Democratic Republic of São Tomé and Príncipe: Selected Issues

Selected Issues

Abstract

Selected Issues

Prospects of Growth in São Tomé and Príncipe. A Comparative Case Study1

A. Introduction

1. Economic performance in São Tomé and Príncipe(STP) has lagged behind other small island-states in Africa.2 STP has many historical and socio-economic features in common with the other small island-states in Africa—Cabo Verde, Mauritius, and Seychelles. Yet, its economic growth since independence has significantly lagged behind (Chart). GDP per capita has essentially stagnated in STP, whereas it has tripled or quadrupled in the other islands.3

Text Figure 1.
Text Figure 1.

Small Island States in Africa. Real GDP per Capita in Constant 2000 USD, 1960-2017

Citation: IMF Staff Country Reports 2018, 322; 10.5089/9781484385005.002.A001

Sources: WEO, IMF; and IMF staff calculations.

2. This case study seeks explanations for STP’s relative under-performance and draws lessons for the future. It compares past economic developments in the islands and recommends policies that could most effectively foster future growth in STP. The paper is organized as follows. Section 2 provides a brief historical background; Sections 3 and 4 describe the conditions prevailing at independence and developments since then; Section 5 draws lessons from the past and Section 6 concludes.

B. Background

3. STP shares a similar history with Cabo Verde, Mauritius, and Seychelles. All four islands were settled by European countries between the fifteenth and eighteenth century and initially prospered as a stopover for intercontinental commerce, including the slave trade. They subsequently evolved into plantation economies, except for Cabo Verde which has an arid climate. Mauritius and Seychelles were transferred from French to British control in the early nineteenth century, but the French plantation owners stayed and dominated the economy. Cabo Verde and STP were ruled by the Portuguese uninterrupted from the fifteenth century until independence.

4. Independence came relatively peacefully in all four countries: in 1968 for Mauritius, followed by Cabo Verde and STP in 1975, and Seychelles in 1976. However, Mauritius and Seychelles had earlier earned some political and economic autonomy which gave them experience in government and enabled the establishment of a middle class with vested interests in private property, whereas the transition in Cabo Verde and STP took place with little advance preparation or experience in self-rule, and no market foundations.

5. Although the political regimes differed, in all cases the government played a central role in the economy. Immediately after independence, Mauritius remained in the British Commonwealth and adopted the democratic values of the British system. Cabo Verde, Seychelles and STP turned into single-party socialist regimes with centralized planning and administered prices.4 However, in all the islands, the government played a central role in the economy’s development, and initially pursued a protectionist inward-oriented system, which proved inefficient and eventually forced some re-orientation and liberalization of the economy. For Cabo Verde, Seychelles and STP, this also involved a switch to a multi-party democratic regime at the turn of the 1990s.

C. Conditions at Independence

6. The four islands faced considerable challenges at independence, and were viewed by some as economically unviable.5 They were small, remote, undeveloped and with limited resources. Their economies were essentially agriculture-based with few export goods, and highly dependent on imports.6 In the case of STP, the large cocoa plantations accounted for 90 percent of the farmed land and 2/3 of employment.

7. The consequences of small size are worth singling out in STP. It is generally recognized that small size, especially when combined with remoteness, limits market and production capacity, and hence reduces competitiveness and growth due to diseconomies of scale and higher costs of production and trade.7 A less noted, but perhaps equally important phenomenon is that small size, especially micro size whereby people closely know each other, can foster a political and institutional system based on personal connections and favors, at the expense of the rule of law and good governance. As we shall see, STP’s development suffered dearly from this problem, while the other islands appear to have somehow mitigated it.8

8. Initial conditions did not favor STP. Table 1 sums up the relative conditions that prevailed in the four countries in 1975 along a number of indicators of growth found to be significant in the literature.9 The islands are ranked from 1 to 4, 4 being the most favorable for growth. The footnotes explain the bases for the ranking. Thus, at independence, STP had a priori the most to grow, given its lowest starting level of income per capita. However other factors, particularly human capital and natural resources, favored the other islands.

