I. Recent Developments

As expected at the time of the 4^th Review under the PRGF, economic activity has remained robust in 2007. Real output growth is projected to reach 6 percent this year, driven by tourism-related construction, commerce and services, boosted by foreign direct investment. My authorities maintained their prudent policy stance aimed at reducing inflation. As a result of their sustained efforts, inflation went down to 14 percent in June 2007 from a peak of 26 percent in August 2006.

In the fiscal sector, domestic revenue in the first half of the year have been lower than expected owing to lower than projected imports duties and nontax revenue, although income tax collection improved. In light of this development, public expenditure, notably domestically-financed capital expenditure and HIPC-related social spending was contained accordingly. As result, the primary fiscal deficit met the performance criterion for end-June 2007. Strongly committed to maintain fiscal sustainability, the authorities have continued to adjust domestic petroleum prices to changes in international prices as evidenced by the increases from 13 to 24 percent in oil-related products in the archipelago in September 2007. Likewise, electricity and water tariffs were increased by 40 to 60 percent to recover production costs and hence reduce burden on scarce public resources. In July 2007, the authorities agreed on 35 percent increase in wages, instead of 18 percent as initially programmed. They also agreed on payment of other wage-related benefits following the negotiations with civil service unions.

The implementation of fiscal reforms is advancing. The Minister of Planning and Finance has been producing monthly budget execution reports using the pilot budget preparation and execution program (SAFINHO). The approval of the tax reform package is experiencing a delay as some elements of this package are still under discussion at the National Assembly. The US Millenium Challenge Corporation (MCC) has approved a threshold program that will provide technical assistance for strengthening revenue administration.

In the monetary sector, the Central Bank of São Tomé and Príncipe’s (BCSTP) continued efforts to mop up excessive liquidity, consistent the net international reserves objective in a context of a flexible exchange rate regime, have born fruit. Indeed, continued sterilization of use of oil bonuses and HIPC savings, and containment of net credit to government resulted in a decline of the base money growth from over 110 percent in mid-2006 to about 20 percent in the second quarter of 2007, thereby contributing to the sharp reduction in inflation. The exchange rate which remains market-determined depreciated slightly by 3 percent and the spread between the central bank and commercial banks exchange rate halved since the resumption of foreign exchange auctions in December 2006.

The strengthening of the central bank’s operations is progressing well with notably a proactive communication strategy and a closer collaboration with the Ministry of Finance to improve liquidity forecast and inform the central bank’s foreign exchange operations. The four planned prudential regulations have been issued, although with some delays due to difficulties to secure the needed technical assistance in this area. The Central Bank has also set up the Central Risk Unit and started implementing the “know-your-clients” rules for banks.

On structural reforms, my authorities have prepared and sent to the NA a series of revised legislations aimed at improving the business climate. These include, among others, the investment code, the revised labor code. It is their intention to submit to the NA a legislation that will reduce the cost of investing and doing business in São Tomé and Príncipe. The restructuring of the electricity and water company (EMAE) is well underway. In addition to the adjustment of tariffs, about 1000 prepaid electricity meter systems has been installed in an effort to improve revenue collection.

Despite the uncertainty surrounding oil reserves, significant progress has been made in enhancing transparency and governance in the oil resources management. With World Bank support, the Oversight Committee for auditing and supervising petroleum receipts and expenditures is now operational. The Minister of Natural Resources and Environment issued an order in August 2007 verifying São Tomé and Príncipe’s formal adherence to the Extractive Industries Transparency Initiative (EITI). A national coordinator for implementation of the EITI has also been appointed. The National Oil Agency will strive to conduct the licensing round for the Exclusive Zone transparently, consistent with the ORML and the EITI.

Overall, performance under the program in the first semester of 2007 has been satisfactory, with all quantitative performance criteria and structural benchmarks for end-June 2007 met. However, as noted above, the structural performance criterion for end-June 2007 on the four prudential regulations was met with delay. As this delay was beyond my authorities’ control, they request a waiver for the non-observance of this performance criterion. Based on this satisfactory performance, my authorities are requesting Board approval for the completion of the fifth review of the PRGF-supported program.

