Abstract
Context: S�o Tom� and Pr�ncipe's economic development is constrained by its insularity, fragility, limited resources, and low capacity as a small island state. GDP growth has averaged over 4 percent per year since 2012, faster than many small island states. Inflation has also fallen sharply from 28 percent down to about 4 percent, the lowest in the past two decades. These developments notwithstanding, growth has not been sufficiently strong and diversified to meaningfully improve economic prospects and reduce poverty significantly. The poverty rate is high at 66 percent. Focus: Discussions centered on aligning fiscal policy to bring debt to a downward trajectory toward a moderate risk of debt distress; addressing the liquidity overhang to enhance monetary management; improving competitiveness; and safeguarding financial sector stability to support growth. S�o Tom� and Pr�ncipe is participating in the second round pilot of countries to mainstream macro-financial linkages.
On behalf of our São Toméan authorities, we would like to express our gratitude to the Board, Management and Staff for their continued support and valuable advice to São Tomé and Príncipe. The authorities are thankful to Fund Staff for the constructive discussions held in São Tomé in March 2016, during the 2016 Article IV Consultation and the first review of São Tomé and Príncipe’s economic program supported by the Extended Credit Facility (ECF).
The authorities have made great efforts in achieving macroeconomic stability, sustainable economic growth and poverty reduction under the National Poverty Reduction Strategy Paper (PRSP-II), including improving macroeconomic stability, stabilizing economic growth, and declining inflation. Despite this progress, the economy continues to face significant challenges in terms of rising public debt and weak competitiveness. The authorities broadly concur with the main policy recommendations of the staff report as a support for better implementation of PRSP-II.
As regards performance under the ECF, all end-December 2015 performance criteria (PC) were met with exception of just one. The PC on domestic primary deficit was missed by a small margin, about 0.3 percent of GDP, due mainly to tax revenue underperformance and the absence of corresponding expenditure cuts. Regarding structural reforms, the authorities have made strong progress by implementing all structural benchmarks through end-December, including the new banking law and two other measures related to improvements in the national accounts and consumer price statistics. Overall performance is satisfactory and the program is on track.
Recent Economic Developments and Performance under the ECF Arrangement
Although highly vulnerable to external shocks, the economy of São Tomé and Príncipe has grown faster than many small islands states, with average GDP growth over 4 percent per year since 2012. However, as noted by staff, these macroeconomic performance has not been sufficiently strong and diversified to improve economic prospects and reduce poverty significantly. Real GDP growth is estimated to have fallen below the budget target of 5 percent in 2015, by almost 1 percentage point, mainly due to late approval of the 2015 budget-which slowed down the execution pace of public investment projects-and poor rains, that resulted in a decrease of agricultural output (cocoa production). Helped by weakened demand and falling international prices of oil and other commodities, inflation has fallen to its lowest level in two decades, from 28 percent to below 5 percent at end December 2015.
In the fiscal area, the authorities’ efforts have been affected by lower than expected tax revenue and donor budget support. As a result, the domestic primary deficit was 0.3 percent of GDP, higher than the program target of 2.7 percent of GDP. Lower collection of arrears is a main cause of the tax revenue short fall, although more arrears were collected in 2015 (24 percentage points) compared to 2014. Efforts to increase arrears collection are being strengthened.
The authorities have also started to implement a comprehensive plan to clear the outstanding stock of arrears, including to the oil importing company (ENCO) and the state utility company (EMAE). In this regard, it is worth noting that the government has cleared all arrears to EMAE in 2015, 1.2 percent of GDP (0.5 percent of GDP higher than budgeted). EMAE in turn paid the equivalent of 2.6 percent of GDP of its arrears to ENCO. For its part the government will start clearing its arrears to ENCO this year and provision has been made accordingly in the 2016 budget. In addition, the automatic fuel price adjustment mechanism will also be implemented and will help to prevent accumulation of new arrears.
In line with the weaker economic activity and contraction in oil and other commodity imports, the external current account deficit declined to 17 percent of GDP in 2015, which offset the drop in cocoa exports as production declined. Gross international reserves remained at a comfortable level of 4.4 months of imports cover at end 2015.
Monetary policy has been adversely affected by the excess liquidity, low profitability, and high NPLs in the economy. The capital adequacy ratio for the entire banking system fell from 20.3 percent in December 2014 to 15.5 percent at the end of 2015, while capital to risk-weighted assets ratio increased to 24.1 percent from 22.6 percent, following recent capital injections by several banks. NPLs increased to a record high of about 30 percent in 2015, following the reclassification of overdue overdrafts in Banco Equador’s books as bad loans and a downgrade in a sizeable share of the largest bank’s loan classification to loss.
2016 and Medium-term Policies
The prospects for São Tomé and Príncipe are favorable in the near term but challenges remain. On the basis of higher and timely execution of public investments, recovery in cocoa production and increased foreign direct investment (FDI) in the tourism sector, real GDP is projected to grow by 5 percent in 2016. Inflation is expected to remain around 4 percent aided by falling international prices of food and petroleum products.
Over the medium term, real GDP growth is expected to be maintained at 5 percent; inflation is expected to continue to decline to 3 percent; and the current account deficit contracting further.
In the fiscal area, the authorities remain committed to bring the primary deficit down to around 1–1 ½ percent of GDP by 2018 and to ensure that debt remains on a downward path. At the same time the authorities will take steps to create fiscal space to meet the expenditure need for domestically-financed infrastructure spending to complement donor support. To achieve these objectives, the authorities will strengthen revenue collection efforts through a combination of tax policies (including the introduction of VAT), and customs and tax administration measures as well as improving the quality of spending.