9. In particular, STP was at a relative disadvantage in terms of natural resources. While STP enjoyed an unsullied and attractive environment favorable for tourism, and a rich soil and fish stock, Seychelles was more favored for tourism, and Mauritius benefited in addition from ethnic diversity which helped establish trade relations with and attract foreign investment from broader markets.10 Cabo Verde was inauspicious for agriculture due to a Sahelian climate and recurring droughts, but it enjoyed a strategic position between three continents, which supported its trade and service industry.

10. Lack of capital, broadly defined, was another key disadvantage. By the time of independence, most of the Portuguese, and with them most skilled workers, managers and financial capital, had left STP, and the infrastructure was rudimentary. In contrast, Mauritius, and to a lesser extent Seychelles, retained technical know-how and institutional capacity after independence as both the descendants of the early French plantation owners and the new middle class stayed. Seychelles also benefited from the construction of an international airport in 1971, which jump-started its tourism. Cabo Verde had long experience as a service hub, supported by a deep-water port and international airport,11 skilled mid-level administrators and labor force trained by Portugal during its colonizing era, and the backing of an accomplished diaspora whose remittances accounted for about 15-20 percent of GDP.

Table 1.

Small Island States in Africa: Initial Conditions at Independence

article image

Based on population size.

Based on the distance to the islands’ main trade partners which at that time was Europe.

Distinguishing features were Seychelles’ natural attraction for tourism at the time (as suggested for instance by the average number of hours of sun in a year and the number of top beaches); Mauritius’s ethnic diversity which enabled reaching different markets; Cabo Verde’s strategic position and accomplished diaspora.

The ranking in this case is inversely related to an island’s income per capita, on account that the lower the initial income is (everything else being equal), the higher the growth potential (see Barro, 1991).

Life expectancy for Seychelles is not available prior to 1982, at which time it was about the same as in Mauritius; Cabo Verde and STP were about the same in 1975 and both were systematically lower than in Mauritius and Seychelles since 1982.

Partly based on the prevailing level of education. Cabo Verde is ranked higher than STP on account of available skilled workers/managers.

Seychelles’ rating is based on the situation after Rene took power.

11. STP also suffered at independence from weak or absent institutions. With the departure of the Portuguese and a lack of preparation for the transition of power, the country needed to develop its institutions across sectors from the scratch. Quantitative measures of governance going back to 1975 are unavailable, however, historical reports document the prevalence of poor governance at the time,12 and measures starting in 1996 (such as the Worldwide Governance Indicator or the Ibrahim Index of African Governance) systematically give STP the lowest score among the four islands.

D. Developments Since Independence13

12. Immediately after independence, STP’s economy suffered from a lack of effective institutions, a shortage of cadres and skilled labor, including farmers, and macro-economic imbalances. Much of the economy was nationalized in the first few years, including the former Portuguese-owned and -run plantations, and brought under centralized planning with wide-ranging price control and subsidies. Weak institutions, combined with a small communal environment where kinship played a strong role, led to widespread nepotism, with key positions in the new state allotted to well-connected individuals with very little experience. Production in the plantations dropped by almost half due to mismanagement, and state-owned enterprises (SOEs) registered large losses, while commerce and services suffered as Portuguese companies exited.14 Some reforms were launched in the second half of the 1980s, but implementation was very slow. In the meantime, lax fiscal policy financed by external and domestic credit (including by the central bank), combined with connected bank lending to the private sector, led to large imbalances, reflected in rising inflation, deficit and debt, which ultimately forced a political and economic re-orientation (Figure 1).15

13. In the 1990s, economic growth in STP was hindered by political and macroeconomic instability, and weak private investment and social spending. The political regime shifted to a multi-party democratic system in 1991, but the root causes of the economic imbalances observed earlier, specifically low capacity, clientelism and poor governance, remained and were exacerbated by political instability. The country saw 17 changes in government between 1991 and 2014, compared to 3 in Cabo Verde, 5 in Mauritius, and 3 in Seychelles,16 while various indicators of governance regularly placed STP significantly below the other three islands.17 The period was characterized by stop-and-go adjustment policies and lack of ownership of reforms and donor-financed public investment projects. Reform programs were initiated periodically with substantial technical and financial assistance from development partners, but were similarly stymied by weak institutions as in the earlier period and frequent changes in government. The period also featured expansionary fiscal and monetary policies, notably in the run-up to elections and in anticipation, or at receipt, of oil-related revenue.18 Consequently, inflation soared and public debt spiked in the mid-1990s following a sharp depreciation of the dobra (Figure 1). Despite substantial external financial assistance, income per capita during 1990-2000 actually declined in STP.

