Democratic Republic of São Tomé and Príncipe: 2018 Article IV Consultation, Fifth Review Under the Extended Credit Facility, Request for Waivers for Nonobservance of Performance Criteria, and Financing Assurances Review
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International Monetary Fund. African Dept.
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Publication Date:
02 Aug 2018
eISBN:
9781484372227
Language:
English
Keywords:
ISCR; CR; debt; real GDP; measure; authority; central bank; exchange rate; foreign exchange; debt management; private sector; International reserves; Arrears
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2018 Article IV Consultation, Fifth Review Under the Extended Credit Facility Arrangement, Request for Waivers for Nonobservance of Performance Criteria, and Financing Assurances Review

Abstract

2018 Article IV Consultation, Fifth Review Under the Extended Credit Facility Arrangement, Request for Waivers for Nonobservance of Performance Criteria, and Financing Assurances Review

Context: Reform to Accelerate Growth

1. São Tomé and Príncipe is a fragile, small, remote island-state constrained by limited resources and capacity. The economy is based mainly on subsistence agriculture and fisheries and relies heavily on foreign grants, which exceeded 10 percent of GDP in recent years. It exports mainly cocoa and has a nascent tourism industry, while it imports a wide range of goods including not only manufacturing products but also food products such as rice, wheat, and many vegetables. High hopes for commercial oil production receded in 2013 due to prohibitive extraction costs from the deep sea,1 leaving a legacy of high public debt and a vulnerable banking sector. Meanwhile, weak revenues limit social development programs and contribute to the accumulation of government arrears to suppliers. In addition, poor governance in the past created loss-making state-owned enterprises (SOEs) and system-wide cross-arrears, hindering the functioning of the economy. The country’s low capacity and relatively weak institutions impeded reform efforts, underscoring the need for continued support in capacity development.

2. Good progress has been made towards strengthening macroeconomic stability; however, sustained reforms will be essential to unleash the full growth potential. Progress in implementing the 2016 Article IV recommendations has been uneven (Box 1). Some commendable progress has been made, particularly in supporting traditional sectors, lowering the debt level, and reducing the fiscal deficit following slippages in the run-up to presidential elections in 2016. However, continued efforts in revenue mobilization, building reserves buffer, and structural reforms are essential. Over the last three years, GDP grew by 4 percent annually, and inflation averaged only 5.5 percent. Nevertheless, growth has been too slow to meaningfully reduce poverty. With 40 percent of the population under the age of 14, faster growth is needed to absorb the large number of youth entering the labor force each year. In addition, the country’s per capita income and other social indicators lag significantly behind other small island-states in Africa (Selected Issues Paper (SIP) Chapter 1). The government’s debt level remains elevated and is classified as in debt distress as the ongoing negotiations of rescheduling arrears have been delayed pending creditors’ responses. However, the outlook has improved and the debt is sustainable in the medium term.

3. Recognizing the challenges of pursuing sustained reforms, the authorities have committed to continue to build capacity. They stress the need for hands-on technical assistance (TA), particularly by long-term resident experts as highlighted in the medium-term capacity development strategy (Annex I). In line with reform agendas, TA priorities include revenue administration (notably implementing VAT), public financial management (PFM) to improve budget preparation and execution, and banking regulation and supervision. Given the wide scope of reforms envisaged in a fragile environment, sustained support from bilateral and multilateral development partners is also essential to develop capacity in the country.

Main Recommendations of the 2016 Article IV Consultation and Their Current Status

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Source: IMF staff assessment.

Recent Economic Developments

4. Economic activity decelerated slightly in 2017, largely due to lower external support. Real GDP growth slowed from 4.2 percent in 2016 to 3.9 percent in 2017, amid fiscal tightening, delays in foreign-financed projects, and slowing construction activity. Tourism remained robust, as more frequent flights, simplified entry requirements, and increased publicity continue to draw tourists. Meanwhile, bumper cocoa production—the main cash crop—was tempered by lower international prices. Annual inflation, however, spiked to 7.7 percent at end-2017, driven by increased import taxes on selected goods and a temporary shortage of locally produced foods caused by unfavorable weather conditions. Inflation showed signs of deceleration, with annualized seasonally-adjusted monthly inflation decelerating from 11 percent in December 2017 to 0 percent by April 2018. Agricultural programs implemented recently have increased the local supply of vegetables and fish, making the production less vulnerable to excessive rain. The current account deficit was projected to have widened to 8.2 percent of GDP, mainly driven by a substantial increase in imports of oil-related investment goods (up by 67.3 percent), which was largely financed by oil-related FDI.

5. A decline in external inflows and spillovers of foreign exchange pressures from neighboring countries increased foreign exchange shortages, and the authorities responded by tightening foreign exchange regulations. Net official transfers fell from 13.7 percent of GDP in 2016 to 10.6 percent of GDP in 2017. Authorities noted that there was evidence that foreign exchange has been increasingly flowing out of the country to satisfy demand from neighboring oil exporters under stress. They explained that this took place through external trade contracts that did not result in actual imports of goods to the country. Gross international reserves (GIR), marked to market, fell by about US$4.6 million to US$51 million (or 4.2 months of import cover) mainly due to lower external inflows. Net international reserves (NIR), a program target, declined by US$6.1 million to $44 million. At end-March 2018, NIR rose by $2 million to $46 million. While the reserves level missed the unadjusted indicative target of $52 million, the accumulation exceeded the projection of $1 million. In response to the increasing shortage and to prevent further depletion of international reserves and safeguard the exchange rate peg, the authorities intensified an existing exchange restriction that predated the current program, through the implementation of a new regulation (NAP 05/2017) on March 1, 2017 (MEFP ¶37-39). This tightening inadvertently breached the continuous performance criterion that prohibits the intensification of existing exchange restrictions.

6. A combination of revenue and expenditure measures was implemented in 2017 to reduce the DPD (Text Table 1). Tax measures implemented in 2017 included a new consumption tax on imported alcoholic beverages, a hike in duty on selected imported commodities starting in July, particularly on alcoholic beverages, and the collection of tax arrears from large taxpayers. While these measures offset the loss of revenues from a correction of the income tax return formula, the revenue outturn was 0.9 percent of GDP lower than anticipated. Imports of goods affected by the hike in duty plummeted, and some large taxpayers failed to honor the agreements with the government on tax arrears clearance. The authorities offset the revenue shortfall by under-executing the budget on transfers and personnel costs, while they spent about ½ percent of GDP more than anticipated on capital and current expenditure in health and education, partly due to a virus outbreak that led to a public health emergency. Accordingly, total discretionary expenditure was cut by almost 2 percent of GDP relative to 2016, and the DPD exceeded the target by ½ percent of GDP.

Text Table 1.

Fiscal Performance 2017

(in percent of GDP)

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Sources: Ministry of Finance and IMF staff estimates.
Text Table 2.

Impact of Fiscal Measures

(in percent of GDP)

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Sources: Ministry of Finance and IMF staff estimates.

7. Preliminary fiscal data for the first quarter in 2018 are broadly in line with last year’s outturns. The continued revenue underperformance from the hike in import duties in 2017 was exacerbated by delayed tax payments from large firms (notably ½ percent of GDP in import taxes due by ENCO as of May). This was partially offset by higher oil import tax revenue, reflecting higher international oil prices, and budget under-execution. As a result, the end-March fiscal indicative targets for the DPD, tax revenue and new domestic arrears were missed by about 0.3, 0.5 and 0.07 percent of GDP, respectively. However, the indicative target on the change in net bank credit to the central government was met.

8. Public and publicly guaranteed (PPG) debt has declined. External debt decreased from 52.5 percent of GDP in 2016 to 45.7 percent of GDP in 2017, reflecting economic growth, a strengthened euro-dollar exchange rate, and little new borrowing (0.5 percent of GDP).2 The government accumulated a small amount of domestic arrears to suppliers (0.1 percent of GDP) and failed to clear previous arrears as programmed (0.1 percent of GDP), partly because the EU budget support grant was reduced by €1 million (0.3 percent of GDP) in 2017 due to slow progress in PFM reform. Meanwhile, the higher oil price at the pump, relative to import prices, generated gains that were used to pay down debt to ENCO, bringing total debt down from 67.6 percent of GDP in 2016 to 64.4 percent of GDP in 2017.

9. Financial soundness indicators (FSIs) improved somewhat but continued to show signs of vulnerability (Table 5). Starting in August 2016 with the exit of Banco Equador, all banks have regulatory capital to risk-weighted assets greater or equal to 10 percent. The overall NPL ratio fell by 2.2 percentage points to 24.9 percent at end-2017 from end-2016. The system-wide capital adequacy ratio improved to 33.6 percent of risk-weighted assets as banks shifted resources into government paper. In addition, provisioning coverage of NPLs is quite high, in excess of 80 percent of NPLs. Sensitivity analyses suggest that the system-wide capital is ample, and the capital adequacy ratio will become insufficient only if the NPL ratio increased by another 22 percentage points (to 47 percent). However, pockets of vulnerability persist and require vigilance. System wide, the default rate among new and restructured loans issued since end-2016 doubled to 6.7 percent. FSIs were broadly unchanged in the first quarter of 2018. The smallest bank (Banco Privado) was intervened and put up for sale by the BCSTP in February 2018 after the bank incurred large loan losses and became undercapitalized. BCSTP decided in mid-June to close the bank outright, transferring its portfolio to other banking institutions in the country. Sensitivity analyses of individual banks show that one bank could have insufficient capital should its NPLs increase by 5½ percentage points. In addition, most banks are still loss-making due to high operational cost, including of energy. Meanwhile, the liquidation of Banco Equador is still pending court approval of required procedures although the liquidator assumed his position in October 2017.

Table 1.

São Tomé and Príncipe: Selected Economic Indicators, 2015–20

(Annual change in percent, unless otherwise indicated)

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Sources: Sào Tomé and Príncipe authorities’ data and IMF staff estimates and projections.

Central Bank (BCSTP) mid-point rate.

Excludes oil related revenues, grants, interest earned, scheduled interest payments, and foreign-financed capital outlay.

Percent of exports of goods and nonfactor services.

Gross international reserves exclude the National Oil Account and commercial banks’ foreign currency deposits at the BCSTP in order to meet reserve requirements, for new licensing, and for meeting capital requirements.

Imports of goods and nonfactor services, excluding imports of investment goods and technical assistance.

Table 2a.

São Tomé and Príncipe: Financial Operations of the Central Government, 2015–20

(Millions of new dobra)

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

Excludes oil related revenues, grants, interest earned, scheduled interest payments, and foreign-financed capital outlays.

Includes loan from Angola in 2016 and 2017.

Includes use of IMF program support.

The central bank shows receipt of $5 mln in budget support from the World Bank at the very end of 2016, whereas the treasury accounts for them in 2017 when they received them.

Revenue is measured on a cash basis.

Table 2b.

São Tomé and Príncipe: Financial Operations of the Central Government, 2015–20

(In percent of GDP)

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Sources: Sào Tomé and Príncipe authorities’ data and IMF staff estimates and projections.

Excludes oil related revenues, grants, interest earned, scheduled interest payments, and foreign-financed capital outlays.

Includes loan from Angola in 2016 and 2017.

Includes use of IMF program support.

The central bank shows receipt of $5 mln in budget support from the World Bank at the very end of 2016, whereas the treasury accounts for them in 2017 when they received them.

Revenue is measured on a cash basis.

Table 3.

São Tomé and Príncipe: Summary Accounts of the Central Bank, 2015–20

(Millions of new dobra)

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

Gross international reserves exclude the National Oil Account and commercial banks’ foreign currency deposits at the BCSTP in order to meet reserve requirements, for new licensing, and for meeting capital requirements.

Imports of goods and nonfactor services excluding imports of investment goods and technical assistance.

Net international reserves exclude the National Oil Account and commercial banks’ foreign currency deposits at the BCSTP in order to meet reserve requirements, for new licensing, and for meeting capital requirements.

Table 4.

São Tomé and Príncipe: Monetary Survey, 2015–20

(Millions of new dobra)

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Table 5.

São Tomé and Príncipe: Financial Soundness Indicators, December 2012 – March 20181

(Percent)

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Sources: São Tomé and Príncipe authorities’ data and IMF staff estimates. Note: Beginning June 2013, data are based on improved methodology and not strictly comparable with earlier data.

Excluding Banco Equador (from the time that its banking licence was withdrawn in August 2016).

10. The central bank successfully redenominated the local currency on January 1, 2018. After removing three zeros, the currency is now valued at 24.50 new dobras per euro, maintaining a peg implemented in 2010. Anecdotal information and data suggest that the redenomination went smoothly with negligible impact on inflation.

11. Credit growth decelerated. The growth of credit to the economy slowed to 2.5 percent in 2017 compared with 6.6 percent in 2016. Banks shrank credit in some segments, notably the trading sector, reflecting slow economic activity and continued risk aversion. At the same time, banks invested some excess liquidity in Treasury Bills, the issuances of which were over-subscribed. Consequently, the average liquidity ratio declined from 58 to 50 percent but remains high overall. Meanwhile, a new facility for small and medium-sized enterprises (SMEs)—funded by the International Finance Corporation—at a large bank has been slow to generate credit.

Program Performance

12. Program performance at end-2017 was uneven (MEFP Table 1). The performance criteria (PCs) on the DPD and net bank financing of the central government (NCG) were missed by ½ percent of GDP, due to the substantial shortfall in revenue and higher spending in health and education. The authorities noted that they spent more on health and education in anticipation of external budget support that failed to materialize and to address a virus outbreak of “necrotizing cellulite.” Nonetheless, the reduction in the DPD in 2017 was still a substantial 1.7 percent of GDP. The PC on net international reserves (NIR) was missed partly because of a one-off large shortfall of external financing, particularly from international financial institutions, which was only partly accommodated by program adjusters. Two other PCs on external arrears and external borrowing were met. The continuous PC that prohibits the introduction or intensification of exchange restrictions was inadvertently breached (¶13). Fiscal indicative targets (IT) on tax revenue and new domestic arrears were missed by about 0.5 and 0.07 percent of GDP, respectively, while the pro-poor spending target was met. Corrective measures to address tax revenue under-performance have been introduced (¶19-21 and MEFP ¶20-22).

Table 1.

São Tomé and Príncipe: Performance Criteria and Indicative Targets for 2017, Preliminary

(Millions of new dobra, cumulative from beginning of year, unless otherwise specified)

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

Performance at the December 2017 test date is assessed on the fifth review.

The floor will be adjusted upward or downward according to definitions in the TMU.

The ceiling will be adjusted downward or upward according to definitions in the TMU.

Excluding the National Oil Account (NOA) at the Central Bank:

The term “central government” is defined as in ¶ 5 of the TMU, which excludes the operations of state-owned enterprises.

This criterion will be assessed as a continuous performance criterion.

The term “external” is defined on the basis of the residency of the creditor per paragraph 5 of the Guidelines on Public Debt Conditionality in Fund Arrangements, adopted by Decision No. 15688 of the Executive Board (Dec. 5, 2014).

This performance criterion or memorandum item applies not only to debt as defined in paragraph 8 of the Guidelines on Public Debt Conditionality in Fund Arrangements, adopted by Decision No. 15688 of the Executive Board (Dec. 5, 2014), but also to commitments contracted or guaranteed for which value has not been received. For further details on the definition of debt and external arrears refer to the TMU, ¶¶ 6 and 13.

