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
Author:
International Monetary Fund. African Dept.
Search for other papers by International Monetary Fund. African Dept. in
Current site
Google Scholar
Close

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

article image
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)

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

Impact of Fiscal Measures

(in percent of GDP)

article image
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)

article image
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)

article image
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)

article image
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)

article image
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)

article image
Table 5.

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

(Percent)

article image
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).