14. The poor performance in the 1990s also reflected weak private investment and social spending. All indications are that private investment was sparse during this period, including in the tourism sector, as further evidenced by the absence of measurable tourism activity during that time. In contrast, substantial private investment in the tourism sector in the case of Cabo Verde and Seychelles and in the textile manufacturing sector in the case of Mauritius, promoted by more favorable macroeconomic and political conditions, helped income per capita grow annually between 3 and 4½ percent in these islands (Figure 1). Meanwhile, tax revenue in STP remained meagre and cyclical, with bouts of increases driven by expansionary fiscal policies or international oil price increases which raised import tax revenue. The low and cyclical tax revenue perpetuated dependence on external aid and fiscal imbalances, and prevented domestic spending on priority social programs, hindering poverty reduction and the buildup of human and physical capital.

15. Reforms implemented since the 2000s improved macroeconomic stability and boosted economic performance (Figure 1).19 Faced with an economic crisis and cases of fraud,20 and spurred by the HIPC initiative, the authorities took some steps towards reforms in the early 2000s, albeit implementation was slow.21 The exchange rate was stabilized and inflation brought down from its peak in the 90s (although it reemerged in the wake of the global financial crisis). Growth surged in the mid-2000s, driven by government expansion, financed by oil exploration bonuses, and foreign direct investment in the tourism and banking sectors. Investors were attracted by the country’s prospects of finding oil and the expected HIPC-related debt forgiveness, which eventually cut debt to about 60 percent of GDP in 2007. Thereafter, improved macroeconomic conditions and structural reforms supported by substantial donor-financed programs have helped STP maintain robust growth, including significant growth in tourism, even though the prospects for finding oil have dimmed. Yet, growth in STP, and private investment, never reached or sustained the levels experienced by the other islands in the past.

Figure 1.
Figure 1.

Small Island States in Africa: Selected Indicators, 1964-2017

Citation: IMF Staff Country Reports 2018, 322; 10.5089/9781484385005.002.A001

Sources: World Economic Outlook, IMF; and IMF staff calculations.1/ Investment data is not available for STP prior to 2000.

E. Current Conditions and Policy Recommendations

A few lessons stand out from STP’s own past and the other three islands’ experience (diagram below).

Figure 2.
Figure 2.

Small Island States in Africa: Determinants of Growth

Citation: IMF Staff Country Reports 2018, 322; 10.5089/9781484385005.002.A001

16. Past experience in the four islands underscored that macroeconomic stability, supported by political continuity and good governance, is a prerequisite for robust growth. Macroeconomic imbalances, combined with poor governance and political instability, undermined growth in STP through the 90s, while more stable conditions promoted private investment and faster growth in the other three islands. It wasn’t until the 2000s, when macroeconomic conditions improved, that STP began growing at a steady pace. Macroeconomic conditions continued to strengthen in recent years—GDP growth has been steady around 4 percent, inflation declined to about 5 percent, anchored by the dobra peg to the euro since 2010, and the domestic primary deficit has been brought close to 2 percent of GDP. However, macroeconomic stability remains vulnerable to fiscal slippages at the central government, particularly in the runup to elections, and large contingent liabilities from SOEs. The risk is accentuated by weak public financial management, large cross-arrears in the economy (at 60 percent of GDP in unconsolidated terms), and high public debt (at 70 percent of GDP).

Text Figure 2.
Text Figure 2.

STP: Domestic Primary Balance, 2001-2017

(percent of GDP)

Citation: IMF Staff Country Reports 2018, 322; 10.5089/9781484385005.002.A001

Sources: WEO, IMF; and IMF staff calculations.

