to the original program target of 13–15 percent by the end of 2007.

11. The authorities intend to accelerate public financial management reform. They have prepared the 2008 budget consistent with the PRGF-supported program. With support from the World Bank, they also plan to upgrade SAFINHO, aiming to put in place a strengthened budget execution and monitoring system by March 2008. The government intends to adopt by the end of this year a petroleum sector strategy and the relevant laws consistent with the ORML and the Extractive Industries Transparency Initiative (EITI) to launch licensing for the Exclusive Economic Zone (EEZ) in 2008 (MEFP paras. 11, 13).

IV. The 2008 Program

12. Economic policies in 2008 aim to consolidate macroeconomic stabilization gains and promote private-sector-led growth. The authorities face two major challenges in 2008 and beyond: (i) maintaining fiscal sustainability with an uncertain oil outlook; and (ii) developing the country’s production and export base to reduce poverty and aid dependence.

13. The authorities and staff shared the view that the country’s fiscal and external financing strategies need to adjust to the uncertain oil revenue prospects. While in recent years oil bonuses have filled in budget financing gaps, the remaining balance in the National Oil Account (NOA) is low, the prospects of additional oil bonuses in 2008 are uncertain, and finding commercially viable oil reserves is a long and uncertain process. Besides mobilizing more foreign grant aid, continued fiscal adjustment is not only prudent but also necessary to safeguard macroeconomic stability and long-term growth prospects.

A. Fiscal Policy

14. The draft 2008 budget aims to reduce the domestic primary deficit to 4.8 percent of GDP. The domestic primary deficit is expected to be fully financed by a grant of 2.5 percent of GDP from the IDA Development Policy Operation (DPO), the use of existing oil bonuses equivalent to 1.9 percent of GDP, and other net external financing including debt relief.

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Sources: São Tomé and Príncipe’s authorities, and IMF staff estimates and projections.1/ Baseline scenario assumptions: Oil production and exports start in 2014 and oil bonuses for block 5–6 are received in 2008.

15. On the revenue side, the authorities intend to implement the direct tax reform package after its approval by the National Assembly. The package includes a revised corporate tax law that reduces the rate from 45 to 25 percent, a new personal income tax law with a progressive tax structure, and a new urban property tax code (MEFP para. 17). Although these reforms are expected to be revenue-neutral in 2008, timely implementation would help reduce distortions and increase revenue buoyancy over time. With MCC support, the authorities also plan to strengthen tax and customs administration, including by stepping up efforts to audit tax returns and increase tax arrears’ collection.

16. Fiscal consolidation under the 2008 budget would come mainly from the expenditure side (MEFP paras. 17, 18). The main elements of the expenditure program are:

  • Containing personnel costs. After a sharp increase in 2007, the wage bill would increase by about 3 percent in real terms but fall relative to GDP from 9.1 percent in 2007 to 8.8 percent in 2008 (Box 1). As part of the DPO-supported program, the government plans to undertake a public wage reform, based on a comprehensive wage study, as a first step toward a civil service reform strategy. Key elements of the wage reform would include a revised salary structure and the integration of fringe benefits into the wage bill.

  • Curtailing nonwage nonessential current spending. The adjustment of up to 2 percent of GDP would be mostly in discretionary expenditures (administrative expenses, fringe benefits, and other goods and services), returning these spending categories to their levels relative to GDP before the inflows of large oil bonuses.

  • Increasing domestically financed capital expenditure and pro-poor spending. Allocations for maintenance, investment, and propoor programs are expected to increase, in line with the priorities identified by the PRSP.

  • Strengthening budgetary execution and monitoring. Efforts will be made to train staff and further develop SAFINHO.

The Wage Bill, Composition of Public Expenditure, and Fiscal Sustainability

The government wage bill has increased rapidly in recent years, financed in part by large inflows of oil bonuses. The increase reflected an expansion in the public payroll, a significant increase in real wages, and substantial overtime compensation and benefit payments.

Consequently, budgetary personnel costs accounted for an increasing share of public expenditure. If fringe benefits currently recorded under other current expenditures were included, the share would be even higher.

Maintaining fiscal sustainability is a serious challenge. In addition to civil service reform, the private sector needs to develop to provide alternative employment opportunities and to provide the basis for increasing domestic revenue.

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Sources: São Tome and Príncipe authorities; and IMF staff estimates and projections.