Only applies to debt with a grant element of less than 35 percent. For further details refer to the TMU, ¶ 17.

Changed to a memorandum item.

Only applies to debt with a grant element of at least 35 percent.

As defined in the TMU, valued at the program exchange rate, excludes HIPC-related amortization.

13. The BCSTP adopted a foreign exchange regulation (NAP 05/2017), effective March 1, 2017, which further tightened an existing foreign exchange restriction. This exchange restriction predates the ECF arrangement. During the staff visit in June 2018, market participants—both banks and importers—reported long-standing difficulties to meet foreign currency demand, which were further intensified with the adoption of the March 2017 regulation. Staff also received a copy of the regulation and determined that it intensified the limitations on access to foreign exchange. As such, the continuous PC against the intensification of exchange restrictions had not been observed at the time of the completion of the third and fourth reviews under the ECF arrangement last December. However, this is not a case of misreporting, since the authorities informed Fund staff when discussing the third review that they had tightened the foreign exchange regulation. Staff should have followed up to obtain a copy of the regulation to enable an assessment about its consistency with the PC.

14. The government has made progress in implementing structural reforms (MEFP Table 2). A draft Public-Private Partnership (PPP) law was submitted to the National Assembly on October 30, 2017, and has been approved, and measures to contain financial losses at EMAE in the near term have been implemented (MEFP ¶22), meeting end-December 2017 structural benchmarks. Furthermore, some end-June 2018 structural benchmarks have been met (MEFP Table 4)—a VAT law was submitted to parliament on May 24, and a Tourism Development Strategy (the core of the National Export Diversification Strategy) was launched in January 2018. The end-June benchmark to adopt a financial management plan and least cost energy-production plan for EMAE and the end-June benchmark to complete an independent detailed asset quality review of banks were delayed because of longer-than-expected procurement processes (¶33, ¶42, MEFP ¶15, and MEFP ¶29).

Economic Outlook and Risks

15. The economic outlook remains positive on balance. The economy is forecast to grow by 4 percent in 2018 and to accelerate to 5 percent in the medium term as new externally-financed projects—including an airport expansion, road construction and restoration, and the rehabilitation of the electricity system—get underway. Faster growth, accompanied by appropriate structural reforms, will lay the foundation for increasing employment and reducing poverty. Inflation is expected to moderate to 6 percent in 2018 as the one-off supply and tax effects in 2017 subside, and to fall below 5 percent in the medium term.

16. The outlook is fraught with risks (Box 2). The downside risks include pre-election pressures that could delay structural reforms, impede revenue mobilization, particularly tax arrears collection from large taxpayers, and raise extra-budgetary spending. These potential slippages could undermine hard-won fiscal consolidation and discipline. In addition, delayed reforms of EMAE would lead to continued large losses and increased fiscal burden. Meanwhile, prolonged bank resolution and continued high NPLs could further stall credit expansion, particularly to small enterprises, and hinder growth. Externally, delays in donor disbursements would undermine growth prospects and affect reserves accumulation, and weak growth in key advanced economies, particularly Portugal, could dampen the country’s exports, especially its tourism industry. On the upside, faster implementation of large externally-financed projects could spur growth. In addition, lower international energy prices could reduce imports.

17. The country is classified as being in debt distress because of the existence of long-standing external arrears, although the updated Debt Sustainability Analysis (DSA) shows that the outlook has improved and the debt is sustainable in the medium term. The government has sought debt rescheduling agreements on external arrears with Angola, Brazil, and Equatorial Guinea. An agreement with the Brazilian government was reached, but is pending the ratification by the Brazilian Senate. The government is still waiting for responses from the other two countries to continue negotiations, as well as from Nigeria on discussing the disputed loan. Meanwhile, as noted previously, external and PPG debt declined in 2017, a trend expected to continue. Under the baseline scenario, the present value (PV) of PPG external debt-to-GDP ratio now stays below the threshold for high risk of debt distress during the entire projection period. Nevertheless, the ratios of the PV of PPG external debt to exports and to revenue still exceed their respective thresholds under the baseline scenario, though they both decline over time to be below the thresholds. The DSA underscores the importance of continuing fiscal consolidation, eschewing non-concessional loans, limiting external concessional borrowing, and expanding the export base. Provided that such policies are followed as envisaged under the program and the economy and export base continue to grow steadily, staff assesses that debt is sustainable in the medium term, with all indicators eventually falling below their thresholds in the baseline scenario.

São Tomé and Príncipe: Risk Assessment Matrix 20181

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Source: IMF staff assessment.
1/ The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. “Short term (ST)” and “medium term (MT)” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.

Authorities’ Views

18. The authorities broadly agreed with staff’s assessment of the medium-term outlook and associated risks, but have a more optimistic view on near-term growth prospects. They expected GDP growth to accelerate in 2018, on account of planned infrastructure projects. They concurred that without policy actions, public debt dynamics and fiscal liabilities from large losses of EMAE are unsustainable. They reiterated their commitment to the program, notwithstanding the elections, and intention to press ahead with the structural reform agenda, including adopting a VAT and implementing various sectoral development plans. They pointed out that the delays in implementing reforms also reflected lengthy procedures of their development partners. In addition, they have actively sought debt rescheduling agreements with Angola, Brazil, and Equatorial Guinea, through correspondence and high-level meetings.

Policy Discussions

Policy discussions focused on immediate measures to offset the revenue shortfall to achieve the fiscal targets for 2018; the transition to a VAT regime in 2019; reforms of EMAE; boosting international reserves to protect the peg; safeguarding financial sector stability in the face of persistently high NPLs; and promoting private sector led growth, particularly tourism.

A. Address Revenue Shortfall and Contingent Liabilities, and Reduce Debt Burden over the Medium Term

19. The government has taken revenue measures to partially offset a revenue shortfall in the near term (MEFP ¶20-22). Under unchanged policies, the drop of imports due to the hike in duty on imports in 2017, weak tax performance in the first quarter of 2018 and lower collection of tax arrears, and the cancellation in January 2018 of the earlier decision to suspend the deductible of the personal income tax (PIT) in the tax law would cause a revenue shortfall in 2018 of about 1.8 percent of GDP relative to the previous review. To offset the revenue shortfall, and as a prior action for the fifth review, the government will collect close to ½ percent of GDP in tax arrears plus applicable penalties owed by the local beer producer Rosema and other firms, largely consisting of consumption tax on sales and PIT on their employees that the firms collected on behalf of the state (MEFP ¶21). The government will also endeavor to collect tax arrears from other large taxpayers, including the airport authority ENASA (SIP Chapter 3).

20. Preliminary data suggest that the government is on track to meet the end-June fiscal targets (Text Table 3). The government has committed as a prior action to collect current taxes of about 0.7 percent of GDP before end-June from some large taxpayers that fell behind their payments in the second quarter of 2018 (MEFP ¶20). Preliminary fiscal data indicate a DPD of about 1.4 percent of GDP at end-May. The combined gains from collecting tax arrears and late payments of close to 1.1 percent of GDP should then bring the DPD below the end-June’s target of 95 million new dobras (1 percent of GDP), given the expected budget execution for the month of June. In addition, the government will monitor monthly the top ten large taxpayers’ payments against their projected taxes due (new end-November 2018 structural benchmark).

Text Table 3.

Fiscal Performance 2018:H1

(percent of GDP)

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Sources: Ministry of Finance and IMF staff estimates.

21. Spending measures will complement the revenue measures to continue fiscal consolidation in 2018. The end-December 2018 DPD target is set at 1.3 percent of GDP, slightly higher than the 1 percent targeted in the fourth review to allow for measured adjustment, but still below the 1.8 percent of GDP target for last year. The government intends to generate savings of about 1.1 percent of GDP in primary domestic expenditures largely through maintaining the cuts in transfers and personnel costs introduced in 2017 and reducing consumption of electricity, water, and fuel by public agencies (MEFP ¶22). As previously programmed, the nominal public wage bill will grow below the rate of GDP growth by keeping wages largely unchanged to free resources for new hiring for priority needs in education, health, and security services. Domestically-financed capital expenditure will be slightly reduced from 2017 in light of the higher spending last year and expected higher externally-financed spending this year. In view of the uncertainty of revenue, as a precautionary measure to ensure the DPD target is met, the government will hold back expenditure to match available resources. The Minister of Finance has issued a resolution to limit budgetary expenditure in line with the program, meeting a prior action for the completion of the review.

22. The government also remains committed to bring the arrears clearance plan back on track (MEFP ¶23). The government has agreed to prioritize arrears clearance if additional resources, including additional budget support or revenue, materialize. Given expected disbursement of budget grants equivalent to 2.1 percent of GDP, the government would allocate the equivalent of 0.7 percent of GDP in non-project grants to pay down debt. In addition, effective from 2019, a surcharge will be applied to the price of oil products in place of the current differential between domestic and import prices to pay the debt to ENCO.

23. Over the medium term, fiscal policy will continue to be aimed at reducing debt to a more sustainable level and reducing aid dependency. The DPD would be maintained close to 1 percent of GDP to reduce aid dependency while safeguarding social spending. To this end, policy will continue to rely on expenditure rationalization in the near term while efforts are being stepped up for the transition to the VAT regime and the necessary realignment of regulations (see ¶25). New external borrowing would eschew non-concessional loans (including for large infrastructural projects).3 To balance the needs to reduce the debt burden and meet large investment needs, concessional borrowing will be kept below 4 percent of GDP per year. This will keep debt relative to GDP and revenue below debt distress thresholds and bring debt relative to exports gradually below the distress threshold.

24. Reducing fiscal risk posed by the state-owned enterprises (SOEs), particularly the utility company, EMAE, remains a priority. EMAE’s arrears to ENCO increased by US$16.6 million (4¼ percent of GDP) in 2017 to reach US$77 million, despite immediate measures to contain operational costs and collect unpaid bills. EMAE is likely to remain loss-making until medium-term investment projects supported by development partners decrease operational costs. Several reform projects, notably rehabilitation of the energy grid and installation of meters, the Financial Management Improvement Plan (FMIP) and the Least Cost Development Plan (LCDP) are advancing. Two other financially-fragile SOEs—the port and airport operators—have agreed on plans with the government to gradually clear their large tax arrears. However, timely implementation will hinge critically on the SOEs’ success in containing costs, including reducing staff costs, and collecting dues. In this connection, the ongoing pre-audit of all SOEs by an international firm (supported by the World Bank) is an important step. Restoring the cost recovery of these SOEs will also be essential to disentangle the web of domestic arrears, the total gross value of which reached about 60 percent of GDP (in unconsolidated terms), of which 14 percent of GDP is owed by the government and 3 percent of GDP is owed to the government.

25. The recent revenue underperformance underscores the need for revenue mobilization. Tax revenues have so far relied heavily on customs and, as a consequence, have been vulnerable to volatility of imports (including in international oil prices) and low tax compliance. Preparations are ongoing to introduce a VAT regime in early 2019, which is expected to gain 2.1 percent of GDP in revenue over the medium term (Box 3, MEFP ¶25). These preparations include alignment of tax regulations on VAT and other taxes, including the recent hikes in import duty. In line with the recommendations of IMF TA on tax administration, the government is also working to implement a more systematic inspection of large taxpayers and a wider computer-based surveillance of taxpayers. In this connection, the authorities will start to monitor large taxpayers’ tax payment against the estimated tax due, while work continues to establish a dedicated large taxpayers’ unit (MEFP ¶25). Also in line with IMF TA, the authorities plan to strengthen revenue forecasts and budget control to avoid arrears accumulation, improve project coordination and management, and strengthen financial programming consistency in budget preparation. In particular, controls of spending on energy and telecommunications have been devised in coordination with the suppliers. The government is committed to effectively apply the automatic fuel price adjustment mechanism, and has accordingly raised prices in June to reflect the recent international oil price increases.

26. The government is implementing some of the main recommendations of the Debt Management Performance Assessment (DeMPA). In particular, the authorities are developing the medium-term debt management strategy, establishing a debt database, and training officials on debt management, including T-Bill issuance (MEFP ¶42).

Authorities’ Views

27. The authorities agreed with staff’s assessments and measures proposed. They noted that they have begun procedures to collect tax arrears owed by Rosema and expected to collect all the arrears by end-June 2018. In addition, they are discussing with Ghana’s government to help recuperate fees owed to ENASA and hence to the Treasury. They also committed to contain discretionary spending and to use any additional resources available to clear the arrears by the state. They further noted that while preparations for the adoption of the VAT have taken longer than expected, this partly reflects their caution to ensure a smooth transition and to avoid the difficulties that other countries faced at the beginning, such as a large backlog in VAT refunds. They pointed out that some of the delays in reforms, including regarding EMAE, stemmed from delays in technical and financial assistance provided by development partners. In addition, they broadly agreed with staff’s recommendation to identify further short-term measures to improve SOEs’ operational performance, notably in reducing staff costs and accelerating arrears collection.

B. Boost International Reserves Buffers

28. Monetary policy will continue to be anchored by the peg to the euro. As a small-island economy that depends extensively on imports, the pegged exchange rate (introduced in 2010) has served the country well. Inflation rates have been reduced from pre-peg double digits to around 6 percent.4 As banks continue to hold large excess reserves and the interbank market remains dormant, monetary transmission is muted; this is illustrated by the lending rate’s limited response to the reduction of the BCSTP reference rate in June 2017. Given the limited effectiveness of current tools, efforts are being made to strengthen the toolkit (MEFP ¶33). In the meantime, sound fiscal policies and structural reforms to boost exports, reduce energy imports, and improve implementation of externally funded projects are the most important tools for supporting reserves and the peg.

29. The External Balance Assessment (EBA) suggests that the external position of São Tomé and Príncipe is moderately weaker than indicated by fundamentals and desirable policies, implying a moderately overvalued real effective exchange rate (REER) (Annex II). The external imbalance underscores the need for structural reforms to strengthen competitiveness, diversify the economy, reduce the reliance on oil imports via electricity sector reforms, and improve the efficiency of implementing externally funded projects to avoid disbursement delays. To this end, the Treasury will publish quarterly reports on the progress of externally financed projects. It will also revise the projected external disbursements in cooperation with the central bank, including both project and budgetary grants and loans (MEFP ¶32), which will increase aid transparency and facilitate macroeconomic management. In addition, continued fiscal consolidation will help build a higher reserves buffer in the near term.

30. Efforts have been made to upgrade the infrastructure for monetary management, including the securities’ market. The BCSTP drafted revised regulations to introduce a secondary market and longer-term instruments. The central bank also took welcomed steps to increase transparency and promote interbank activity by enforcing publication of banks’ financial statements.

Authorities’ Views

31. The authorities agreed that the peg serves the country well and recognized the need to address the existing external sector imbalances. The central bank is committed to continue to monitor changes to inflation and to tighten monetary policy if necessary. They concurred that diversifying the economy and reducing its dependence on imports for basic needs would strengthen competitiveness and the external balance position. In particular, to diminish dependence on oil imports and the accompanying demand for foreign exchange reserves, the government is developing the country’s hydro capacity and exploring the options of solar and natural gas power plants.

C. Safeguard Financial Stability

32. NPL resolution is moving ahead, albeit at a slow pace. Stringent bank supervision by the BCSTP has strengthened asset classifications. The BCSTP agreed with the mission’s recommendation to introduce a requirement for banks to write off a loan when it is past-due for a certain period, given the slim chance of recovering through the judicial system. Meanwhile, the authorities are looking for start-up funding for the new arbitration centers to start operation and facilitate out-of-court settlement.

