Performance under the Program and Recent Economic Developments

São Tomé and Príncipe continues to make progress in the implementation of the ECF-supported program, thus strengthening further macroeconomic stability. Program performance, however, was uneven. On the one hand, two out of six performance criteria (PC) were missed, namely those related to the domestic primary balance and net international reserves. While the underperformance with regard to the domestic primary balance resulted primarily from expenditure overrun, the nonobservance of the PC on net international reserves was triggered by the delayed disbursement of external financing. On the other hand, indicative targets on new domestic arrears and tax revenue were met, while good progress was also made in the implementation of key structural reforms, with the completion of two out of three end-June 2016 structural benchmarks. The missed end-June structural benchmark on the automatic fuel price adjustment mechanism has now been implemented in November.

Despite the adverse external environment, economic activity remains broadly robust, helped by a strong performance of the tourist and cocoa sectors. In 2016, real GDP growth is projected to hover around 4 percent, slightly lower than initially forecasted due to the unanticipated shortfall in foreign-financed capital spending. Inflation is expected to remain around 5.5 percent, reflecting temporary food shortages and changes introduced to the CPI basket. The external position continues to be strong as gross international reserves remain adequate, as noted by staff.

In the fiscal sector, performance in the first half of 2016 was mixed. While domestic revenue mobilization was slightly stronger than projected, public expenditure overshot significantly program targets, so did the primary deficit. Nevertheless, the overall fiscal deficit was in line with program commitments on account of weaker privatization and externally-financed capital spending.

In the banking sector, capital adequacy ratios are broadly satisfactory. However, banks’ profitability remained elusive as excess liquidity continued to be high and nonperforming loans on the rise, with Banco Equador accounting for a significant part. In this context, the central bank (BCSTP) took steps to overcome these structural impediments to the health of the banking system. In particular, it initiated the resolution of Banco Equador, cancelling its license and beginning court liquidation proceedings in line with the new banking resolution framework. In parallel, care was taken to protect small and non-connected depositors. The court has since officially ruled in favor of the liquidation and appointed a liquidator.

Economic Policies for the Rest of 2016 Onwards

Our Sao Tomean authorities remain fully committed to the objectives of the ECF-supported program. Going forward, they will focus on ensuring greater fiscal discipline, safeguarding financial sector stability, and advancing their ambitious structural reform program.

Fiscal Policy

To mitigate the impact of fiscal missteps that took place in the first half of 2016, the authorities will aim to ensure a more rigorous and disciplined budget execution, with a view to achieving the end-year program target for the domestic primary deficit and ensuring that public debt remains on a downward path. In this endeavor, stricter control will be exercised over spending on goods and services and treasury-financed capital.

At the same time, steps will be taken to strengthen public financial management. In this connection, the recently completed diagnostic study that was conducted with the assistance of AfDB will play a key role by helping include autonomous services and municipalities in the electronic information management system (SAFEe). The oversight has already been extended to the general inspection finance entity and they are working on extending oversight to the Court of Public Accounts. The authorities are also committed to the prompt implementation of a centralized framework for appraising and prioritizing capital expenditure projects (public investment management assessment framework—PIMA).

The authorities are determined to pursue their fiscal consolidation efforts, notably by boosting revenue mobilization. In this regard, they plan to submit the VAT legislation to the National Assembly while preparing changes to the income tax to maintain coherence in the tax system. In addition, the focus will be put on reforms aimed at developing human capital, improving working conditions, and strengthening fiscal operations.

The authorities of São Tomé and Príncipe reiterate their commitment to reduce fiscal risk and improve debt management. The introduction of the automatic fuel price adjustment mechanism will help to avoid accumulating domestic arrears. On debt management, the authorities will continue to pursue prudent debt management policies consistent with the need to preserve debt sustainability and upgrade the country’s risk of debt distress rating from high to moderate risk. An updated medium term public debt management strategy has been submitted to the parliament together with the draft 2017 budget. Moreover, a new debt management performance assessment (DeMPA) was completed with the World Bank assistance.

Monetary Policy

To address excess liquidity in the banking system, the authorities agree with staff on the need to refine the liquidity forecasting and management tools. The central bank of São Tomé and Príncipe (BCSTP) will continue to closely cooperate with the treasury with a view to further minimizing forecasting errors and improving the assessment of banks’ liquidity needs. To enhance liquidity management, the BCSTP is working towards developing the secondary market for government securities, creating conditions for long-term liquidity management, and promoting transparent public reporting of banks’ audited financial statements.

Financial Sector Stability

Profitability in the banking sector continues to be challenging. Against this background, the BCSTP is taking steps to implement its strategy for reducing non-performing loans (NPLs). As a result, on-site supervision inspections were conducted, resulting in asset reclassifications and increases in provisions. Banks were also called for improving their credit risk evaluation and introduce asset quality reviews. Following these initiatives, the end-September financial sector indicators suggest that the NPLs ratio has slightly decreased relative to their recorded level at the beginning of the year although this is largely related to the exclusion of Banco Equador.

In order to strengthen the risk-based supervision practices, the BCSTP is implementing the policy recommendations drawn from MCM technical assistance and consistent with international best practices for supervision (Basel Core Principles). These include notably updating the legal and regulatory framework and adopting measures to establish an effective supervisory regime capable of maintaining a sound and secure banking system in São Tomé and Príncipe. In addition, the BCSTP is working with the recently appointed Audit Board to ensure independent oversight of the audit mechanisms, internal controls, financial reporting, in line with the recommendations made by the September 2015 safeguards assessment.

Structural Reforms

The authorities are fully committed to operationalizing the 2030 Transformation Agenda, notably by prioritizing export diversification and cost competitiveness to support growth and external stability. The new 5–year National Development Plan is expected to be completed by end-December 2016 with support from the UNDP. The authorities are currently working with the World Bank to finalize a national export diversification strategy centered on sustainable tourism growth. In this context, in early October 2016, São Tomé and Príncipe hosted the forum of the Union of Exporters of the Community of Portuguese Speaking Countries (UE-CPLP). This event sought to identify business opportunities that could be explored through partnerships between economic agents in within Portuguese speaking communities. Likewise, the authorities will continue efforts to improve the supply and reduce the high cost of electricity, including through substitution to alternative and cheaper energy sources, reform of the state electricity company (EMAE), and move to a full cost recovery of electricity tariffs.

Concluding Remarks

Against the backdrop of a challenging environment, São Tomé continues to make inroads in advancing its reform agenda. With the election of new President who benefits from a strong majority in parliament, the authorities are now provided with an opportunity to accelerate their reform efforts. The recent introduction of the automatic fuel price adjustment mechanism, a politically difficult measure, is an illustration of their determination to reap the benefits of this welcome development.

In light of the above, we would greatly appreciate Directors’ support for the second review under the ECF and the authorities’ request for waivers for nonobservance and modifications of performance criteria.