Democratic Republic of S�o Tom� and Pr�ncipe: Selected Issues


Democratic Republic of S�o Tom� and Pr�ncipe: Selected Issues

Promoting Growth and Private Sector Development in São Tomé and Príncipe1

This study discusses growth and private sector development in São Tomé and Príncipe. Using a growth accounting framework, it identifies the main components of growth and analyzes the differences with respect to comparator countries. The study also addresses some constraints facing the business sector and various policy recommendations. The findings suggest that measures for increasing productivity and enhancing the business environment, particularly improving access to credit, among other initiatives, can have a positive impact on economic growth and private sector development.

A. Introduction

1. The Democratic Republic of São Tomé and Príncipe has successfully achieved greater macroeconomic stability in recent time. Economic growth rates have been stable since 2009, averaging over 4 percent per year, after a period of widely fluctuating growth rates. While real GDP has been expanding faster than in many small-island states recently, it has not been sufficiently strong and diversified to meaningfully improve economic prospects and reduce poverty noticeably. Additionally, annual inflation has moderated significantly. Supported by the euro peg and a prudent fiscal policy stance, inflation has fallen sharply from the historic high of 28 percent in 2007 down to 4 percent in 2015, the lowest in the past two decades.

2. On the development front, initial gains in job creation have not been sustained. The unemployment rate declined from 16.0 percent in 2002 to 13.9 percent in 2008, then inched back upwards to 14.5 percent in 2015, with women, the youth (aged 15–34 years), and city-dwellers being disproportionately affected by joblessness. However, it should be noted that the fall in the unemployment rate between 2002 and 2008 was more accentuated for women than for men. Economic growth had less of an impact on underemployment, which increased by almost 40 percent above 2002 levels.

3. Despite improvements in macroeconomic stability, poverty reduction remains an important social and political issue. Over half of the population lives below the national poverty line; in fact, the absolute poverty measure was reported to be 66.2 percent in 2009/10, based on a standard cost-of-basic-needs (CBN) assessment that quantifies the consumption-poverty line at 30,000 São Toméan dobra (about US$1.60) per capita per day. It would require an accelerated and sustained broad-based growth of more than 6 percent of GDP in order to make significant impact on poverty reduction.

B. Sources of Growth

4. To identify the sources of growth and explain income differentials with peers, the analysis uses a growth accounting framework. A common representation of the production process is the Cobb-Douglas production function, in which output is expressed as:


where Y is output, K is the physical capital stock, L is labor input (or human capital stock), and A is total factor productivity (TFP), which captures all other implicit variables that are relevant for the transformation of capital and labor into output, such as technology and institutions. The subscript t denotes time. Following Gijon, Yontcheva, and Dernaoui (2015), the World Bank’s World Development Indicators (WDI) database was used for labor force and the IMF’s World Economic Outlook (WEO) database for physical capital and real GDP growth rates. The capital share (α) is assumed to be 0.4, based on work on growth accounting in sub-Saharan Africa (IMF Working Paper 04/176). Capital shares of between 0.30 and 0.45 were used in research on the Eastern Caribbean Currency Union, which is a region of small-island states much like São Tomé and Príncipe in terms of size, population, and economic orientation, and it was determined that within this range the overall results were largely the same (Thacker et al 2013).

Taking natural logarithm of the function and differentiating with respect to time gives:


where the dotted variables represent time derivatives. The equation essentially indicates that economic growth can be decomposed into contributions from TFP, and capital and labor inputs. It also means that once the growth of output, capital, and the labor force are obtained, TFP growth can be estimated as a residual, based on α’s assumed value.

5. There are some limitations to the model. Given the paucity of data on educational attainment, the analysis uses a basic production function that abstracts the contribution of human capital to growth, including only capital and labor as factor inputs. The TFP component is measured as an unexplained residual and thus picks up measurement errors in the data, including the challenge of accounting for improvements in the quality and composition of physical and human capital, which could be significant. The assumption of constant shares over time may also not necessarily hold. Despite these caveats, this framework remains an important tool for policymakers to help diagnose the contribution of different factors to growth, the constraints to growth, and the design of policies to enhance growth.