33. The asset quality review (AQR) of the banking system is unexpectedly delayed. The AQR is being supported by the World Bank. The international selection process for the consultants, which had started in October 2017, took longer than expected to conclude, as did the negotiations on the price and scope of the project with the selected consultant. An inception report is expected by end-September 2018, a draft report by end-October 2018, and the final AQR results by mid-2019. The BCSTP will liaise with the banks to facilitate a swift evaluation process and intends to leverage the AQR findings for the planned overhaul of its prudential regulation.

34. Financial sector infrastructure and regulation are being upgraded. To mitigate the high risk in private sector credit, the BCSTP recently upgraded its credit registry (MEFP ¶9). An upgrade to the payment systems infrastructure is also underway with World Bank and AfDB support. The World Bank is also assisting the authorities to develop a resolutions manual. International accounting standards (IFRS) are being implemented over a three-year period. Macroprudential policy is in its infancy, though the credit registry offers a proxy for borrowers’ debt-to-income ratio that could be used to this end. Lastly, there has been an implementation delay for some of the recommendations of the last safeguards assessment (¶48 and MEFP ¶30).

35. Financial inclusion indicators compare favorably with those of regional peers, but the development has stagnated. The numbers of ATMs and depositors per adult are the highest among SSA LICs, whereas domestic credit relative to GDP is below average (Text Figure 2). However, these ratios have not improved in recent years. Banks face a disincentive to installing new ATMs since, by regulation, they are not permitted to charge clients for ATM usage. Access to finance by SMEs is hindered by rampant credit risk, shortage of eligible collateral, and a high degree of informality, although some banks help clients become creditworthy (e.g. forming cooperatives, promoting young entrepreneurs).

Text Figure 1.
Text Figure 1.

São Tomé and Príncipe: Non-Performing Loans Ratios by Bank

(percent, 2016-17)

Citation: IMF Staff Country Reports 2018, 251; 10.5089/9781484372227.002.A001

Sources: BCSTP; and IMF staff calculations.
Text Figure 2.
Text Figure 2.

São Tomé and Príncipe: Selected Financial Inclusion Indicators, 2016

Citation: IMF Staff Country Reports 2018, 251; 10.5089/9781484372227.002.A001

Sources: World Development Indicators, World Bank; and IMF staff calculations.

Authorities’ Views

36. BCSTP staff pointed to a recent survey that would inform the financial inclusion strategy going forward. Moreover, the BCSTP has drafted a microfinance law and a payment systems law that address the legal void in microfinance lending and mobile banking, respectively. It is also promoting financial literacy via the media. The BCSTP, however, felt that the objective of higher bankarization superseded the need for banks to recover ATM operation cost, even if only partially, as suggested by the mission.

D. Accelerate Growth-Enhancing Projects and Structural Reforms

37. Structural impediments are limiting growth and keeping poverty and unemployment high, particularly among women and the youth. Long-run growth has been relatively stable, averaging 4 percent; however, poverty and unemployment statistics are persistently high and disproportionately affect the female and young population groups. Labor statistics show that the unemployment rate inched down from 13.9 percent in 2008 to 13.0 percent in 2015 and remains close to that level; in the latter year, of the unemployed, around 60 percent were women and almost 85 percent were below 35 years of age. Poverty and unemployment, particularly among the youth, can not only perpetuate generational cycles of poverty, but also break down social cohesion and lead to higher crime rates, undermining economic growth potential and social stability. Tourism and agriculture are expected to be the main growth drivers (Box 4). Structural reforms to facilitate growth in these sectors are therefore essential. In this connection, ongoing judicial reforms in areas such as enforcing contracts, registering property, and resolving insolvency, will improve the business environment.

38. Besides support for infrastructural projects, the authorities have received assistance from development partners to design key sector strategies. A tourism development strategy, developed with World Bank support, has been adopted; and a private sector strategy (2015–24), prepared with the help of AfDB, is being implemented. The authorities also prepared a National Development Plan (NDP 2017-2021) to operationalize their long-term development agenda over the medium term.

39. São Tomé and Príncipe, as a dual-island state, is vulnerable to climatic changes. Recent events—episodes of coastal erosion and weather-related price shocks—have exposed the country’s vulnerability and underlined the need to strengthen resilience to adverse climate change. Initiatives for mitigating the impact of climate change are underway. On environmental issues, the government has been working with NGOs to implement the national sanitation plan and promote sustainable biodiversity (with the latter focusing on Príncipe Island), among other initiatives. Challenges include limited capacity; not-well-organized associations and cooperatives; and low environmental awareness among residents.

40. Levels of female education and reproductive health exceed those seen in the sub-Saharan Africa (SSA) region; however, women’s participation in the formal economy and representation in the government fall below the regional average. As Text Figure 3 shows, São Tomé and Príncipe fares better than SSA in the Gender Inequality Index, expected years of schooling ratio (EYS), maternal mortality rate (MMR), and adolescent birth rate. The country’s EYS and MMR are also better than the world average. Nevertheless, the share of female legislators, senior officials and managers, and the share of female seats in the parliament are lower than the SSA averages by 5.4 and 3.1 percentage points, respectively. Even though the legal system guarantees equal rights for both genders, women still have a low participation rate in the formal labor market. Entrenched social norms and domestic violence5 against women create gender gaps in both opportunities and outcomes, particularly in rural areas.

Text Figure 3.
Text Figure 3.

São Tomé and Príncipe: Selected Gender Inequality Measures, 2015

Citation: IMF Staff Country Reports 2018, 251; 10.5089/9781484372227.002.A001

Sources: UNDP, Human Development Reports; and IMF staff calculations.Note: Data may not be available for all countries. Latest available data was used to construct this presentation.1/ Gender Inequality Index (GII) is an index developed by the UNDP. It measures gender inequalities in three aspects: reproductive health, female empowerment, and economic status.2/ Ratio between the expected years of schooling for females, and the expected years of schooling for males.3/ Ratio between the labor force participation rate females, and the labor force participation rate for males.4/ Births per 1,000 women ages 15-19.5/ Percent of total legislators, senior officials and managers who are female.6/ Percent of total seats occupied by women in the country parliament.7/ Measured in deaths per 100,000 live births.

Authorities’ Views

41. The authorities agreed that structural reforms are key to achieve strong and sustained growth. In particular, registering property, granting farmers land rights, and establishing accurate information about property records would help reduce credit risk. They pointed out that recent reforms to rationalize court fees and strengthen insolvency legislation should reduce legal costs and help make justice available to all. Meanwhile, private sector representatives pointed to inefficiencies in the judicial system that create delays and add to the costs of doing business. Regarding gender issues, the authorities underscored the progressive laws that give women equal rights and noted that they are working with development partners, such as the EU and UN, to promote gender equality.

Program Issues, Safeguards, and Risks

42. Staff proposes to adjust program indicative targets for 2018 in line with the policy discussions (MEFP Table 3). The DPD target for end-September is revised up in line with an upward revision also in the end-December target from 1 to 1.3 percent of GDP (¶21). The NIR targets for end-December are revised down by US$4 million, following the US$7 million shortfall relative to the unadjusted target at end-2017, to allow a measured rebuilding of reserves. These targets are consistent with rebuilding NIR closer to the end-2016 level and the associated GIR reserves cover to 4.6 months of imports by end-2018, above the optimal GIR of 3.8 months of imports as indicated by the IMF low-income country reserve metric. Given the delays in contracting an auditing firm, staff proposes to change the benchmark of completing the AQR to requiring the external consultant to prepare an inception report by end-September 2018. Similarly, the adoption of the financial management plan and least cost energy-production plan for EMAE is proposed for rephasing to end-September 2018.

43. Completing the fifth review is conditional on the authorities’ implementation of three prior actions (MEFP Table 4). These are collecting tax arrears from Rosema, collecting tax liabilities accumulated in 2018 from large taxpayers, and issuing a resolution to limit budgetary expenditure in line with the program.

44. The authorities are requesting waivers for the nonobservance of three periodic PCs—DPD, NCG, and NIR—and one continuous PC that prohibits the imposition or intensification of exchange restrictions. In the case of the DPD and NCG, the requests are based on corrective measures to ensure continued fiscal consolidation (¶19-21). In the case of the end-2017 NIR target, which partly reflected a one-off large shortfall of external support, the request is based on corrective measures to bolster the balance of payments, including fiscal consolidation based on the measures noted above, continued electricity sector reform to reduce oil import demand, and appointment of the Treasury to coordinate externally financed projects to avoid disbursement delays. The authorities have also committed to eliminate foreign exchange restrictions over time once balance of payment pressures have eased.

45. The authorities are also requesting approval of the retention of the measures that give rise to exchange restrictions and a multiple currency practice subject to Fund jurisdiction under Article VIII, Sections 2(a) and 3, respectively. These exchange measures include: (i) an exchange restriction arising under Articles 3(g) and 18 of the Investment Code of 2016 due to limitations on the transferability of net income from investments; and (ii) an exchange restriction arising from limitations on the availability of foreign exchange for payments of current international transactions, due to the rationing of foreign exchange by BCSTP. The latter exchange restriction also gives rise to a multiple currency practice as it has resulted in the channeling of transactions to the parallel market where the exchange rate is at a spread of more than 2 percent from the exchange rate in the formal market. The authorities have requested approval of these measures for a period of twelve months because they are temporary, non-discriminatory and needed for balance of payments reasons.

46. The program is subject to downside risks. In particular, pressure on spending could heighten ahead of the legislative elections in October 2018. In addition, weak capacity could constrain program implementation, which, in turn, could delay external financing.

47. The country’s capacity to repay the Fund is adequate (Table 8). Requisite financing assurances exist and the program is fully financed. External repayments under the ECF-supported program will remain below 0.3 percent of exports of goods and services during the program period, and peak at 0.8 percent of exports of goods and services in 2024. However, because of São Tomé and Príncipe’s imposition of exchange controls, there are non-sovereign external payment arrears and a financing assurances review must be completed by the Executive Board.

Table 6a.

São Tomé and Príncipe: Balance of Payments, 2015–20

(Millions of U.S. dollars)

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

Percent of exports of goods and nonfactor services.

Gross international reserves exclude the National Oil Account and commercial banks’ foreign currency deposits at the BCSTP in order to meet reserve requirements, for new licensing, and for meeting capital requirements.

Imports of goods and nonfactor services excluding imports of investment goods and technical assistance.

Table 6b.

São Tomé and Príncipe: Balance of Payments, 2015–20

(In percent of GDP)

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

Percent of exports of goods and nonfactor services.

Gross international reserves exclude the National Oil Account and commercial banks’ foreign currency deposits at the BCSTP in order to meet reserve requirements, for new licensing, and for meeting capital requirements.

Imports of goods and nonfactor services excluding imports of investment goods and technical assistance.

Table 7.

São Tomé and Príncipe: External Financing Requirements and Sources, 2015–20

(Millions of U.S. dollars)

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Sources: São Tomé and Príncipe authorities’ data and IMF staff estimates and projections.
Table 8.

São Tomé and Príncipe: Indicators of Capacity to Repay the Fund, 2018–32

(as of June 19, 2018)

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

After HIPC and MDRI debt relief. Including IMF repurchases and repayments in total debt service.

Gross international reserves exclude the National Oil Account and commercial banks’ foreign currency deposits at the BCSTP in order to meet reserve requirements, for new licensing, and for meeting capital requirements.

Table 9.

São Tomé and Príncipe: Schedule of Disbursements Under an Extended ECF Arrangement, 2015–18

article image
Source: International Monetary Fund.

Board date, in the case of completed reviews.

48. A number of key recommendations from the previous safeguards assessment remain outstanding. Strengthening the BCSTP law was put on hold, pending alignment with the financial institutions law, and enactment is now expected during 2018. The BCSTP entered into an agreement with the Central Bank of Brazil for technical assistance on IFRS implementation and scoping work has begun. While the Audit Board Regulations were revised in line with Fund advice, the Audit Board has not significantly changed its modalities on oversight of audit mechanisms and controls, pending change in the composition as envisaged in the amendments to the BCSTP law. Furthermore, the BCSTP has not made much progress in strengthening internal audit.

Other Surveillance Issues

49. Further efforts are needed to improve the economic data, although they are broadly adequate for surveillance. Data provision and development are constrained by a lack of capacity. While the authorities have published the rebased (2008 base year) national account series (in satisfaction of an end-2015 structural benchmark), this is already outdated and needs a new update. The authorities plan to enhance leading indicators of economic activities, including data on tourism activity, while continue to strengthen other critical macroeconomic statistics. The authorities should leverage VAT implementation to develop foundational data for national account statistics. VAT data are a key source for compiling contemporary estimates of GDP (i.e., quarterly data) and implementation plans should provide for data collection for statistical purposes, which would support GDP compilation.

50. São Tomé and Príncipe continues to avail itself of the transitional arrangements under Article XIV, but does not maintain restrictions under Article XIV. However, it maintains two exchange restrictions subject to Fund approval under Article VIII (¶45). The authorities are committed to removing the existing exchange restrictions over time and continue to make efforts to facilitate the private sector to settle arrears to external private creditors, stemming from the past imposition of exchange controls. The country’s exchange rate arrangement is, since 2010, a de facto fixed peg to the euro.

Staff Appraisal

51. Macroeconomic stability has been strengthened, but more efforts are needed. While the economy grew steadily at 4 percent in recent years, acceleration is needed to reduce poverty in light of the young population. The spike in inflation in 2017 appears to have begun to wane as one-off effects subside. Fiscal consolidation and expected foreign inflows should buttress international reserves. However, vigilance is needed to safeguard the exchange rate peg.

52. Staff commends the authorities’ resolve to continue fiscal consolidation to improve the fiscal position and reduce public debt. The continued underperformance of tax revenue calls for steadfast implementation of identified revenue-enhancing measures, including the collection of tax arrears from large private companies and SOEs in the near term. Preparation for the adoption of VAT next year should be accelerated, particularly harmonization of the VAT with the rest of the tax system. The cuts in discretionary expenditure are appropriate. In addition, the commitment to prioritize arrears clearance if additional resources materialize and the planned introduction of the oil surcharge to help pay down the debt from past oil subsidies are welcome.

53. Continued reliance on grants and concessional loans for external financing while strengthening debt management capacity is at the core of the debt reduction strategy. Staff welcomes the authorities’ decision to eschew non-concessional loans, including for large infrastructural projects, and to limit external concessional borrowing to less than 4 percent of GDP per year. Work should continue to implement recommendations under the DeMPA and finalize the medium-term debt management strategy. Continued efforts are needed to resolve external arrears and disputed debt with creditors.

54. Reforming the utility company, EMAE, is a priority. The high cost of energy is hindering growth and the prolonged delays in reforming the energy sector pose a serious fiscal risk. The authorities are encouraged to work with development partners to accelerate the implementation of reforms and increase the cost effectiveness of electricity generation, which will also help reduce oil imports and the external imbalance. In this context, the pre-audit of all SOEs, including EMAE, by an international firm with the support of the World Bank will help to improve the commercial viability of SOEs and reduce fiscal risk.

