Democratic Republic of São Tomé And Príncipe: Request for a 40-month Arrangement Under the Extended Credit Facility—Press Release; Staff Report; and Statement by the Executive Director for Democratic Republic of São Tomé and Príncipe
Author: International Monetary Fund. African Dept.
Publication Date:
29 Oct 2019
eISBN:
9781513517407
Language:
English
Keywords:
ISCR; CR; ECF arrangement; debt; Extended Credit Facility arrangement; GDP; central bank; IMF staff estimate; financing gap; debt service; HIPC Initiative; Imports
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Democratic Republic of Sao Tome and Principe: Request for a 40-month Arrangement Under the Extended Credit Facility-Press Release; Staff Report; and Statement by the Executive Director for Democratic Republic of Sao Tome and Principe

Abstract

Democratic Republic of Sao Tome and Principe: Request for a 40-month Arrangement Under the Extended Credit Facility-Press Release; Staff Report; and Statement by the Executive Director for Democratic Republic of Sao Tome and Principe

Context

1. São Tomé and Príncipe is a fragile, small island-state with limited resources and capacity. The economy has a very narrow production base and depends heavily on imports and foreign aid. Exports of goods amount to only four percent of GDP. While offshore oil exploration continues, no commercial production is expected in the near term. Tourism, agriculture, and fisheries have potential for growth but require better infrastructure and private-led investment. While tourism grew significantly in recent years, local value-added of the sector is very low due to high import content.

2. The latest Ex-Post Peer Reviewed Assessment found that progress under the 2012–15 and 2015–18 ECF arrangements was limited due to low capacity and policy slippages (Annex I). Overspending, particularly during election years, and large losses by the state-owned utility company EMAE kept public debt high, while a narrow tax base and poor tax administration kept revenue low. The Quantitative Performance Criteria (QPC) on the domestic primary balance (DPD) was missed in six out of seven completed reviews. Growth, averaging four percent during 2012–18, was insufficient to significantly reduce poverty and unemployment, which is disproportionately high for the country’s large youth population. Some progress was made on structural reforms; notably, an automatic fuel pricing mechanism, EMAE reform plans, and a tourism strategy were adopted, albeit with delays. A number of other structural reforms however, including the VAT, are pending. Because of low capacity and fragility, some reforms required more than one program cycle to complete. The eventual implementation of some benchmarks of the 2012–15 program during 2015–18 are cases in point. The fragility also requires prioritization and limiting conditionality.

3. A new coalition government took office in December 2018 following parliamentary elections. As was often the case in the past, the new government replaced most senior civil servants across public institutions. During 2001–2014, the country saw ten different coalition governments, and a majority government completed its term for the first time in 2014–2018. Frequent government turnovers hindered reforms and growth and contributed to the fragility.

4. The authorities’ reform program seeks to restore macroeconomic stability and unlock growth potential. An immediate challenge will be to arrest losses at EMAE and bring debt under control, tighten fiscal and monetary policy to address the external and internal imbalances, and mobilize revenue. The impact of these contractionary policies will be mitigated by the launch of foreign-supported projects, structural reforms to promote inclusive growth, a floor on social spending, and a World Bank supported program to protect the most vulnerable.

Recent Economic Developments

5. Economic growth slowed and inflation accelerated in 2018 and the first half of 2019. Real growth in 2018 fell by more than one percentage point to 2.7 percent, reflecting lower external inflows, election-related disruptions, and severe power outages in the last quarter due to breakdowns of aging generators. Inflation rose to 9.0 percent at end-2018, up from 7.7 percent at end-2017, driven by higher international oil prices and shortages of local produce affected by changing weather patterns. Preliminary data suggest economic activity remained sluggish in the first half of 2019, although the small export sector showed strong growth—non-cocoa exports grew by 27 percent and tourist and business arrivals by 14 percent, both from a low base. Inflation slightly decreased to 8.6 percent at end-June. Fuel and power shortages during May-June 2019 also weighed on the economy.