6. The results suggest that economic growth in São Tomé and Príncipe has been underpinned by the contribution of investments in physical capital—largely public sector-financed. Over the period 1980–2012, the contribution of capital to growth was 6.7 percent on average while that of labor averaged 0.7 percent (Table 1). On the other hand, productivity seems not to be contributing to the growth momentum. Analysis of the results also reveal that growth could be further accelerated over the medium term through mobilizing private investment and enhancing productivity, which are important given the country’s level of indebtedness and limited fiscal space for sustaining high levels of public sector investment.

Table 1.

Sources of Real GDP Growth, 1960–2012

(α = 0.4)

article image
Sources: IMF, World Economic Outlook database, 2012; World Bank, World Development Indicators, 2012; Thacker et al (2013); Gijon et al (2015); and authors’ calculations.

Percentage change.

Data from 1980-2012.

Data from 1971-2007. Alpha, α = 0.35; using different values for α (=0.30-0.45) make little difference to the overall results according to the authors.

Data through 2001.

7. Growth composition in peer groups in sub-Saharan Africa is broadly similar to that of São Tomé and Príncipe. Sub-Saharan African low-income countries’ average growth decomposition also shows that physical capital is the most important factor contribution to growth, followed by labor input while productivity losses have held back growth. By contrast, independent countries in the Eastern Caribbean Currency Union—namely, Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, Saint Lucia, and St. Vincent and the Grenadines—have grown twice as fast as São Tomé and Príncipe with a positive contribution from productivity despite lower capital contribution. The same is true for all low-income countries in the world when grouped together.

C. Constraints to Growth and Private Sector Development

8. Companies in São Tomé and Príncipe have consistently identified “getting credit” as a key barrier for doing business. Among the reasons put forward by credit institutions for their reluctance to lend are high credit risks (due to over-indebtedness and asymmetric information) and costs of funds, especially in relation to loan size, even though these factors are largely priced-in given the relatively high lending rates in the market. Private sector credit growth, while recently turning positive, has remained weak and supports non-productive sectors like distributive trades and private consumption disproportionately relative to agriculture and tourism. Credit to the private sector, which increased by 3.8 percent in 2015, seems to be trending back upwards since early 2015 after successive months of year-on-year declines in 2014. The slow credit growth has led to the build-up of excess liquidity in the banking system and this has also been compounded by growing household debts (high non-performing loans) and the lack of liquidity management tools. The withdrawal of large-scale oil exploration activity, coupled with declining prospects for commercial oil production, has also meant that opportunities for banks to lend are scarce, entrenching the liquidity overhang. While economic diversification and vibrancy in private sector activities would help, banks also need to resolve the issue of high non-performing loans before they can lend more money. Development of non-banking financial institutions and services has also been limited. The microfinance sector is miniscule, in which there is a single operator and no formal regulatory framework to support the growth and development of the sector.

9. The costly business environment also extends to the price of electricity, which has been invariably mentioned as a challenge for the private sector. In addition to the high price for electricity, the oft-times inefficient and unreliable service adds both direct and indirect costs to the private sector in terms of generator usage and lost productivity during times of service disruptions. Some businesses in the financial sector report spending as much as 40 percent of their total operating costs on electricity alone and service reliability is a concern across the board. Frequent outages are largely the result of the aging generation equipment.

10. Governance—particularly bureaucratic and legal systems—while necessary, has become a constraint as there is insufficient transparency and excessive delays. While São Tomé and Príncipe has been lauded in recent time for its stable political environment and swift business registry procedure, the judicial system has been singled out by the private sector as a major challenge with governance, and in need of reform to provide more legal protection for investors and enable banks and credit institutions to realize collateral claims in a timely manner.

11. Other identified issues that require attention are infrastructure bottlenecks and health and environmental challenges. The business community agrees with the political directorate on the necessity for further infrastructure development, especially as it pertains to road and airport development. However, infrastructure investment must be done judiciously; high value-added projects should be expedited, especially if financing is available at terms and conditions that do not jeopardize the country’s debt sustainability. Moreover, health and sanitation concerns need to be addressed by expanding the water supply coverage area, discouraging litter and encouraging healthy lifestyles. All efforts should be directed to preserving the unspoiled image of the islands.