55. Strengthened banking supervision is welcome, though vigilance continues to be essential. It is commendable that the authorities have strengthened asset classifications and upgraded laws and financial sector infrastructure, including the microfinance law and the credit registry. The long-delayed AQR should enable further strengthening of prudential regulation. Nevertheless, concerted efforts to reform the legal system to assist loan recovery will be crucial for lowering the NPL ratio and for the banking sector to support economic growth. While the authorities have made good progress towards the establishment of arbitration centers to facilitate out-of-court settlements, more efforts are needed to make them operational. The recommendations of the last safeguards assessment should be implemented without further delay.

56. The external position, which is assessed to be moderately weaker than warranted by fundamentals and desirable policies, and loss of foreign reserves last year call for vigilance. The central bank’s commitment to develop the monetary policy tools available to support reserves accumulation is welcome. In the meantime, continued fiscal consolidation and structural reforms will be essential to strengthen the external position and improve competitiveness. In particular, improvement of the electricity system to reduce oil imports will help reduce the current account deficit. In addition, better implementation of externally funded projects to facilitate timely disbursements will also buttress reserves accumulation.

57. Structural reforms will be essential for promoting inclusive growth and reducing poverty. The recently adopted tourism development strategy could provide good foundations for promoting this key sector and for opening opportunities to a young population. More efforts are needed to speed up implementation of infrastructure projects, including road rehabilitation, airport expansion, and water and sanitation, to support tourism as well as the other key sectors such as agriculture and fisheries.

58. Staff recommends the completion of the fifth review under the ECF arrangement. The authorities have taken corrective measures to keep the program on track following the slippages last year, and economic policies for 2018 are consistent with the program’s objectives. Staff also recommends waivers for the nonobservance of the PCs on the floor on the domestic primary balance, the ceiling on changes in net bank credit to the central government, the floor on net international reserves, and the continuous PC on not introducing or intensifying exchange restrictions based on corrective measures committed by the authorities (¶19-21 and ¶28-30) and because the program can still be successfully implemented despite these slippages. Staff also supports the establishment and modification of indicative targets and structural benchmarks for end-September through end-December 2018, as well as the completion of the financing assurances review. Staff also supports the sixth disbursement in the amount of SDR 634,285.

59. Staff recommends that the next Article IV Consultation for São Tomé and Príncipe be held on the 24-month cycle.

Figure 1.
Figure 1.

São Tomé and Príncipe: Recent Macroeconomic Developments, 2009-18

Citation: IMF Staff Country Reports 2018, 251; 10.5089/9781484372227.002.A001

Sources: São Tomé and Príncipe authorities; and IMF staff estimates.
Figure 2.
Figure 2.

São Tomé and Príncipe: Financial Sector Developments, 2011-181

Citation: IMF Staff Country Reports 2018, 251; 10.5089/9781484372227.002.A001

Sources: São Tomé and Príncipe authorities’ data and IMF staff estimates and projections.1 Includes BPSTP, which was intervened by the central bank on February 12, 2018.

Introduction of the VAT

Tax revenue in São Tomé and Príncipe relies heavily on import duties, and at about 13 percent of GDP it is insufficient to meet the country’s growth and development goals. Until 2016, when the Decree Law 13-2016 introduced taxation of imported liquor, alcoholic beverages and tobacco products, the consumption tax was levied solely on locally produced beer and the provision of services. All other imported goods, which make up the vast majority of goods consumed in the country, are still only taxable under import duties. In 2016, an IMF technical assistance mission recommended the adoption of a consumption-type VAT under the destination principle, charged by the invoice-credit method, to replace the consumption tax and, partially, the real estate transfer tax (SISA) and the stamp duty. To avoid cascading and enhance production efficiency, refunds would be provided immediately for exporters and after 4 months of carrying forward for other taxpayers. It was also recommended to adopt a VAT threshold of US$24,000 of annual turnover. Taxpayers below the threshold would pay a 7 percent presumptive tax based on gross income, except for micro-enterprises (with annual turnover below US$2,400) that would pay a fixed annual or semi-annual tax. It is estimated that the VAT system would raise tax revenues by 2.1 percent of GDP over the medium term, assuming a single positive VAT rate of 15 percent, with additional revenue supplemented by excises taxes on alcoholic beverages, tobacco, oil products, and motor vehicles. In order to mitigate the price increase that will occur upon the introduction of VAT as well as its effect on low-income households, the IMF mission proposed to review the import tariff structure on products such as food, raw materials and capital goods and/or exempt from VAT a limited list of basic food items (vegetables, plants, roots, consumables and fish), which have large weights in the price index and in the budget of low-income households. The successful introduction of the tax requires a combination of policy, legal and administration reforms. To help implementation, the IMF began providing technical assistance under the Revenue Mobilization Trust Fund in August 2017 focused on (i) completing the appropriate VAT legislation (including other related regulations), (ii) monitoring the development of the new IT system (supported by the AfDB), (iii) recruiting and training 25 new officials for administration of the new tax (supported partially by the World Bank), (iv) enhancing physical infrastructure and logistics, (v) implementing a new organizational structure, and (vi) defining education and communication strategies. The project has been assisting the authorities to complete all VAT preconditions with the help of a peripatetic resident expert and it will continue monitoring the completion of other VAT-related milestones in a timely manner. Additional structural changes in the Tax Directorate—especially related to paper-based and bureaucratic processes and lack of compliance risk management practices—are needed in the medium term to properly manage the VAT in the coming years.

Economic Diversification in São Tomé and Príncipe

São Tomé and Príncipe, one of the world’s smallest economies, is striving to diversify its economy for sustainable growth and poverty reduction. With a population of roughly 206,000 and a GDP of about US$393 million, per capita income is estimated at US$1,847 in 2017, below the average of other small-island developing economies. It is a young country with more than 60 percent of the population under 25 years. While the country has made commendable progress toward greater macroeconomic stability over the last decade, with GDP growth averaging at 4 percent per year since 2000, to achieve substantial poverty reduction and ensure sustained growth, economic diversification is imperative.

Constrained by its insularity, fragility and limited resources, São Tomé and Príncipe has a largely mono-culture economy. Among the productive sectors, the agriculture sector contributes more than 15 percent to total GDP, ranking as the second largest sector, and is a key employer. However, the sectoral share of output shows distributive trade’s dominance in the economy (contributing roughly a quarter to real GDP), reflecting the island economy’s reliance on foreign aid and trade (imports). Its export base is undiversified and consists of cocoa and a nascent tourism industry that is yet to be fully tapped. The European Union has been the dominant market for some time and there is opportunity to diversify both its export target markets for products and services.

The government has identified agriculture (including fisheries), tourism, and transportation as the key drivers of the structural transformation and economic diversification process. Leveraging the country’s competitive advantages—political stability, fertile land, long coastline, and various tourism resources—the government hopes to create stronger pillars for inclusive and sustainable growth and development. A recently-launched tourism development strategy, published in January 2018 and developed in partnership with the World Bank, aims to transform the tourism sector by 2025. It markets São Tomé and Príncipe as being a comprehensive destination (focusing on other areas beyond beach tourism), and targets high-end tourists from more diversified sources than the current ones. If well implemented, it would transform the tourism sector into one of the main sectors of income and employment in the country. Given its trade dependence, investments in infrastructure are being pursued to reduce the transportation cost for its agricultural, trade, and tourism sectors. In the long run, the government expects that the country’s political stability and geographic location will propel it into a travel and transshipment hub in the sub-region.

To realize its development strategy, some business-friendly reforms are being introduced to generate long-run economic payback. Recent reform initiatives, such as an e-Visa system and single windows for business registration and foreign trade, have already led to increased tourist arrivals and better doing business indicators. However, the country’s low capacity and relatively weak institutions (with a CPIA score of 3.05, lower than the sub-Saharan Africa average) continue to undermine its reform effort. Reforms in ICT and the legal system, among others, can feasibly improve labor productivity and enable a more diversified economy with vibrant private sector participation.

Annex I. Capacity Development Strategy 2018-20 Summary

A. Main Macro Challenges

1. São Tomé and Príncipe’s policy imperatives focus on ensuring fiscal and debt sustainability, strengthening the financial sector, and improving macroeconomic statistics. The main sources of short-term risks to the macroeconomic outlook are weakness in revenue administration and public expenditure control including accumulation of arrears at SOEs, high risk of debt distress, and high levels of non-performing loans in the banking sector.

B. Past TA Assessment

2. CD activities in recent years reflected actual demand from the authorities and were fully in line with the reform priorities identified in the context of Article IV consultations and program reviews. The IMF has provided São Tomé and Príncipe with substantial technical assistance (TA) focused on: revenue administration and tax policy; PFM reform; banking resolution; and macroeconomic statistics.

Key achievements include:

  • Implementation of an automatic fuel price adjustment mechanism

  • Measures to strengthen PFM

  • Drafting of a VAT law and preparation towards the introduction of the VAT

  • Approval of a banking resolution law

  • Adoption of risk-based supervision

  • Introduction of an interbank market

3. However, limited human capacity has slowed implementation of reforms. The TA activities that were most effective are those that were accompanied by hands-on support and close follow-ups.

C. Main TA priorities

4. The top priority reforms going forward are:

  • Maintain fiscal and debt sustainability and reduce the risk of debt distress through fiscal consolidation and improved public financial management, including at SOEs.

  • Enhance revenue mobilization, notably by introducing a VAT regime, to create fiscal space for social and capital spending.

  • Strengthen financial stability and intermediation by reducing NPLs, enhancing banking regulation and supervision, and improving the bank resolution framework.

  • Improve quality and timeliness of economic statistics.

5. Accordingly, the capacity development (CD) strategy for São Tomé and Príncipe focuses on the following areas in order of priority for the next 3 years and the main objectives sought.

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D. Authorities’ Views

6. Experience shows that Technical Assistance (TA) provided by long-term experts has been more effective because it not only produces the diagnosis of the problems but also supports the implementation of the actions. In other words, long-term experts can facilitate the full cycle of TA from diagnosis to implementation of recommendations.

7. The effectiveness of TA could be improved through mobilization of Portuguese speaking experts to facilitate interaction, because they are more likely to perceive the core of the problem and are better positioned to enhance the capabilities of local technicians.

8. In particular, TAs that include on-the-job training have also been shown to be quite effective in the context of Banking Supervision and Statistics.

Annex II. External Sector Assessment

Staff’s bottom-line assessment is that São Tomé and Príncipe’s external position in 2017 was moderately weaker than warranted by fundamentals and desirable policy settings, suggesting a moderate overvaluation of the real effective exchange rate. The level of gross international reserves is assessed to be adequate based on standard benchmark metrics. Although immediate risks to the external position seem manageable, medium-term vulnerabilities remain significant given the country’s narrow export base and large reliance on volatile external financing. As the peg to the euro has served the country well by decreasing the inflation rate, external imbalances should be addressed through structural reforms that aim to increase competitiveness and diversify the economy, as well as continued efforts to ensure a sound fiscal position.

A. Evolution of the Balance of Payments

1. The current account (CA) deficit has decreased considerably since 2015. While the average CA deficit (excluding grants) was 44 percent of GDP between 2000 and 2014, it declined to 22 percent of GDP between 2015 and 2017. The decline partly reflects a considerable increase in tourism receipts since 2014 when the frequency of flights from Europe to São Tomé and Príncipe was increased. In addition, lower oil prices since 2015 have contributed to a contraction of imports. The CA deficit is expected to stay around the current level over the medium term, as further expansion of the tourism sector offsets rising investment-related imports.

2. Receipts from tourism have increased from 5 percent of GDP in 2006 to 19 percent of GDP in 2017, leading to an improvement of the CA balance. Tourism revenue (19 percent of GDP) is significantly more important to the external balance than cocoa exports (2 percent of GDP). Data from the tourism authority shows that approximately half of the number of tourists come from Portugal. Cocoa exports go mostly to Europe (74 percent), mainly to the Netherlands (24 percent) and France (22 percent). Around half of São Tomé and Príncipe’s goods imports come from Portugal and another 20 percent from Angola (Annex Figure 1).

Annex Figure 1.
Annex Figure 1.

São Tomé and Príncipe’s balance of payments

Citation: IMF Staff Country Reports 2018, 251; 10.5089/9781484372227.002.A001

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

3. The largest share of the CA deficit is financed by grants, followed by FDI and then loans. Grants to São Tomé and Príncipe amounted to 10½ percent of GDP in 2015-17, down from 20 percent on average between 2000 and 2014. Meanwhile, FDI accounted for on average 8½ percent of GDP and loan disbursements for 5 percent of GDP during 2015-17. Most FDIs are related to the oil sector. The availability of these three types of financing has proven to be volatile in the recent past, which leaves São Tomé and Príncipe vulnerable.

B. Exchange Rate and Current Account Assessment

4. São Tomé and Príncipe’s real effective exchange rate (REER) has appreciated considerably since the introduction of the peg to the euro in January 2010 (Annex Figure 2). The REER has appreciated by 40 percent between 2010 and 2017, as the gradual disinflation process has been too slow to close the inflation differential with trading partners. Specifically, average inflation in the euro area was 1.2 percent in 2010-17 compared to 8 percent in São Tomé and Príncipe. In other words, prices in the euro area have increased by 9 percent since 2010, compared to 71 percent in São Tomé and Príncipe.

Annex Figure 2.
Annex Figure 2.

São Tomé and Príncipe: Exchange Rate Developments

Citation: IMF Staff Country Reports 2018, 251; 10.5089/9781484372227.002.A001

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

5. Nonetheless, the peg has helped São Tomé and Príncipe to halve the average inflation rate from 16 percent during 2000-09 to 8 percent during 2010-17. Since 2015, annual average inflation has been around 5½ percent. Price inflation in the tourism sector has been even lower, limiting somewhat the effect of the REER appreciation on export competitiveness. As a small open economy, the peg has served the country well overall. However, the peg needs to be supported by strong macro policies (continued efforts to ensure a sound fiscal position and structural reforms) to avoid external imbalances.

6. The EBA-lite models yield a range of assessments of the external position in 2017 (Annex Table 1). However, the results should be interpreted with caution given the inherent difficulties in benchmarking external stability for a fragile and small country with significant data limitations, such as São Tomé and Príncipe.

Annex Table 1.

São Tomé and Príncipe: Real Effective Exchange Rate Assessment 2017

(Percent of GDP, unless otherwise indicated)

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Sources: São Tomé and Príncipe authorities’ data and IMF staff estimates

Deviations of São Tomé and Príncipe’s actual policies from its optimal level and also the average policy misalignment relative to the rest of the world.

“+” overvaluation, “-” undervaluation. Change in the REER (in percentage) needed to close gap.

Using 2022 projected current account as the medium-term reference period.

Average IIP position of fragile small states in 2016.

  • The EBA-lite CA model suggests that the external position is broadly consistent with fundamentals and desirable policies. The model estimates a cyclically-adjusted CA norm of -8.4 percent of GDP. This is essentially equal to the actual cyclically-adjusted CA balance in 2017, implying a CA gap of only 0.1 percent of GDP, and consequently, a slight undervaluation of the REER of about 0.4 percent (assuming an elasticity of the CA to the REER of -0.2). The policy gap (or the sum of deviations of São Tomé and Príncipe’s actual fiscal balance, change in reserves, and private sector credit from their optimal levels and the world’s averages of the same policy variables from their optimal levels) of 1.0 percent of GDP mainly reflects deviations from the world’s policy variables and their optimal levels, which more than offsets a modest negative fiscal policy gap for São Tomé and Príncipe due to fiscal policy in 2017 being moderately looser than desirable medium-term levels. The resulting negative residual (i.e., the difference between the CA gap and policy gap) may reflect unmeasured structural policy gaps.