17. Past economic developments also show that steady and sufficient revenue is needed to invest in social programs to reduce poverty and build capital. The other three islands have brought tax revenue to over 15 percent of GDP since the early 1990s, enabling them to finance priority social programs and infrastructure, and gain public support for reforms (Figure 1). In contrast, tax revenue in STP remained on average around 13.5 percent of GDP, supported by bouts of high international oil prices. It is currently around 12 percent of GDP, as oil prices are in a down cycle, significantly lower than in the other islands, or the median (15 percent) in Sub-Saharan Africa, and lower than the minimum threshold (close to 13 percent) that recent empirical literature estimated to be necessary to support growth and development (Table 2).22 STP’s weak revenue is most evident in the consumption tax revenue, which falls between 5½ and 9 percent of GDP below the other three islands.23

Table 2.

Small Island States in Africa: Financial Operation of the Government in 2016

(Percentage of GDP)

article image
Sources: IMF calculations and authorities’ data

Refers to fiscal year 2016/17

Includes excise duty

Includes social contributions

For STP, 13.9 percent of GDP in capital expenditure are financed by grants or concessional loans

For STP includes HIPC-related social expenditures equal to 0.24

18. In addition, the private sector, and particularly foreign capital and knowhow, is key to developing the economy. As noted earlier, the small size, remoteness, and limited capacity and capital of the islands hindered their growth at independence. To mitigate these barriers and propel their economies, Cabo Verde and Seychelles promoted their tourism sector by improving infrastructure and logistics and attracting foreign direct investment, while at the same time protecting the still developing local agricultural and fishing sector.24 STP has taken steps along the same path and has made some progress towards developing its tourism sector, starting with foreign investment in the mid-2000s. Tourism receipts rose almost fivefold since 2010 from $11 million to about $66 million in 2017 (or from $60 per capita to slightly over $300). Nevertheless, there is still considerable room to grow (Text Figure 3). In absolute terms, STP tourism receipts remain significantly behind the other islands (Cabo Verde and Seychelles’s close to $400 million in 2017, and Mauritius close to $1 billion), and in per capita terms it pales compared to Seychelles’ almost $4,500.

Text Figure 3.
Text Figure 3.

Small Island States in Africa: Tourism Receipts, 1998-2017

Citation: IMF Staff Country Reports 2018, 322; 10.5089/9781484385005.002.A001

Sources: WEO, IMF; and IMF staff calculations.

Recommendations

19. Consolidate macroeconomic stability by strengthening fiscal discipline at the central government and containing vulnerability from public debt and losses from SOEs. For a small country like STP, where the government plays a central role in the economy, fiscal imbalance has wide-ranging negative spillovers, and credibility of fiscal policy is essential to promote the private sector. Accordingly, it is critical to contain the fiscal deficit at a sustainable level, instill financial discipline and clear arrears, and reduce the public debt. In view of the recurrent fiscal slippages in the past, particularly during election periods, STP could anchor fiscal policy around a medium- to long-term fiscal deficit target, to restrain political interference.

20. Strengthen revenue through implementing the planned transition to a VAT regime in 2019 and improving tax compliance. The introduction of the VAT will be an important accomplishment. Nonetheless, the expected gain from the VAT of about 2 percent of GDP in additional revenue over the medium term will not be enough to bridge the revenue gap, particularly in the short run. More efforts are needed to improve tax administration, broaden the tax base and improve tax collection.25 The strategy to clear the pervasive cross-arrears in the economy, which in 2017 amounted to about 60 percent of GDP (in unconsolidated terms), including tax arrears amounting to 3.5 percent of GDP, also needs to be accelerated to enhance the credibility of the tax system and discourage tax evasion. Relatedly, government services should be improved to encourage tax compliance and reduce the informal economy.

21. Continue efforts to expand STP’s market and attract private investment, and implement a holistic strategy to develop the tourism sector. The authorities’ plans to improve infrastructure, including the airport and seaport, will help alleviate logistical barriers and reduce costs of trade, although financial sustainability should be a prerequisite for undertaking such projects given the potentially large fiscal liabilities.26 The recently-elaborated tourism strategy also provides good foundations to market tourism in STP.27 But more efforts are needed to better integrate the private sector and foreign capital and knowhow in the strategy, which will be critical to tap the potential in the tourism sector.