D. Policy Recommendations

12. São Tomé and Príncipe can do well with venture capital-type financing for micro, small and medium-sized enterprises (MSMEs). Venture capital is defined as long-term, committed share capital invested in enterprises that are subject to certain risks that make them unattractive to bank financing or to financiers in the public or quoted capital markets. The risks of the venture bear some relation to its size, stage of development, degree of leverage, and/or the nature of the industry. Venture capital addresses the challenge of access to credit by providing investment funds—primarily, but not exclusively, to entrepreneurial ventures that simultaneously possess promising potential yet risky returns. In this way, venture capital can be viewed as a supplement to traditional financial intermediation and inflows of foreign direct investment as it reduces information asymmetries, creates investment incentives and rewards entrepreneurial talent.

13. Branding and product certification, trade promotion, and training are necessary to highlight the unique offerings of the country to a global market. It is important for a small-island economy, which has peculiar challenges (such as market size and production scale limitations), to be outward-looking in its orientation, and to find and perfect its market niche—whether it be high-end tourism or premium chocolate, or both. Linked to this point is the need for respecting the natural environment and preserving the natural assets of the country, especially given the certification of the biosphere reserve on Príncipe Island, which distinguishes it as a leader in sustainable tourism. Tying all of these points together is the imperative for training and capacity building through education, technical assistance and information-sharing so that the population understands its roles and responsibilities, and can contribute more effectively to growth and private sector development initiatives in order to share its benefits.

E. Conclusion

14. São Tomé and Príncipe faces key policy challenges to ensure sustained growth in the periods ahead. Two important points stand out: a decline in productivity, rather than a lack of investment, appears to be the principal reason for the slower growth relative to peer groups over the time span of more than 30 years; and improving access to credit can be a significant growth stimulus, reducing poverty and promoting economic empowerment, provided that the stability issues are appropriately addressed. Staff projections show that economic growth will stabilize at a modestly higher 5.5 percent in the medium term. The forecast assumes a conservative implementation of the government’s strategic investments given the financing needs. Longer-term growth could potentially hover at 6.0 percent.

15. While capital investment intensification is necessary to support São Tomé and Príncipe’s high growth potential, productivity gains are essential. Productivity losses may explain some of the differences between São Tomé and Príncipe’s growth performance and that of its main peer groups so, while capital investment intensification is useful, productivity gains are vital to maximize growth potential. Further improving São Tomé and Príncipe’s productivity requires, among other measures, addressing its challenging business climate and promoting a more diversified economy with vibrant private sector participation.

16. Providers of credit, especially banks, have an important role to play and venture capital financing could be considered to support growth and private sector development. The role of banks for spurring private sector development given São Tomé and Príncipe’s nascent stage of development cannot be overemphasized. While both institutions and markets are complementary for growth, too much and rapid market development at the embryonic stages of institutional development may have negative implications for stability. Hence, establishing the appropriate balance between financial markets and institutions is important.

17. Financial sector development could stimulate economic growth, while reducing poverty and inequality. By mobilizing pooled savings into investment, improving resource allocation, and increasing access to financial services, financial development would likely convey net benefits to São Tomé and Príncipe, provided there is adequate regulatory oversight to prevent excesses. However, if the financial system becomes too large to allow for effective regulation and supervision, it could conceivably divert resources away from productive activities, generate financial instability and macroeconomic volatility (with adverse consequences on long-term growth), and engender financial crises. Structural reforms—such as expanding the credit registry and strengthening the legal codes (e.g., for possessory title)—are required to facilitate further financial sector development and increase potential growth.

18. Other business-friendly reforms can also have significant potential for creating longer-run economic payback. These should focus on: improving the effectiveness of public investment; improving the business environment and providing more efficient public services; increasing linkages between sectors with strong potential growth, e.g. tourism, agriculture and fisheries, and geothermal energy; and increasing efficiency in the product, labor, energy and financial markets.

Figure 1.
Figure 1.

São Tomé and Príncipe: Sources of Growth

Citation: IMF Staff Country Reports 2016, 175; 10.5089/9781498308373.002.A003

Sources: IMF World Economic Outlook database, and IMF staff estimates and projections.


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This note was prepared by Jehann Jack (AFR).