  • The EBA-lite REER Index model estimates a substantially stronger REER overvaluation than warranted by fundamentals and desirable policies (27.5 percent). However, the REER Index model can be inaccurate for countries with limited data. As such, the result should be interpreted with caution.

  • The EBA-lite external sustainability (ES) approach estimates an overvalued REER if the target net International Investment Position (IIP) is benchmarked to the average of other fragile states. In all three scenarios, an underlying (medium-term) current account of -8.6 percent and an elasticity of the CA to REER of -0.2 are used. Targeting the net IIP to -66.0 percent of GDP, a level consistent with the 2016 average for fragile countries, results in an overvalued REER of 10.4 percent if the net IIP is stabilized over time (Scenario 2), or an overvaluation of 15.2 percent if the net IIP is stabilized by 2036 (Scenario 3).1

C. Reserve Adequacy Assessment

7. São Tomé and Príncipe needs to build strong international reserve buffers given the persistence and magnitude of shocks it faces as a small and fragile LIC with a pegged exchange rate regime. São Tomé and Príncipe’s 2017 level of gross international reserves (GIR) was adequate, slightly above the benchmark level. GIR corresponded to 4.2 months of prospective imports and 39 percent of the broad money measure at the end of 2017 (Annex Table 2). These values are above the standard metrics of 3 months of imports and 20 percent of broad money coverage. The IMF LIC reserve metric, also known as the ARA metric for credit-constrained countries, suggests that the optimal reserves metric for São Tomé and Príncipe is of 3.8 months of imports. This metric balances the benefits of holding reserves against the opportunity costs. It considers country specificities, such as being a small state and having a fixed exchange rate peg. Furthermore, São Tomé and Príncipe has access to extra reserve buffers in the form of exceptional access to a USD 12 million deposit at the National Oil Account (NOA) and a EUR 25 million contingent credit line from Portugal in case reserves fall below 3 months of imports.

Annex Table 2.

São Tomé and Príncipe: Gross International Reserves Coverage Metrics

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Sources: São Tomé and Príncipe authorities; and IMF staff calculations.

D. Non-price Competitiveness Assessment

8. São Tomé and Príncipe should continue to improve its competitiveness according to the 2018 World Bank’s Doing Business survey. Compared to SSA countries, São Tomé and Príncipe outperforms in the categories “protecting minority investors,” “getting electricity,” and “trade across borders,” and underperforms in the categories “resolving solvency,” “enforcing contracts,” and “getting credit” (Annex Figure 3). Compared to the previous assessment, São Tomé and Príncipe improved in the category “starting a business” by eliminating the minimum capital requirement for business entities with no need to obtain commercial license, and in “trade across borders” by reducing the time required for border compliance after the implementation of an electronic trade single-window. On the other hand, São Tomé and Príncipe worsened its position in the category “enforcing contracts” due to a longer process period. It takes 1,185 days to enforce a contract in São Tomé and Príncipe while the SSA average is 657 days. The planned reform of the judicial sector aims to improve this situation.

Annex Figure 3.
Annex Figure 3.

São Tomé and Príncipe: Doing Business Indicators

(0=worst, 100=best)

Citation: IMF Staff Country Reports 2018, 251; 10.5089/9781484372227.002.A001

Sources: World Bank Doing Business survey and IMF staff estimates.

E. Conclusion

9. Overall, staff’s assessment is that São Tomé and Príncipe’s external position in 2017 was moderately weaker than warranted by fundamentals and desirable policy setings. Specifically, staff assesses the CA gap to be between -1 and -2 percent of GDP. Consistent with this, staff estimates the REER to be overvalued by 5 to 10 percent. This range is obtained mainly by taking into account the results of both the CA model and the ES approach and allowing for some uncertainty. Specifically, using the CA model and Scenario 2 of the ES approach, the overvaluation would be around 5 percent; using the CA model and the Scenario 3 of the ES approach, it would be around 7½ percent.

10. Strong policies will help strengthen the external position. The peg has served this small open economy well by promoting disinflation and reducing exchange rate volatility. However, to support the peg and strengthen the external position, it will be important to continue efforts to ensure a sound fiscal position and advance structural reforms. For the latter, key reforms include the envisaged diversification strategy and reform of the electricity company, which should lead to higher exports and lower oil imports, respectively, thereby helping external rebalancing.

Appendix I. Letter of Intent

São Tomé, July 9, 2018

Ms. Christine Lagarde

Managing Director

International Monetary Fund

700 19th Street N.W.

Washington, D.C. 20431

USA

Dear Ms. Lagarde:

The government of the Democratic Republic of São Tomé and Príncipe requests the IMF Executive Board to complete the fifth review of the Extended Credit Facility (ECF) arrangement and to approve the disbursement of the sixth tranche of the loan based on partial implementation of end-December 2017 performance criteria (PC) and satisfactory implementation of the prior actions.

As documented in the attached Memorandum of Economic and Financial Policies (MEFP), economic conditions remained challenging in 2017 and program performance was uneven under an unfavorable external environment. Both reduced and delayed financial support from our partners led to less dynamism in the economy, presenting a difficult challenge for striking the right balance between adjustment and growth and for achieving the program targets. Therefore, we would like to request the IMF Executive Board to approve waivers for the nonobservance of the program targets in 2017, including the domestic primary balance and bank financing of the central government (both missed by ½ percent of GDP), as well as net international reserves and the continuous PC on not introducing or intensifying any exchange restrictions. Additionally, as a sign of our commitment to the program, we have completed the prior actions for the fifth review.

The MEFP updates the government’s policies and objectives for 2018 and beyond, which are anchored by our development strategies as outlined in the National Development Plan (NDP) 2017-2021 and the Vision 2030: Transformation Agenda. Specifically, the MEFP lays out policies for strengthening program implementation to meet program objectives for the remainder of the current arrangement and continue to safeguard macroeconomic stability and promote growth. We will implement fiscal measures to mobilize domestic revenue (including preparing the groundwork for the implementation of a value-added tax (VAT) in 2019), collect tax arrears owed to the government, keep the arrears clearance strategy on track, and reduce the public debt burden. We will also expedite the reform of a state-owned utility company (EMAE) to cut losses and contain fiscal risks.

The Central Bank of São Tomé and Príncipe (BCSTP) also remains committed to safeguarding financial sector stability and supporting sustainable credit growth. Our focus will be to deal proactively with problem banks and move ahead with the implementation of several key monetary reforms and strategic plans, such as the Non-Performing Loans (NPL) Reduction Strategy and the Financial Sector Development Implementation Plan (FSDIP).

Our country continues to face tremendous challenges and the support of the IMF is necessary to address our development issues. The government believes that measures and policies described in the July 2015 MEFP and its subsequent supplements, together with the attached supplementary MEFP, provide an adequate basis for attaining our economic policy objectives. However, we stand ready to take any additional measures, if necessary, including addressing any revenue shortfall. We will consult with the IMF, in advance, on the adoption of these measures and on any revisions to the policies contained in this supplementary MEFP, in accordance with the Fund policies on such consultation. We will hold timely discussions with the IMF staff on the terms of large external borrowing to ensure that such borrowing meets the concessionality requirement under the program, does not jeopardize debt sustainability, and is in line with the Fund’s debt limit policy.

The government will also provide the IMF staff with all the relevant information required to complete program reviews and monitor performance on a timely manner as outlined in the TMU. During the remaining program period, the government will not introduce or intensify any exchange restrictions and multiple currency practices, or import restrictions for balance of payments purposes, nor conclude any bilateral payment agreements in violation of Article VIII of the Fund’s Articles of Agreement.

The government agrees to make public this Letter of Intent, along with the attached supplementary MEFP and TMU, and the entire IMF staff report on the 2018 Article IV consultation and the fifth ECF review. We hereby authorize their publication and posting on the IMF website, once the IMF Executive Board approves the completion of the 2018 Article IV consultation and the fifth review under the three-year ECF arrangement.

Sincerely yours,

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Attachments:

  • /1 Memorandum of Economic and Financial Policies.

  • /2 Technical Memorandum of Understanding.

Attachment I. Supplementary Memorandum of Economic and Financial Policies for 2018

Introduction

1. The Executive Board of the International Monetary Fund approved on July 13, 2015 a three-year arrangement under the Extended Credit Facility (ECF) in support of São Tomé and Príncipe’s economic reform program to promote sustainable growth and reduce poverty. The program aims to lay the foundation for stronger, more inclusive growth, and to catalyze financial support from bilateral and multilateral partners. Key aspects of the program include actions to strengthen public finances, reduce balance-of-payments vulnerabilities, and clear large domestic arrears.

2. This supplementary Memorandum of Economic and Financial Policies (MEFP) reviews recent economic developments and performance under the ECF-supported program and updates the supplementary MEFP for the combined third and fourth review approved by the IMF Executive Board on December 11, 2017. It provides an assessment of recent macroeconomic developments, implementation of the ECF-supported program, the economic outlook and risks, and macroeconomic policies for 2018 and beyond.

Recent Economic Developments

3. Economic activity in 2017 decelerated somewhat, as the public spending impetus was constrained by reduced external inflows. Real GDP growth slowed to 3.9 percent in 2017 from 4.2 percent in 2016. Wholesale and retail trade sectors grew, while indications are that tourist receipts also increased. Increased activity in the agricultural sector (mostly for cocoa), however, is moderated by lower international prices, and construction activity is estimated to have fallen, evidenced by a reduction in the imports of construction material.

4. Inflation increased, mainly driven by higher prices for locally-produced food, despite economic slack and fiscal consolidation. Unseasonal rain impeded fishing and damaged vegetable crops, leading to an acceleration of year-on-year inflation from a low of 3.5 percent during May 2017 to 7.7 percent at end-2017. One-off factors, such as the introduction of new import taxes and charges, also contributed to this development. However, seasonally-adjusted monthly inflation shows that inflation decelerated during the first four months of 2018. The January 2018 dobra redenomination did not come with any price gouging effects.

5. Given strong headwinds, the fiscal deficit targets for 2017 were missed. New tax measures, including a higher tax on imported alcoholic beverages, higher duties on selected imported commodities, and collection of tax arrears from large enterprises, raised revenue by less than 0.1 percent of GDP in 2017. The higher taxes on alcoholic beverages also reduced consumption, promoting good health among the population. However, the reduced imports, along with cash flow problems and operational difficulties among some of the firms, lowered the yields from import taxes and arrears collection, leading to a shortfall of about 0.9 percent of GDP than expected. While the revenue shortfall was largely offset by under-executing the budget on transfers and personnel costs, it was necessary to increase investment in health and education by about ½ percent of GDP more than anticipated, partly to address a virus outbreak of “necrotizing cellulite”. As a result, the domestic primary deficit (DPD) exceeded the program target of 1.8 percent of GDP by ½ percent of GDP, which was mirrored by a similar miss of the target on the change in net bank credit to the central government.

6. Preliminary data suggest broadly similar trends in the first quarter of 2018. The hike in import duties and delayed tax payments from large firms (notably ½ percent of GDP in import taxes due by ENCO as of May) continued to dampen tax revenue. This was mitigated by higher oil import tax revenue from higher international oil prices and budget under-execution. As a result, the end-March DPD indicative target was missed by 0.3 percent of GDP. However, the indicative target on the change in net bank financing of the central government was met.

7. While accelerating the debt payment to ENCO, the government fell behind in arrears clearance with other domestic suppliers. It accumulated a small amount of domestic arrears (6 million new dobras) and was unable to clear arrears as assumed in the revised budget (36 million new dobras), partly because budget support from the World Bank did not materialize and that from the EU was reduced by €1 million due to slow progress in public financial management (PFM) reform. In addition, the EU disbursement was used for investment projects that are needed to meet the requirements associated with the grant. Nonetheless, total public and publicly guaranteed debt fell from 67.6 percent of GDP in 2016 to 56.6 percent of GDP in 2017 on account of an appreciation of the euro-dollar exchange rate, accelerated debt payment to ENCO from gains through the higher domestic relative to import prices of oil, low external disbursements, and nominal GDP growth.

8. Credit growth stalled in 2017 amid banks’ efforts to de-risk their portfolios to become profitable. While lending to the economy was stagnant, banks increased their holdings of Treasury Bills (T-bills), reducing excess liquidity at the BCSTP and deposits abroad. The T-bill stock held by banks now accounts for 9 percent of total assets, up from 2 percent in 2016. After breaking even on average in 2016, banks’ return on assets (ROA) turned negative (-0.7 percent) again, with two-thirds of the banks posting losses as in 2016. As net interest income is flat, banks resolved to increase their fee income by 20 percent in 2017. This notwithstanding, banks’ operating costs remain relatively high, with the cost-to-income ratio (before loan loss provisioning) at 75 percent.

9. The NPLs remained high while provisions improved further. Write-offs and loan recoveries—including out of court settlement—improved the NPL ratio by 2 percentage points to 25 percent, offsetting a spike in the default rate to 6.7 percent among loans contracted or restructured since end-2016. The rebound in this default rate may be temporary but vigilance is still required to ensure that NPLs stay on a declining path. At the same time, provisions coverage of NPLs rose to 88 percent, pointing to more stringent classification of NPLs. The still-elevated NPL ratio is also owed to banks’ slow write-off practices, despite the slim chance of recovering collateral because of the bottleneck at the judicial system. To mitigate the high credit risk, the BCSTP has recently upgraded its credit registry (CRC) along several dimensions, providing a wealth of real-time borrower information for banks to make well-informed lending decisions.

10. In line with banks’ portfolio shift, liquidity indicators in the banking system fell somewhat while capitalization increased and monetary aggregates contracted slightly. The liquidity ratio (liquid assets to total assets) dropped from 54 to 50 percent, while the average capital adequacy ratio increased from 28 to 33 percent, as the decrease in risk-weighted assets more than offset negative profits that have been weighing on banks. One bank with a capital shortage injected additional capital in accordance with current regulations. Broad money (M3) fell marginally (0.4 percent) in 2017, reflecting lower net foreign assets from reduced external inflows.

11. The BCSTP intervened in a small bank in early 2018, while the liquidation of Banco Equador is waiting for court approval of the relevant procedures. Banco Privado (BPSTP)—the smallest bank in the system—was intervened on the grounds of several governance problems that led to sharply-higher NPLs, consecutive losses, and inadequate equity with own funds below the statutory minimum. After carefully considering various resolution options, the central bank announced in mid-June its decision to close the bank and transfer its portfolio to other financial institutions. Regarding Banco Equador, the liquidation process will be advanced as soon as the court approves the relevant procedures.

12. The current account worsened in 2017 after an improvement in 2016, mainly due to a contraction in grants and an increase in oil and investment imports. Imports of goods and non-factor services increased by almost 3 percent in 2017, after remaining broadly constant in 2016. Capital goods imports were up by 18 percent, and increased volume and rising international prices led to a 27 percent expansion in the value of oil imports. These factors more than offset the growth in exports of goods and non-factor services of 9.6 percent, given its low base. Tourist receipts are estimated to have grown by 8.8 percent while lower international prices offset the rising cocoa production. The lower external inflows and uptick in imports caused the gross international reserves at the market value to decline by $4.6 million to $51 million (4.2 months of imports).