F. Conclusion

22. Country-specific characteristics as well as weak institutions contributed to STP’s relative underperformance since independence. Initial conditions, particularly regarding human capital and natural resources, contributed to STP’s relative underperformance, especially in the first decade after independence. However, political instability and weak institutions contributed to inefficient use of resources, delaying reforms, and causing large macroeconomic imbalances, which hindered growth and wasted opportunities in the 90s and in the 2000s.

23. Nonetheless, the times could be propitious for a turning point. Macroeconomic conditions have improved, while institutions have been strengthened and human capital has been rising, as evidenced by various governance and development indicators.28 Furthermore, a number of important infrastructure projects are ongoing or close to being launched,29 while STP has experienced more continuity in policy in recent years. The rise in popularity of eco-tourism globally also provides STP with an opportunity to expand the tourism sector.

24. Past experience in the four island-states suggests that fiscal discipline, revenue mobilization, and a more active private sector, particularly in the tourism sector, may be key to tap STP’s growth potential. Fiscal discipline is needed to contain the fiscal deficit and bring the debt to a sustainable level. Continuing to strengthen public financial management, including implementing multi-annual fiscal framework as recommended by the IMF technical assistance, would help.30 In particular, maintaining a medium- to long-term fiscal deficit target as under the program with the IMF would help to anchor fiscal policy and restrain political interference. Improved tax administration and tax compliance are needed in addition to the VAT introduction to mobilize revenue and finance priority social programs and infrastructure. At the same time, a holistic tourism strategy that attracts private investment in this sector would be critical to unlock growth potential.

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1

Prepared by Gabriel Srour.

2

The “small” island-states are those with a population of less than 1.5 million, and they consist of Cabo Verde, Comoros, Mauritius, São Tomé and Príncipe, and Seychelles. However, Comoros is excluded from this study because its economic development was largely dictated by political conflicts.

3

Other indicators, such as GDP per capita in PPP terms, GNI per capita, etc. show similar results.

4

For Seychelles, this followed a bloodless coup in 1977.

5

For example, by Nobel Prize recipient James Meade regarding Mauritius in 1961.

6

For Cabo Verde, services accounted for the larger part of GDP, but most of the population was employed in agriculture.

8

See Seibert (2006) for a comprehensive account of the socio-political conditions in STP before and after independence.

11

In 1980, the airport served about 50 flights a week including jumbo jets.

12

See for instance Seibert (2006).

13

This section focuses on developments in STP.

14

Difficulties at the utility SOE, EMAE, and cross-subsidies between EMAE, treasury, and the oil importer ENCO, can be traced back to this period.

15

See São Tomé and Príncipe IMF staff reports, 1978-1991.

16

Based on changes in prime ministers in Cabo Verde, Mauritius and STP, and changes in presidents in Seychelles.

17

See for instance World Bank “World Governance Indicators” and the Index of African Governance on ‘rule of law, transparency, and corruption’.

18

See São Tomé and Príncipe IMF staff reports, 1992-2001. The prospect of finding oil began in the mid-1990s, raising expectations of large receipts by 2005-6.

19

See São Tomé and Príncipe IMF staff reports, 2002-2017.

20

See for instance IMF Article IV Consultation staff reports (1999, 2001) and Seibert (2006).

21

For instance, a new anti-corruption law was not approved until 2012

23

Some consumption taxes in STP are collected by customs, and recorded as import taxes. However, the size of the latter is comparable to the other islands.

24

Mauritius was able to diversify into textiles and other small manufacturing, but this benefited from circumstances, including highly preferential trade agreements, very special to Mauritius.

26

See STP National Development Plan 2017-21.

27

See “Plano Estratégico e de Marketing para o Turismo de São Tomé e Príncipe” (2018), Ministério das Finanças, Comércio e da Economia Azul / Direção Geral do Turismo e da Hotelaria.

28

See for instance Worldwide Governance Indicators and World Development Indicators.

29

This includes the rehabilitation of roads and energy sector with World Bank support and expansion of the airport with China’s support.

Democratic Republic of São Tomé and Príncipe: Selected Issues
Author: International Monetary Fund. African Dept.