II. Financial policies for 2008

The authorities remain committed to macroeconomic stabilization and sustained economic growth. In 2008, policies will continue to be geared towards greater macroeconomic stabilization through further fiscal consolidation and prudent monetary policy. The main objectives of the program for 2008 are to (i) maintain a real GDP growth at 6 percent; (ii) reduce inflation to 9–12 percent; (iii) safeguard international reserves equivalent to about 4 months of imports; and (iv) accelerate the implementation of the reform agenda in order to lay the basis of a private sector-led growth. My authorities stand ready to adjust their policies as needed to meet their program objectives.

In the fiscal sector, the 2008 budget which is consistent with the fiscal program under the PRGF has been submitted to the NA for approval. It aims to reduce the domestic primary fiscal deficit to 4.8 percent of GDP compared to the projected 7 percent in 2007. This fiscal consolidation will come mainly from the expenditure side because the revenue impact of the envisaged direct tax reforms, which aim to reduce distortions, would be largely neutral in 2008. The deficit will be financed in part by statutory drawings from the National Oil Account (NOA) and by assistance under the World Bank’s Development Policy Operation (DPO) facility.

In addition to the implementation of tax reforms, once they are approved by the NA, fiscal reforms will essentially focus on strengthening tax and customs management and public expenditure management. In particular, a comprehensive wage study will be undertaken as part of the DPO-supported program with a view to revising the salary structure with improved incentives for civil servants, and thereby avoiding the recourse to ad hoc increases in wages. My authorities also intend to review their contribution to the Joint Development Authority (JDA) and make it more consistent with domestic budget constraints and oil revenue prospects. They will increase pro-poor spending through systematic application of the execution mechanisms contained in the new Organic Budget Law and continue to work closely with external development partners to accelerate implementation of foreign-funded projects, while ensuring adequate resources for domestically-funded investment projects. In order to strengthen the monitoring and execution of the 2008 budget, including the use of debt relief resources, my authorities will continue to upgrade SAFINHO and training users. With assistance from multilateral and bilateral donors, efforts will be made to develop SAFINHO into a fully fledged eSAFE system incorporating all public accounts.

The main objective of the monetary policy is to reduce annual inflation to 9–12 percent by the end of 2008. This will be achieved by ensuring that the 12-month base money growth remains on a declining trend. To this end, the central bank will continue to use foreign exchange sales to mop up liquidity, consistent with the NIR objective. The central bank is committed to deepening foreign exchange market reform, with a view to complying with obligations under Article VIII, Sections 2(a), 3, and 4 of the IMF’s Articles of Agreement. The adoption of the investment code which foresees, among others, the elimination of exchange restriction on transfer abroad of dividends will be critical in this regard. The Central bank intends to continue with its communication strategy of informing the market on its monetary and exchange policies, and information-sharing meetings with the Ministry of Planning and Finance to ensure the attainment of the program objectives. Following the issuance of the four prudential regulations, the central bank is awaiting the NA’s approval of the AML/CFT law to press ahead with the financial sector reform. In order to further strengthen its banking supervision, the central bank is requesting Fund technical assistance in the implementation of the new charts of accounts and quarterly financial reporting by banks.

On structural reforms, my authorities intend to make concrete progress in enhancing the investment climate through regulatory reform and upgrading infrastructure. They will work closely with donors to press ahead with reforms in key areas such agriculture, transportation and energy. They believe that the approval by the NA of the new investment code and revised labor code will be a positive step towards a more attractive business climate.

As regards debt management, my authorities are fully aware of the importance of ensuring debt sustainability after HIPC and MDRI debt relief. They will refrain from new external borrowing, particularly on commercial terms, and redouble their efforts to seek full delivery of HIPC debt relief from the remaining official creditors. As sufficient assurances for the disbursement of the Fund’s share of topping-up under the HIPC initiative have been secured, I request the support of Executive Directors for the proposed decision on this issue.

III. Conclusion

São Tomé and Príncipe has continued to maintain a satisfactory implementation of its economic program supported by the PRGF, thus demonstrating continuous commitment to macroeconomic stabilization and reform. My authorities remain committed to their reform program but given the uncertainty in oil production prospects, they still count on the international community to make further progress towards its objectives of sustained growth and poverty reduction. I therefore call on the international community to continue providing such support.