Program Performance

13. Program performance at end-2017 was uneven (Table 1). Three out of five performance criteria (PCs) are missed. The PC on the domestic primary balance and net bank financing of the central government (NCG) were missed by ½ percent of GDP. The PC on NIR was missed mainly because of lower external support, which was only partly accommodated by program adjusters. Two other PCs on external payment arrears and borrowing on non-concessional terms were met. The continuous PC which prohibits introducing or intensifying exchange restrictions was inadvertently missed. Fiscal indicative targets (IT) on tax revenue and new domestic arrears were missed, marginally for the latter. The pro-poor spending target was met.

14. The end-2017 structural reform agenda progressed according to plans (Table 2). A draft Public-Private Partnership (PPP) law was submitted to the National Assembly in October 2017 and promulgated in March 2018, and immediate measures to contain the financial losses of EMAE mostly through improving collection have been implemented.

15. Progress was also made on preparing for the end-June 2018 structural benchmarks (Table 4). A VAT law, drafted with the support of the IMF, was submitted to parliament on May 24, meeting an end-June structural benchmark. The strategy for tourism development was launched in January 2018 with the support of the World Bank. In light of the crucial role of tourism in the country’s export diversification, this document forms the core of the planned export diversification strategy. On the other hand, the further delays in both the adoption of the financial management plan and least cost energy-production plan for EMAE and the commencement of an asset quality review (AQR) were attributable to needed steps for procurement. We wish to propose that the associated benchmark on the AQR be revised to require the delivery of an inception report from the external consultant in lieu of the completion of the AQR and that both benchmarks be rephased to end-September 2018.

16. In addition, we have also implemented other structural reforms. To prepare for VAT implementation, a law was promulgated to require companies to issue fiscal invoices. With the World Bank’s support, a draft law on microfinance was submitted to parliament to address the legal and regulatory void for providers of microfinance, and a new National Payment Systems Law was submitted to parliament for regulation of modern payment methods, including agent banking, mobile money, and electronic payments.

Economic Outlook and Risks

17. Economic growth is expected to remain stable in 2018 and accelerate gradually in the medium term. Real GDP growth is expected to stay at around 4 percent in 2018 and average around 5 percent in the medium term, supported by externally-financed projects in the construction, agriculture, and tourism sectors. Key infrastructure projects—such as a grant financed airport expansion and road rehabilitation, part of the latter started in early 2018. These projects will not only increase construction activity, but also lay the foundation for growth in the tourism and agro-processing industries. Faster growth, accompanied by appropriate structural reforms, will support plans for job creation and poverty reduction. Annual inflation is expected to recede to only 6 percent in 2018 as forecasts for rising oil prices could slow down its deceleration. Medium-term inflation is likely to average below 5 percent.

18. The economy also faces downside risks. The upcoming legislative elections in October 2018 could disrupt policy implementation as pressures to overspend heighten in the run-up to the elections; they may also hold back investment if investors take a wait-and-see approach. Furthermore, there are other uncertainties, concerning external financing, and infrastructure and service constraints that may restrict necessary investments and tourism growth. Limited implementation capacity also challenges the implementation of structural reforms and associated external financing. Continued high NPLs could further stall private sector lending and impede economic growth. On the upside, heightened interest from oil prospectors in acquiring exploration rights from the country is likely to boost external inflows through signing bonus, exploration activities, and social projects as components of the contracts.

Policy Objectives for 2018

The main priorities for 2018 will be to consolidate macroeconomic stability, strengthen the financial sector, advance monetary reforms, and remove structural bottlenecks to higher, sustained, and inclusive growth.

A. Fiscal Policy

19. The government has reduced the deficit in 2017 and is committed to meet its fiscal targets in 2018. As noted above, the higher duty on selected products that took effect in July 2017 substantially reduced the import volume of these items. The government recognizes that this effect will also dampen revenues by about 1.4 percent of GDP this year relative to the initial budget. To avoid an unfair burden on families, the government has also rescinded its initial decision to suspend the deductible of the PIT in the tax law, lowering revenue by an additional 0.2 percent of GDP. The preliminary fiscal data for the first quarter of 2018 broadly confirmed this assessment. In addition, tax performance was also weakened by delayed tax payments from large firms.

20. The government will forcefully collect taxes due from large taxpayers. In particular, as a prior action, it will collect tax liabilities accumulated in 2018, amounting to over 60 million new dobras, from large taxpayers such as ENAPORT, BCSTP, INAC, and ENCO. To facilitate this ongoing assessment, we will put in place a system to closely monitor tax collections from large taxpayers, and will share with the IMF staff two weeks after each month monitoring tables of tax payments by top ten taxpayers against their projected taxes due during June-October 2018 (newly proposed end-November 2018 structural benchmark), and are prepared to launch administrative and legal procedures, including penalties, promptly if large taxpayers fail to comply.

21. The government has also identified revenue measures to offset the projected lower tax revenues (Table below). Taxpayers owe over 300 million new dobras in tax arrears to the state. As a first step, the state will target companies with large tax arrears such as Rosema (a beer maker) and ENASA (the airport authority). Rosema owes the state about 42 million new dobras, mostly in revenues it collected on behalf of the state for consumption tax on sales and income tax on its employees’ salaries. ENASA owes 62 million new dobras mostly in legacy arrears prior to 2014. These tax arrears have not only deprived the state much needed revenue for social programs, such as education and health, but have also damaged the credibility of our tax system. For these reasons, the government has initiated fiscal and legal procedures to collect tax arrears owed by Rosema plus applicable penalties and has already collected 12 million new dobras. As a prior action for the completion of the fifth review (Table 4), the government will collect an additional 29 million new dobras of tax arrears from Rosema and 9 million new dobras from other large tax payers. The government has already reached agreements with other large taxpayers, including ENAPORT and ENASA, to collect tax arrears, and will take prompt legal actions if necessary to enforce these agreements. At the same time, it will help ENASA recover payment arrears from its clients for airport services and airport tax withheld amounting to about 38 million new dobras, including from an SOE in Ghana and various airlines. In return, ENASA’s arrears clearance will be accelerated by the amount recovered which is expected to be at least 10 million new dobras. The government will pursue similar plans to collect tax arrears from other large taxpayers. It is committed to keep the arrears collection plan on track, which is essential for completing the program review, catalyzing the financing of projects and reform programs supported by other development partners.

22. The revenue measures will be complemented with spending restraint. The cuts in transfers and personnel costs that were introduced in 2017 will be maintained, and strict limits will be applied with the help of EMAE on the consumption of electricity and water as well as on fuel by public agencies, while domestically-financed capital expenditure will be reduced in light of expected higher externally-financed spending. Furthermore, in view of the uncertainty of revenue, the government will hold back expenditure to match available resources and meet the DPD target.

Impact of New Fiscal Measures

(Millions of new dobras)

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23. Fiscal consolidation will continue in 2018 and over the medium term. Consistent with the budget law, the Minister of Finance has issued a resolution to limit budgetary expenditure in line with the program, meeting another prior action for the fifth review. Specifically:

  • The DPD target is set at 1.3 percent of GDP for end-September and end-December. This assumes budget support grants in 2018 of $6 million from the World Bank and €3 million from the EU, and no privatization proceeds. As previously programmed, the nominal public wage bill will grow below GDP growth through keeping wages largely unchanged to free resources for new hiring for priority needs in the education, health, and security services, costing about 0.2 percent of GDP, while at the same time seeking savings through rationalization and higher efficiency in these sectors.

  • The government is also committed to make up for delayed domestic arrears payments to suppliers to bring the arrears clearance plan back on track by 2020. To this end, a portion of budget grants and domestic borrowing (65 million new dobras) will be used to pay down arrears. In addition, a surcharge will be introduced in 2019 over the price of oil products to pay the debt to ENCO even after the differential between the current domestic and import prices fades. The surcharge will be set to raise about $2.7 to 3 million per year. The government will also prioritize arrears clearance if additional resources, including tax revenue, budget grants, delayed planned investment using budget support or privatization proceeds materialize. In addition, the Treasury has begun to prepare monthly liquidity projection to guide liquidity management and the issuance of T-bills.

Domestic Payables/Arrears 2016-18, Stocks

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24. Reducing fiscal risks posed by the state-owned enterprises (SOEs), particularly the utility company, EMAE, remains high on the government’s agenda. EMAE’s arrears to ENCO increased by $16.6 million (4¼ percent of GDP) in 2017 to reach $77 million, like last year, despite immediate measures taken. To contain costs, retired staff are not replaced; customers missing three payments are disconnected; arrears payment plans are being developed with large debtors; a communication campaign was launched to change the non-payment culture; and customer services were improved, including shortened installation time and ease of bill payment. At the same time, we are advancing several medium-term efficiency-enhancing reform projects, notably the Financial Management Improvement Plan (FMIP) and the Least Cost Development Plan (LCDP), supported by our development partners. Other important steps encompass the pre-audit of all SOEs by an international firm under the auspices of the World Bank, and preparations for rehabilitation of the energy grid and large-scale installation of meters.

25. Ongoing work to introduce the VAT in 2019 will be accelerated. Focus will be placed on the finalization of the VAT law and its approval by Parliament, and: (i) hiring and training of 25 new employees; (ii) drafting regulations for the implementation of VAT, including the harmonization of other laws with the new VAT Law; (iii) providing adequate space, including furniture and computers to all staff by June 2018; (iv) adopting a clear organizational structure along functional lines and/or taxpayer segments for the tax administration by June 2018; (v) adopting a modern computer information system with key functionalities, such as automatic notification of taxpayers in default, extraction of statistical data, surveillance, and oversight support by July 2018; and (vi) implementing a customer services area and continued taxpayers education. To improve domestic revenue mobilization in the medium term, and in line with the recommendations of IMF TA on tax administration, the government will implement a more systematic inspection of large taxpayers and a wider surveillance coverage of taxpayers through a computer-based selection process, and improved risk management.

26. The government will continue to strengthen public financial management. The government, with the support of African Development Bank (AfDB), is further improving the electronic information management system (SAFEe), and has extended access to the general inspection finance entity and to the Court of Public Accounts. In this context, it has already submitted the state’s accounts for 2015 and will accelerate the submission of those for 2016 to the Court of Auditors by July 2018. The government will also move to a centralized framework for monitoring and evaluating projects to ensure value for money. This will be done through the prioritization of capital projects and the adoption of public investment management assessment framework, and medium-term fiscal and expenditure frameworks. Additional TA will be needed in this regard. The government will implement the recommendations of a recent IMF TA mission on public financial management, including strengthening revenue forecasting and ensuring the coherence of the financial programming and macroeconomic framework in budget preparation and management, and limit the accumulation of arrears.

27. In addition to the VAT mentioned above, structural reforms will be accelerated to strengthen the fiscal position. The government is committed to effectively apply the automatic fuel price adjustment mechanism as international oil prices increase. The government has taken steps to control spending and rein in arrears. In particular, instructions have been sent to EMAE to control unbudgeted spending on electricity and water following recommendations by a working group that assessed the appropriate limits for different government units.

B. Financial Sector Policy

28. The BCSTP will continue to reduce banking sector vulnerabilities through frequent monitoring and enhanced supervision. In line with the NPL reduction strategy, the BCSTP is addressing the elevated level of NPLs through encouraging more concerted efforts to step up recoveries and write-offs by banks, enforcing collateral guidelines, and strictly overseeing banks’ credit risk management frameworks and lending policies. To safeguard depositor interests and minimize fiscal cost, the central bank will continue to monitor the resolution of Banco Equador and spearhead the transfer of BPSTP’s bank book to viable commercial banks.

29. Preparations for the AQR of the banking system with the support of the World Bank (structural benchmark, end-June 2018) are advancing though delayed. The external consultant is expected to sign the contract in July 2018 after a lengthy procurement process and contract negotiation period, and is required to prepare an inception report by end-September 2018 (revised structural benchmark) and a draft report by end-October 2018. The central bank has already communicated the plans and expectations to banks, and reviewed credit files to ensure that all documentation is in order to facilitate the work of the consultant. The BCSTP intends to leverage the AQR findings—the full report is expected by mid-2019—to update its loan classification system and the set of prudential regulations more broadly, with support from the Central Africa Regional Technical Assistance Center (AFC).

30. There has been an implementation delay for some of the recommendations of the last safeguards assessment. To ensure consistency, the revision to the Central Bank (Organic) law has been put on hold after some work was carried out in 2016 while the financial institutions law is being revised to align it with the proposed changes to the organic law regarding areas of oversight and resolution. The government hopes to have both laws approved by end-2018. The BCSTP Audit Board Regulations were revised in line with advice from the IMF Finance Department and approved in March 2017. However, staffing and physical space constraints have led to difficulties in adding staff to the Internal Audit Department. The completion of a new central bank headquarters, expected by end-2018, will allow for the eventual recruitment of more staff. An international auditing company, BDO, has already done field work on a central bank audit and submitted its draft report. BCSTP signed a cooperation agreement with the Central Bank of Brazil in November 2017 to support IFRS implementation over a three-year period. Banks will provision according to their calculations of expected loss, which may be higher than what the BCSTP requires as per its provisioning table. However, the CRC tool will help to validate whether the rates are in line with default history. A Brazilian team visited São Tomé in April 2018 on a scoping mission to begin working on the different modules of IFRS implementation. Another technical assistance mission from the Central Bank of Brazil in May supported the modernization of the CRC in collaboration with the World Bank.

31. The central bank is also working on other medium-term financial sector reform initiatives, such as developing a movable collateral registry (with support from the World Bank in line with our Financial Sector Development Implementation Plan (FSDIP)) and a corporate balance sheet repository (under a cooperation agreement with the Bank of Portugal and with financial support from the World Bank). An upgrade to the payment systems infrastructure is also underway with World Bank and AfDB support. BCSTP benefitted from AFC TA in May 2018 to modernize the prudential regulations on internal control (11/2007) and align it with the recently-issued regulation on corporate governance (17/2017).

C. Monetary Policy

32. The government will implement a set of measures to rebuild the reserves buffer. Continued fiscal consolidation will help control inflation and build a higher reserves buffer. The central bank, in an environment in which policy transmission depends on various structural factors of the national financial system (including the high credit risk index and bottlenecks in enforcing guarantees), will continue to monitor changes to inflation and develop the monetary policy tools available to support reserves accumulation. In addition, the Ministry of Finance will require the Treasury to act as project coordinator, working with various ministries, departments and external agencies to improve the implementation rate of externally-funded projects to avoid disbursement delays. The Treasury will publish quarterly reports on the progress of externally financed projects and revise the projected external disbursements in cooperation with the central bank, including both project and budgetary grants and loans. Among medium-term initiatives, ongoing plans to diversify the economy (centered around tourism, agriculture and fisheries) and efforts to reduce reliance on oil imports via electricity sector reform will both generate and save reserves. The future sale of exploration rights within the administrative areas will also generate needed foreign exchange for the country through attendant social programs, even though the associated signing bonuses are not considered for the calculation of the program target on reserves. The recent sale of two exploration blocks will add US$10 million oil signature bonus to the National Oil Account.

33. The government is making good efforts to develop monetary instruments. Recent amendments to the regulations (16/2017) allow the government to issue Treasury Bills, for which the maturity can bridge years. Based on this legislative amendment, the government successfully issued new bills in the second half of 2017 to manage the non-disbursement of World Bank funds as well as the shortfall and delay in EU assistance. Plans are also underway to further develop the securities market to allow for longer-term instruments, for which legislation is already drafted, and a secondary market overtime.