Various measures will be implemented to attain this objective, including, greater and more rigorous audits, improving the capacity and incentives at the large taxpayer unit, increasing the number of products subject to imposition of minimum custom value, and introducing a number of legislative changes. The authorities will also submit to the National Assembly a new VAT law, a step toward to the introduction of VAT.
On the expenditures side, the authorities are focused on strengthening public financial management and transparency. They intend to steadfastly implement key measures, notably, rolling out of SAFEe (the electronic information management system) from the current pilot stage to cover all ministries and others state institutions to strengthen public financial oversight; enhancing SAFEe with added functionality such as reconciliation of treasury bank accounts, revenue tracking, management of fixed assets and a government contracts registry to facilitate the preparation of more comprehensive general government accounts. In addition, the authorities intend to move towards medium-term fiscal and expenditure frameworks in 2017. As regards, extra budgetary spending in the run-up to the presidential election, the authorities are fully commitment not to exceed the amount budgeted.
Mindful of the need to preserve debt sustainability, our authorities are committed to implement the debt framework law and strengthening debt management capacity. In pursuit of these objectives, among other measures, they will: (i) prepare a national debt strategy, as required under the debt framework law, that will put a ceiling on the overall debt of the nonfinancial public sector as well as annual debt policies that fix annual ceilings for each public entity; (ii) update the medium-term debt management strategy; (iii) seek technical assistance to prepare a manual of procedures for debt management and to carry out a new debt management performance assessment (DeMPA) by the end of 2016. Concerning external borrowing, the authorities will continue to pursue policies consistent with debt sustainability, by giving priority to concessional financing for infrastructure projects and social spending.
Monetary Policy
The monetary authorities are focusing their efforts on removing the excess liquidity in the economy and in this regard the central bank of São Tomé and Príncipe (BCSTP) has introduced the interbank market and treasury bills. In addition, the BCSTP is working towards developing a treasury bonds market, creating the conditions for longer-term liquidity management, as well as developing the secondary market.
The BCSP has continued its efforts in developing monetary liquidity management framework by implementing a new payment methodology for the commercial banks in 2015, to allow payment orders issued by the Treasury to commercial banks in a given period to be paid in the following period, thus enabling the BCSTP to include them in its liquidity forecasting, considerably reducing forecasting errors.
Macro-Financial Linkages and Financial Sector Stability
The authorities are mindful of the need to address the weakness in the financial sector, as to enhance fiscal and financial stability to support growth. In this regard, The BCSTP has been making efforts to strengthen its capacity in banking regulation and supervision. Three out of seven banks increased their capital in the last quarter of 2015, to meet the minimum requirement. BCSTP is at the early stage of building adequate crisis management and bank resolution frameworks to deal with risks in the financial system. The new banking resolution law provides the legal framework for a swift and orderly resolution of banks, including Banco Equador. A transition bank is being created with quality assets and liabilities of Banco Equador, and steps are being taken to identify potential buyers and conclude the process within 1 year from the establishment of the transition bank.
In order to reverse the trend of NPLs and credit to the private sector, the BCSTP is implementing necessary measures to tackle the large stock of NPLs, notably by stocktaking, provisioning and recapitalizing specific banks if needed, conduct detailed asset quality reviews for all banks to reduce the uncertainty surrounding bank assets, and where necessary demand recapitalization of affected banks.
Furthermore, the authorities will take additional measures to address other weakness in the financial sector, including, improving the coverage and effectiveness of the credit reference bureaus, streamlining procedures to ensure collateral enforcement, and capacity building of SMEs in basic accounting, financial management, and preparation of bankable projects.
Improving Competitiveness and Setting the Stage for Sustainable and Inclusive Growth
The authorities recognize the need to promote private sector-led growth in order to set the stage for higher and sustainable growth. Consistent with this goal, our authorities have listed in their 2030 Transformation Agenda the priorities for medium to long-term growth, social cohesion and external credibility, including diversifying the economy, broadening the production base, and modernizing the economic and social infrastructure. In addition, the authorities are seeking to create the conditions conducive to support the traditional sectors, such as agriculture, fisheries, and tourism to boost job creation and reduce poverty.
In order to maximize the great tourism potential, the authorities are focusing their efforts on medium-term structural reforms on high-yielding tourism activities, broader diversification of source markets, and more open, competitive air transport connections. They will also continue efforts to diversify tourism source markets and take steps to support open, competitive air transport policy, including allowing direct links to the sub region. Furthermore, they will seek to implement policy initiatives in 2016 aimed at introducing targeted reforms to improve the indicators in the World Bank’s Doing Business survey, and pursue efforts to encourage diversification of production and exports.
Conclusion
Our São Toméan authorities remain committed to fiscal prudence and to undertake crucial reforms so as to lower the public debt level and increase São Tome and Principe’s competitiveness and business environment. They will also continue their efforts in enhancing liquidity management and banking supervision in order to maintain financial stability. In this regard, they will rely on the IMF and other partners’ support to help consolidate their efforts to achieve the goal of sustained growth and poverty reduction. We therefore, call on Directors for a favorable consideration of our authorities’ request for the completion of the first review, waiver for nonobservance of performance criterion and modification of performance criteria.