B. Monetary and Exchange Rate Policies

17. The monetary program aims to reduce annual inflation to 9–12 percent by the end of 2008, with base money as the anchor in the context of a flexible exchange rate regime (MEFP para. 20). The BCSTP will continue to improve liquidity forecasts and proactively use monetary instruments, primarily foreign exchange sales, to ensure that 12-month base money growth, especially the dobra component, is on a declining trend. The authorities shared the view that their monetary policy needs to be supported by fiscal restraint, which is essential for containing aggregate demand (MEFP para. 21).

18. The BCSTP is committed to deepening foreign exchange market reform. In 2008, it would consider revising the mechanism for setting the daily central bank exchange rate to further narrow the spread between the central bank and commercial bank exchange rates. The investment code that has been submitted to the NA contains provisions that aim to remove the exchange restriction on transfers abroad of dividends. The BCSTP emphasized, however, that a dynamic export sector is needed to increase both foreign exchange supply and the participation of commercial banks in the market (MEFP para. 22).

C. Structural Reforms

19. The authorities attached high priority to structural reforms that would help develop the supply side of the economy. They considered that at the root of their persistent internal and external financial imbalances is the lack of development of the country’s productive and export sectors (Box 2). Therefore, their reform agenda will focus on removing regulatory impediments, developing the financial sector, and upgrading the country’ infrastructure.

20. To attract private investment, the authorities intend to press ahead with regulatory reform. They plan to adopt laws to sharply reduce the cost and duration of starting a business, modernize the country’s commercial codes, and implement the new investment code and the revised labor code after NA approval (MEFP paras. 24, 25, 26).

21. On financial sector reform, the BCSTP would further strengthen banking supervision, especially its enforcement capability. Key measures include improving accounting standards and bank financial disclosures and putting in place an anti-money laundering regime (MEFP para. 27).

22. With support from donors the authorities aim to start reforming the key sectors, including utility, transportation, and agriculture. They plan to focus initially on addressing the financial weaknesses of EMAE, ENASA (the airport authority), and other state-owned entities, with a view to corporatizing and commercializing them over the medium term.

D. Debt Management

23. The authorities are conscious of the need to maintain debt sustainability after HIPC and MDRI debt relief. They are committed to refraining from new external borrowing, especially on non-concessional terms. Having recently secured debt relief from the EU, they plan to seek full delivery of HIPC debt relief, aiming to conclude agreements with Angola and Portugal, the two largest remaining creditors (MEFP para. 29).

Impediments to Private Sector Development and Supply Constraints

A shrinking traditional sector. As output, exports, and employment have been declining in the cocoa sector, the government has become the largest employer in the economy in recent years.

Impediments to the development of new productive sectors. These include: (i) high cost of investing and doing business, as assessed by the IFC’s 2008 Doing Business Report; (ii) weak financial intermediation and difficulty in accessing financing, with high euro-rization; and (iii) poor infrastructure. These difficulties are compounded by the small size of the market.

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Source: São Tomé and Príncipe authorities

V. Program Monitoring and Risks

24. The quantitative performance criteria related to the sixth review of the program for end-December 2007 remain unchanged (Table 7). Indicative targets for end-March and end–June 2008 are proposed. The PRGF arrangement will expire on July 31, 2008. To simplify the use of adjustors in monitoring the 2008 program, indicative targets on NIR, NDA, and net credit to the government will include only unblocked oil funds (MEFP paras. 31, 32).

Table 4.

São Tomé and Príncipe: Monetary Survey, 2006–08

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Sources: São Tomé and Príncipe authorities; and IMF staff estimates and projections.

Includes MDRI assistance from the Fund as debt reduction totalling SDR1.6 million, assumed for 2007.

The changes in net credit to the economy and other items net after mid-2008 reflects increased government deposits in the financial system due to oil signature bonuses expected in the second half of 2008.

3 Based on 2001 census and survey-based GDP series.

Table 5.

São Tomé and Príncipe: Balance of Payments, 2005–10

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Sources: São Tomé and Príncipe authorities; and IMF staff estimates and projections.

Following the closure of the national airline, tourism receipts fell in 2006 and 2007. The airline was privatized in 2007.

Include HIPC and MDRI debt relief delivered at the completion point in 2007.

From 2006, FDI increases due to oil drilling by foreign companies as well as FDI in the hotel sector.

For 2007, assumes rescheduling agreement with non-Paris Club bilateral creditors for current maturities and stock of arrears.

Based on 2001 census and survey-based GDP series.

Percent of exports of goods and nonfactor services. The difference between debt service before and after HIPC relief is larger than debt service saving in cash terms because this table is on an accrual basis.

Gross reserves exclude the National Oil Account and guarantee deposits placed at the central bank by financial institutions pending operating licenses; imports exclude oil sector-related imports of capital goods and services.