34. Interest in the domestic debt market remains strong, supporting the government’s effort to issue securities as part of its cash management strategy. Each of the three issuances in 2017 were oversubscribed by an average of 60 percent; however, commercial banks continue to submit bids only at the ceiling of the variable rate, so allocations are done on a proportional basis.

35. The BCSTP, in coordination with the Treasury, has made some improvement in liquidity forecasting. Furthermore, thanks to better coordination and information sharing with economic agents—namely, commercial banks, the Treasury, as well as departments within the central bank, liquidity forecasting is more reliable. The BCSTP Markets Department now generally receives better and timely information. The main problem in the past with liquidity management was due to asymmetric information and reporting delays. Reporting today is more reliable, which helps to minimize forecasting errors that still occur, partially due to one-off unexpected operations.

36. The central bank successfully redenominated the domestic currency, effective January 1, 2018. The BCSTP kept the exchange peg unchanged and eliminated three zeros from the dobra and issued new notes and coins for use. The new bills include innovative features that secure against counterfeiting and the redenominated exchange rate is 24.50 new dobras for 1 euro. In large part due to the rollout of an extensive awareness campaign, involving all sectors, the public at large has welcomed the monetary reform plan and the risk of a negative impact on inflation did not materialize as post-redenomination inflation is in line with year-on-year figures.

D. External Sector Policies
Exchange Restrictions

37. As a microstate and a fragile economy, São Tomé and Príncipe faces wide fluctuations in foreign inflows and has experienced frequent foreign exchange shortages, which intensified in recent years from the delayed external support and the impact of lower oil prices on our neighbors. With a population of less than 200,000 and an economy based mainly on subsistence agriculture and fisheries, the country relies heavily on imports for basic needs, requiring a large amount of foreign currency. Relative to these needs, sources of foreign currency (mainly official transfers and tourism receipts) are limited and volatile. For example, net official transfers fell from 13.7 percent of GDP in 2016 to 10.6 percent of GDP in 2017. The lower oil prices since 2014 put the economies and the foreign exchange markets of neighboring oil exporters under stress. In response, residents of those countries obtained foreign currency from São Tomé and Príncipe, including through external trade contracts that did not result in actual imports of goods to the country. There has been an intensification of such transactions since 2016. Because of the FX shortage and volatility, international reserves have been managed carefully.

38. Against this backdrop, a foreign exchange regulation (NAP 05/2017) was introduced on March 1, 2017 to ensure that import transactions of a bona fide nature are covered by the central bank while avoiding pressure on international reserves. The new regulation intensified an existing exchange restriction by limiting further the BCSTP’s foreign exchange coverage to payments of imported goods that have already been delivered and excluding from such coverage payments for imports of services, invisible transactions, advance payments for goods, and import payments for goods based on invoices dated later than 6 months from the date of the foreign exchange coverage request. It also makes clear that foreign exchange from the BCSTP would not be provided for the banks’ own proprietary current international transactions. While these measures were needed to meet the balance of payment needs, they also caused private external payment arrears for current international transactions.

39. The authorities are committed to eventually remove the exchange measures that limit the availability of foreign exchange for payments and transfer for current international transactions, and has been taking steps to improve its balance of payments to support such removal over time. In particular, the authorities are (i) implementing structural reforms to promote private-sector led growth, particularly in tourism and agro-business, to foster exports, (ii) reducing energy imports by revamping the electricity sector with World Bank and European Investment Bank support, and (iii) pursuing fiscal consolidation to address domestic demand. These measures are expected to improve the balance of payments over the medium term. This strengthening of the balance of payments should eventually allow an easing of exchange restrictions.

External Debt

40. Given the prolonged negotiations on rescheduling external arrears, the country is classified as being in debt distress, although the Debt Sustainability Analysis (DSA) shows that the outlook has improved. Under the baseline scenario, the ratio of the present value of public and publicly-guaranteed external debt to GDP no longer exceeds its threshold compared with the previous DSA, and the ratios to exports and to revenue still exceed their respective thresholds early in the projection period but decline over time with prudent policies. The government will continue its fiscal consolidation program and work to diversify the economy and expand the export base. In addition, the government will limit concessional borrowing to about 4 percent of GDP in the medium term and eschew non-concessional loans to help reduce the high risk of debt distress to ensure debt sustainability.

41. Despite the government’s best efforts, the outstanding arrears with external creditors are yet to be resolved. The government has actively sought debt rescheduling agreements with Angola, Brazil, and Equatorial Guinea, through correspondence and high-level meetings. An agreement with the Brazilian government was reached, pending the ratification by the Brazilian Senate. The government is still waiting for responses from the other two countries on scheduling negotiation sessions, as well as from Nigeria on discussing the disputed loan.

42. The government is implementing measures to strengthen debt management, improve the management of its current loans portfolio, and manage the acquisition of new loans. The government is in the process of implementing some of the main recommendations of the Debt Management Performance Assessment (DeMPA), which was completed with the support of the World Bank in November 2016. In particular, a draft medium-term debt management strategy has been prepared and is being discussed within the government. With the help of the World Bank, a debt database is being established, which is critical for improving debt service projections, conducting risk analyses, and reporting more detailed information on the debt stock. Training of officials on debt management, including T-Bill issuance, is planned to start in 2018 with the help of the World Bank and the AfDB. The government will develop and publish an annual schedule of T-Bill issuance that aligns with cash flow forecasts and borrowing plans.

Borrowing Plan 2018–20

(Millions of U.S. dollars)

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Contracting and guaranteeing of new debt. The present value of debt is calculated using the terms of individual loans and applying the 5 percent program discount rate.

Debt with a grant element that exceeds a minimum threshold of 35 percent.

Debt with a positive grant element below the minimum grant element.

Debt without a positive grant element. For commercial debt, the present value would be defined as the nominal/face value.

43. The government has secured a grant from China to complement a Kuwaiti loan in financing the Dr. Ayres Menezes Hospital. The financing package will have a grant element of well above the 35 percent threshold required under the program, although the Kuwaiti loan itself has a grant element of 34 percent. This project will bring significant benefits to our people by improving health services.

E. The Implementation of Other Structural Reforms
Development Planning

44. São Tomé and Príncipe has made considerable progress in promoting inclusive growth and tackling environmental issues, although significant challenges remain. The government passed the National Development Plan (NDP) for 2017-2021, in which some of the development priorities include quality education and a functioning judicial system accessible to all. On gender equality, the legal system provides equal rights to men and women; however, in practice, there is room for improvement in some social norms and outcomes. For example, the estimated gross national income per capita for women was less than half of that for men in 2015. On environmental issues, the government (particularly the Ministry of Agriculture) has been working with NGOs to implement the national sanitation plan and promote sustainable biodiversity (with the latter focusing on Príncipe), among other initiatives. Challenges include limited capacity in sectoral ministries; not-well-organized associations and cooperatives; and low environmental awareness among local residents.

Business Climate

45. The government is committed to create a conducive environment for private sector development. To this end, our structural reforms agenda prioritizes export diversification and cost competitiveness to support growth and external stability. The government adopted a tourism development strategy as a core element of an export diversification strategy (end-June 2018 structural benchmark). In addition, the government will pursue strategies to address the unreliable supply and high cost of electricity, including the development of cheaper energy sources. As discussed previously, the government will follow through on plans to reform the state electricity company (EMAE), eliminate cross-subsidies, and move to full cost recovery of electricity tariffs. The authorities are also committed to revise the Investment Code (12/2016) and its regulations on foreign exchange cover (05/2017) to remove the remaining exchange restrictions and multiple currency practice over time, while addressing balance of payment needs through implementing the policies under the program.

Capacity Development

46. Capacity development remains key and continued IMF support will be needed. The priority areas for capacity development include domestic revenue mobilization, public financial management, public investment management, public debt management, and financial sector regulation and supervision. However, weak domestic capacity has slowed the implementation of TA recommendations and delayed external project-related disbursements, requiring more hands-on support from our partners. The government will continue working with the IMF and other development partners to achieve its capacity development goals. The government will particularly welcome increased hands-on follow-up support on the implementation of TA recommendations to improve the impact of TA.

F. Statistics

47. Efforts to address data shortcomings in economic statistics for surveillance will continue. Having received TA from the IMF to improve balance of payments statistics and extend the coverage of the international investment position, the BCSTP is working on implementing the recommended actions to ensure better quality and broader coverage. Following the rebasing of the national accounts to 2008 and a new CPI, using a broader basket of goods and services and 2014 as the base year, and reweighting the sub-indices, the national statistics institute (INE) is planning to publish the analytical back series. It also expects to improve the real-sector statistics by developing data on the components of GDP on the demand side and quarterly GDP, including leading indicators of economic activity.

Program Monitoring

48. The performance criteria (PCs), indicative targets (ITs), prior actions, and structural benchmarks for end-June 2018 are presented in Tables 3 and 4. The definitions of quantitative PCs and ITs are provided in the attached TMU, which also defines the scope and frequency of data reporting for program monitoring purposes. The sixth review is expected to be completed on or after October 15, 2018.

Table 2.

São Tomé and Príncipe: Structural Benchmarks Under ECF Program, December 2017

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Table 3.

São Tomé and Príncipe: Performance Criteria and Indicative Targets for 2018, Preliminary

(Millions of new dobra, cumulative from beginning of year, unless otherwise specified)

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

Performance at the June 2018 test date is assessed on the sixth review.

The floor will be adjusted upward or downward according to definitions in the TMU.

The ceiling will be adjusted downward or upward according to definitions in the TMU.

Excluding the National Oil Account (NOA) at the Central Bank.

The term “central government” is defined as in ¶ 5 of the TMU, which excludes the operations of state-owned enterprises.

This criterion will be assessed as a continuous performance criterion.

The term “external” is defined on the basis of the residency of the creditor per paragraph 5 of the Guidelines on Public Debt Conditionality in Fund Arrangements, adopted by Decision No. 15688 of the Executive Board (Dec. 5, 2014).

This performance criterion or memorandum item applies not only to debt as defined in paragraph 8 of the Guidelines on Public Debt Conditionality in Fund Arrangements, adopted by Decision No. 15688 of the Executive Board (Dec. 5, 2014), but also to commitments contracted or guaranteed for which value has not been received. For further details on the definition of debt and external arrears refer to the TMU, HH 6 and 13.

Only applies to debt with a grant element of less than 35 percent. For further details refer to the TMU, H 17.

Changed to a memorandum item.

Only applies to debt with a grant element of at least 35 percent.

As defined in the TMU, valued at the program exchange rate, excludes HIPC-related amortization.

The expected WB budget support in 2018 is $6 million of which $1 million will be treated as project grants and excluded from the DPD if it is spent on facilities for the tax administration.

Table 4.

São Tomé and Príncipe: Structural Benchmarks Under ECF Program, 2018

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Attachment II. Technical Memorandum of Understanding, July 2018

1. This Technical Memorandum of Understanding (TMU) contains definitions and adjuster mechanisms that clarify the measurement of quantitative performance criteria and indicative targets in Table 3, which are attached to the Memorandum of Economic and Financial Policies for 2018. Unless otherwise specified, all quantitative performance criteria and indicative targets will be evaluated in terms of cumulative flows from the beginning of each calendar year.

2. The program exchange rate for the purposes of this TMU1 will be 20.299 new dobras per U.S. dollar, 24.5 new dobras per euro, and 29.236 new dobras per SDR for 2018.

Provision of Data to the Fund

3. Data with respect to all variables subject to performance criteria and indicative targets will be provided to Fund staff on the frequency described below (paragraph 24) with a lag of no more than four weeks for data on net international reserves of the Central Bank of São Tomé and Príncipe (BCSTP) and six weeks for other data. The authorities will transmit promptly to Fund staff any data revisions. For variables that are relevant for assessing performance against program objectives but are not specifically defined in this memorandum, the authorities will consult with Fund staff as needed on the appropriate way of measuring and reporting. Performance criteria included in the program are defined below, specifically (i) the floor on domestic primary balance; (ii) the ceiling on changes in net bank financing of the central government; (iii) the floor on net international reserves of the central bank; (iv) the ceiling on central government’s outstanding external payments arrears; and (v) the ceiling on the contracting or guaranteeing of new non-concessional external debt by the central government or the BCSTP.

Definitions

4. For the purposes of this TMU, external and domestic shall be defined on a residency basis.

5. Central government is defined for the purposes of this TMU to comprise all governmental departments, offices, establishments, and other bodies that are agencies or instruments of the central authority of São Tomé and Príncipe. The central government does not include the operations of state-owned enterprises.

6. Debt is defined as in paragraph 8 of the Guidelines on Public Debt Conditionality in Fund Arrangements, adopted by Decision No. 15688 of the Executive Board (Dec. 5, 2014). “Debt will be understood to mean a current, i.e., not contingent, liability, created under a contractual agreement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services at some future point(s) in time; these payments will discharge the principal and/or interest liabilities incurred under the contract.”

7. Government domestic revenue (excluding oil revenue) comprises all tax and non-tax revenue of the government (in domestic and foreign currencies), excluding: (1) foreign grants, (2) the receipts from the local sale of in-kind grants (e.g., crude oil received from Nigeria, food aid, etc.), and (3) any gross inflows to the government on account of oil signature bonus receipts and accrued interest on the National Oil Account (NOA). Revenue will be measured on a cash basis as reported in the table of government financial operations prepared by the Directorate of Budget and the Directorate of Treasury in the Ministry of Finance, Commerce and the Blue Economy (MOF).

8. Domestic primary expenditure comprises all government spending assessed on a commitment basis (base compromisso), excluding (1) capital expenditure financed with external concessional loans and project grants and (2) scheduled interest payments. Reporting of government domestic expenditure will be based on the state budget execution prepared every month by the Directorate of Budget and the Directorate of Treasury in the MOF. The portion of EU budget support grants that is used to finance capital expenditures in the areas linked to the conditionality of the grants, specifically on improving water supply and sanitation, is treated as project grants. The World Bank disbursement of up to $1 million spent on facilities for the tax administration is treated as project grant for September and December 2018 indicative targets.

Official External Program Support

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Performance Criteria

9. Performance criterion on the floor on domestic primary balance. This performance criterion refers to the difference between government domestic revenue (excluding oil revenue) and domestic primary expenditure. For reference, this balance for end 2016 was -314 million new dobras, broken down as follows:

Domestic Primary Balance

(2016, millions of new dobras)

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10. Performance criterion on the ceiling on changes in net bank financing of the central government (NCG). This performance criterion refers to the increase (decrease) of net bank financing of the central government, which equals the stock of all outstanding claims on the central government held by the BCSTP and by other depository corporations (ODCs), less the stock of all deposits held by the central government with the BCSTP and with ODCs. The balance of the National Oil Account (NOA), deposits from project grants and loans, contingent liabilities, and social security operations are not included in NCG. All foreign exchange-denominated accounts will be converted to new dobras at the program exchange rate. The relevant data are reported monthly by the BCSTP to the IMF staff. For reference, at end-2016, outstanding net bank financing of the central government (excluding NOA) was 224 million new dobras, as follows:

Net Banking Financing

(millions of new dobras)

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11. Performance criterion on the floor on net international reserves (NIR) of the BCSTP. The NIR of the BCSTP are defined for program-monitoring purposes as short-term (i.e., original maturities of one year or less), tradable foreign assets of the BCSTP minus short-term external liabilities, including liabilities to the IMF. All short-term foreign assets that are not fully convertible external assets nor readily available to and controlled by the BCSTP (i.e., they are pledged or otherwise encumbered external assets, including but not limited to the HIPC umbrella SDR account and assets used as collateral or guarantees for third-party liabilities) will be excluded from the definition of NIR. Securities whose market value on the last day of the year differs by over 20 percent from their original nominal issue price will be assessed at their market value as reported by the BCSTP’s Markets Department. The balance of (1) NOA at the BCSTP, (2) banks’ deposits related to capital or licensing requirements, and (3) banks’ reserves denominated in foreign currency are excluded from the program definition of NIR. All values are to be converted to U.S. dollars at the actual mid-point market exchange rates prevailing at the test date. For reference, at end 2016 NIR was 1,188 million new dobras (or $50.7 million, using the exchange rate of 23.438 new dobras per U.S. dollar), calculated as follows:

International Reserves

(End-2016, millions of new dobras)

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12. Performance criterion on the ceiling on the contracting or guaranteeing of new nonconcessional external debt by the central government or the BCSTP. This is a continuous performance criterion that refers to the contracting or guaranteeing of new external debt of any maturity (including overdraft positions but excluding normal import and supplier credits) by the government and/or the BCSTP. Debt is considered nonconcessional if it includes a grant element less than 35 percent. The grant element is the difference between the nominal value of the loan and its net present value, expressed as a percentage of the nominal value. The net present value of the debt at the date on which it is contracted is calculated by discounting the stream of debt service payments at the time of the contracting. The discount rate used for this purpose is 5 percent. A loan comes into effect on the signature date of the contract, unless it is specified in the contract that it becomes effective upon ratification by the parliament. For the program monitoring purpose, a loan contract is treated to be in effect on the date of the first disbursement if that is earlier than the date of signature or ratification of the contract. With respect to the precautionary line of credit from Portugal to support the pegging of the new dobra to the euro, unpaid balances outstanding during the first three quarters of a given calendar year will be excluded from this ceiling. However, outstanding balances at the end of a given calendar year will be included in the assessment of compliance with this performance criterion. This performance criterion does not apply to IMF facilities. Debt being rescheduled or restructured is excluded from this ceiling. Medium- and long-term debt will be reported by the Debt Management Department of the MOF (as appropriate), measured in U.S. dollars at the prevailing exchange rates published by the BCSTP. The government should consult with IMF staff before contracting or guaranteeing new medium– or long–term debt obligations.

13. Performance criterion on the ceiling on the accumulation of central government’s new external payment arrears. This is a continuous performance criterion. New central government external payment arrears consist of external debt service obligations (principal and interest) that have not been paid at the time they are due, as specified in the contractual agreement, subject to any applicable grace period. This performance criterion does not apply to arrears resulting from the nonpayment of debt service for which a clearance framework has been agreed or for which the government is actively seeking a rescheduling agreement.

Indicative Targets

14. Ceiling on change of central government’s new domestic arrears is set on the difference between expenditure on a commitment basis and cash payments (amounts past due after 40 days and unpaid).

15. Within domestic primary expenditure, the floor on pro-poor expenditure refers to the floor on government outlays recorded in the budget that have a direct effect on reducing poverty, as agreed with the IMF and World Bank staffs. These expenditures, which include both current and capital outlays, are defined as follows:

  1. Pro-poor current spending: These cover the following functional classifications and expenditure categories (by budget code) as described in the matrix below:

  2. Pro-poor treasury-funded capital spending: This covers projects that are deemed to have a direct impact on alleviating poverty in the following sectors: education, health, social safety nets, agriculture and fisheries, rural development, youth and sports, provision of potable water, and electrification.

Pro-Poor Current Spending

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Source: Diario da Republica de São Tomé Príncipe No. 21 - May 7, 2008, pages 12-13.

Expenditures on fuels and lubricants (combustíveis e lubrificantes) that are affected for administrative purposes are excluded. Likewise, food (alimentação) and clothing and shoes (roupas e calçados) supplied to administrative staff are excluded.

16. Floor on tax revenue is set on tax revenue that includes direct and indirect taxes as well as recovery of tax arrears and additional collection efforts.

Memorandum Items

17. New concessional external debt contracted or guaranteed by the central government or the BCSTP measures such debt with a grant element of at least 35 percent.

18. Net external debt service payments by the central government are defined as debt service due less the accumulation of any new external payment arrears, as defined under the performance criterion on the ceiling on central government’s outstanding external payment arrears.

19. Official external program support is defined as budget support grants and loans, including disbursements from the IMF under the ECF arrangement and in-kind aid when the products are sold by the government and the receipts are earmarked for a budgeted spending item, and other exceptional financing provided by foreign official entities and incorporated into the budget.

20. Treasury-funded capital expenditure is classified as part of domestic primary expenditure and covers public investment projects that are not directly financed by project grants and concessional loans or that have to be partially co-financed with government resources. It includes spending on new construction, rehabilitation, and maintenance. Expenditure on wages and salaries and the purchase of goods and services related to the projects will not be classified as capital expenditure.

21. Ceiling on base money is set on the sum of currency issued—which consists of currency outside depository corporations and cash in vaults—and banks reserves denominated in new dobras. Bank reserves refer to reserves of commercial banks (in new dobras) held with the central bank and include reserves in excess of the reserve requirements.

Use of Adjusters

22. The performance criterion on the domestic primary balance will have one adjuster. The floor on the domestic primary balance will be adjusted downward if the government receives more than projected budget support grants (excluding any portion of the additional EU grant used to finance capital expenditure on water and sanitation, which will be included in project grant financed capital expenditure) and privatization receipts in 2017 and 2018; this adjuster will be capped at 77.7 million dobras (about 1 percent of 2016 GDP) for 2017 and 38.8 million new dobras for the first semester of 2018.1 For program purpose, the projected privatization proceeds are 0 in 2017 and 2018. For end 2018, if the collection of tax arrears from Rosema does not materialize, the floor on the domestic primary balance will be adjusted downward (in absolute value) by the market value of Rosema’s assets that the government seizes.

23. The performance criteria on net bank financing of the central government and net international reserves of the central bank will be subject to the following adjusters based on deviations calculated cumulatively from end-December 2016 or end-December 2017, as appropriate (MEFP Attachment I, Table 3):

  • Adjusters on ceilings on changes in net bank financing of the central government (NCG): Quarterly differences between actual and projected receipts of budget transfers from the NOA, budgetary support grant, net external debt service payments, and domestic arrears will be converted to new dobras at the program exchange rate and aggregated from end-December 2016 or end-December 2017, as appropriate, to the test date. The ceilings will be adjusted:

    • ⚪ (i) downward (upward) by cumulative deviations downward (upward) of actual from projected net external debt service payments (exclude HPIC),

    • ⚪ (ii) downward (upward) by deviation upward (downward) in budget transfers from the NOA,

    • ⚪ (iii) downward by deviation upward of budgetary support grants in excess of 77.7 million new dobras and upward for the full deviation downward of budgetary support grants.

    • ⚪ (iv) downward by deviation upward of domestic arrears.

The combined application of all adjusters at any test date is capped at the equivalent of US$3 million at the program exchange rate.

  • Adjusters for the floor on net international reserves (NIR) of the BCSTP: Quarterly differences between actual and projected receipts of budget transfers from the NOA, official external program support, net external debt service payments, and domestic arrears in new dobras, will be converted to U.S. dollars at the program exchange rate and aggregated from end-December 2016 or end-December 2017, as appropriate, to the test date. The floor will be adjusted upward (downward):

    • ⚪ (i) by the cumulative deviation downward (upward) of actual from projected net external debt service payments of the central government;

    • ⚪ (ii) by deviations upward (downward) for budget transfers from the NOA, and

    • ⚪ (iii) by deviations upward (downward) of official external program support. Budget support loans in 2017 and 2018 are projected to be 0.

The combined application of all adjusters at any test date is capped at the equivalent of US$3 million at the program exchange rate.

Data Reporting

24. The following information will be provided to the IMF staff for the purpose of monitoring the program.

  • 1) Fiscal Data: The Directorate of Treasury and Directorate of Budget at the MOF will provide the following information to IMF staff, within six weeks after the end of each month or quarter, except for the public investment program (PIP), which will be provided three months after each quarter:

    • Monthly data on central government operations for revenues, expenditure, and financing, including detailed description of net earmarked resources (recursos consignados), on commitment (compromisso) and cash payments (caixa);

    • Monthly data on net credit to the government by the BCSTP, recorded account by account in a format fully compatible with the monetary accounts of the BCSTP;

    • Monthly detailed data on tax and nontax revenues;

    • Monthly detailed data on domestically financed capital expenditure on commitment (compromisso) and cash payments (caixa);

    • Monthly data on domestic arrears by type and by creditor;

    • Quarterly data on implicit arrears to ENCO on account of fuel retail prices eventually not covering import costs, distribution margins and applicable taxes;

    • Quarterly data on EMAE’s arrears to ENCO;

    • Monthly data on official external program support (non-project);

    • Quarterly data on the execution of the public investment program (PIP) by project and sources of financing;

    • Quarterly data on the execution of Treasury-funded capital expenditure by project type, amount, timetable of execution, and progress of execution;

    • Quarterly data on project grant and loan disbursement (HIPC and non-HIPC);

    • Quarterly data on bilateral HIPC debt relief;

    • Quarterly information on the latest outstanding petroleum price structures and submission of new pricing structures (within a week of becoming available).

    • Quarterly pro-poor expenditure.

  • 2) Monetary Data: The BCSTP will provide the IMF staff, within three weeks from the end of each month, the monetary accounts of the BCSTP. Other monetary data will be provided within six weeks after the end of each month for monthly data, within two months after the end of each quarter for quarterly data, and within two months after the end of the year for annual data. The BCSTP will provide the following information to IMF staff:

    • Daily data on exchange rates, to be posted on the central bank’s web site;

    • Daily data on interest rates, to be posted on the central bank’s web site;

    • Daily liquidity management table, including base money (in new dobras) and currency in circulation, to be posted on the central bank’s web site;

    • Daily net international reserve position, to be posted on the central bank’s web site;

    • Monthly balance sheet data of BCSTP (in IMF report form 1SR, with requested memorandum items);

    • Monthly consolidated balance sheet data of other depository corporations (in IMF report form 2SR);

    • Monthly consolidated depository corporations survey (in IMF survey 3SG);

    • Monthly central bank foreign exchange balance (Orçamento cambial);

    • Quarterly table on bank prudential ratios and financial soundness indicators;

    • Quarterly data on the BCSTP’s financial position (profit and loss statement, deficit, budget execution, etc.).

  • 3) External Debt Data: The Directorate of Treasury at the MOF will provide the IMF staff, within two months after the end of each month the following information:

    • Monthly data on amortization and interest on external debt by creditor; paid, scheduled, in arrears, and subject to debt relief or rescheduled;

    • Quarterly data on disbursements for foreign-financed projects and program support loans;

    • Annual data on future borrowing plans.

  • 4) National Accounts and Trade Statistics: The following data will be provided to the IMF staff:

    • Monthly consumer price index data, provided by the National Institute of Statistics within one month after the end of each month;

    • Monthly data on imports (value of imports, import taxes collected, and arrears) and commodity export values, provided by the Customs Directorate at the MOF, within two months after the end of each month;

    • Monthly data on petroleum shipments and consumption (volumes and c.i.f. prices, by product), provided by the Customs Directorate.

1

There are still oil exploration activities outside the Joint Development Zone but no confirmation of commercial quantities yet.

2

The debt figures mentioned exclude pre-HIPC arrears and disputed debt.

3

Including the airport expansion, which will be financed by grants only as indicated by the authorities. The mission has been advising the authorities to use means that are non-debt creating and do not require public guarantees for a deep-water port for fisheries, the plan for which is yet to be fully developed.

4

An analysis of the quarterly data shows that the introduction of the peg in January 2010 lowered both food and nonfood inflation (SIP Chapter 2). It also shows that domestically financed fiscal spending, which is reflected in the growth of M2, is associated with higher inflation. From the supply side, food inflation follows the international food price index and rises with higher rainfall, which damages crops and negatively affects fishing. In addition, nonfood inflation is positively correlated with the growth of tourist arrivals, reflecting infrastructure bottlenecks.

5

Although no data on domestic violence seem to be available, interviews with authorities indicate that this is a key area for improvement.

1

Targeting a net IIP at its current level translates into a current account norm of -12.0 percent of GDP, which in turn implies an undervaluation of 16.6 percent (Scenario 1). However, staff assess that such a current account level is not desirable, so the result for Scenario 1 should be substantially underweighted.

1

Data refer to the mid-point exchange rates published on the BCSTP’s webpage for the last day of 2014.

1

Grants and related expenditures to cover the cost of the elections will be excluded from the measurements of the domestic primary deficit.

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Cover IMF Staff Country Reports
Democratic Republic of São Tomé and Princípe: 2018 Article IV Consultation, Fifth Review Under the Extended Credit Facility Arrangement, Request for Waivers for Nonobservance of Performance Criteria, and Financing Assurances Review
Author:
International Monetary Fund. African Dept.
Volume/Issue:
Volume 2018: Issue 251
Publisher:
International Monetary Fund
ISBN:
9781484372227
ISSN:
1934-7685
Pages:
118
DOI:
https://doi.org/10.5089/9781484372227.002
  • Text Figure 1.
    View in gallery
    Text Figure 1.

    São Tomé and Príncipe: Non-Performing Loans Ratios by Bank

    (percent, 2016-17)

  • Text Figure 2.
    View in gallery
    Text Figure 2.

    São Tomé and Príncipe: Selected Financial Inclusion Indicators, 2016

  • Text Figure 3.
    View in gallery
    Text Figure 3.

    São Tomé and Príncipe: Selected Gender Inequality Measures, 2015

  • Figure 1.
    View in gallery
    Figure 1.

    São Tomé and Príncipe: Recent Macroeconomic Developments, 2009-18

  • Figure 2.
    View in gallery
    Figure 2.

    São Tomé and Príncipe: Financial Sector Developments, 2011-181

  • Annex Figure 1.
    View in gallery
    Annex Figure 1.

    São Tomé and Príncipe’s balance of payments

  • Annex Figure 2.
    View in gallery
    Annex Figure 2.

    São Tomé and Príncipe: Exchange Rate Developments

  • Annex Figure 3.
    View in gallery
    Annex Figure 3.

    São Tomé and Príncipe: Doing Business Indicators

    (0=worst, 100=best)

Text Figure 1.

São Tomé and Príncipe: Non-Performing Loans Ratios by Bank

(percent, 2016-17)
Text Figure 2.

São Tomé and Príncipe: Selected Financial Inclusion Indicators, 2016
Text Figure 3.

São Tomé and Príncipe: Selected Gender Inequality Measures, 2015
Figure 1.

São Tomé and Príncipe: Recent Macroeconomic Developments, 2009-18
Figure 2.

São Tomé and Príncipe: Financial Sector Developments, 2011-181
Annex Figure 1.

São Tomé and Príncipe’s balance of payments
Annex Figure 2.

São Tomé and Príncipe: Exchange Rate Developments
Annex Figure 3.

São Tomé and Príncipe: Doing Business Indicators

(0=worst, 100=best)