6. The fiscal position deteriorated significantly in 2018 (Text Table 1). Domestic revenue was about ½ percent of GDP higher than projected, as tax arrears collection and higher import tax revenue from rising international oil prices more than offset a shortfall in direct tax revenue due to the economic slowdown. However, overspending amounted to almost 3.5 percent of GDP, due to unbudgeted increases in personnel and capital spending and failure to cut utility consumption as planned. As a result, the DPD reached 4.1 percent of GDP, 2.8 percent of GDP above the target. Furthermore, some public entities outside the central government were allowed to spend off-budget, effectively loosening the fiscal stance further and raising the public debt by an additional ¾ percent of GDP. Domestic financing and arrears increased accordingly to finance the overspending and to replace €3 million in undisbursed EU budget support because of delays in reform.

Text Table 1.

Fiscal Performance 2018

(Percent of GDP)

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

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

Includes carve out from EU budget support financed investment in 2017 and unidentified spending as measured from financing in 2018.

7. The 2019 DPD through end-June was significantly higher than expected, partly due to policy slippages. Consumption and import tax revenue fell short, mainly reflecting substantial cuts in tariffs on alcoholic beverages, delayed implementation of tax-enhancing revenue measures, and administered fuel prices that were left unchanged despite higher shipping costs. Furthermore, taxes owed by the oil importer ENCO, amounting to almost ½ percent of GDP, were not paid until July. Personnel costs were also significantly higher, due to an increase in wages for military personnel. Thus, the end-June DPD reached 1.8 percent of GDP, 1 percent of GDP higher than projected.

8. Gross international reserves (GIR) fell sharply in 2018 but recovered partially in early 2019. The current account deficit narrowed by more than two percentage points to 10.9 percent in 2018, reflecting lower imports due to lower FDI and project loans. Nonetheless, foreign outflows outpaced inflows because of the fiscal expansion, large public outlays, notably for the new central bank building, and the issuance of redenominated bills.1 This brought GIR (excluding the oil fund) down by $16.3 million (1.5 months of prospective imports) to 3.3 months of imports at end-2018, below the IMF LIC reserve adequacy metric of 3.8 months of imports.2 As of end-June 2019, disbursements of external grants raised GIR to $45 million (4.1 months of imports), although this level is bound to fall as projects are implemented.

9. Credit to the economy contracted. Lending fell by 1.6 percent in 2018 and continued to be anemic during the first semester of 2019, as banks were hesitant to lend while the economy was slowing. Non-performing loans (NPLs) remained high at about 25 percent at end-June 2019. A weak judiciary system impedes collection on defaulted loans, and government-payment delays further impaired suppliers’ loan servicing. Banks’ balance sheets are also constrained by loan exposures to state-owned enterprises (SOEs), particularly to loss-making EMAE. The recently-concluded asset quality review (AQR) found widespread loan misclassification, requiring additional provisioning and re-capitalization by some banks. As a result, the banking system is barely breaking even, and the market dominance of a large partially state-owned bank could contribute to losses at smaller banks. Meanwhile, banks’ excess liquidity declined, driven by higher government borrowing, but is still elevated (Text Figures 1 and 2).

Text Figure 1.
Text Figure 1.

Credit Growth and Excess Liquidity

(Percent)

Citation: IMF Staff Country Reports 2019, 315; 10.5089/9781513517407.002.A001

Sources: São Tomé and Principe authorities’ data and IMF staff estimates.
Text Figure 2.
Text Figure 2.

Non-Performing Loan Ratios by Bank

(Percent)

Citation: IMF Staff Country Reports 2019, 315; 10.5089/9781513517407.002.A001

Program Performance in 2018

10. Performance under the program of 2015–18 unraveled in the fall of 2018, and the last review was not completed. While all end-June performance criteria (PC) and indicative targets were met, except the net international reserves (NIR) PC target (MEFP Table 1), performance deteriorated subsequently. The end-2018 indicative targets for the DPD, net bank financing of the central government, and NIR were missed by large margins due to public overspending.

11. Structural reforms were delayed (MEFP Table 2). A VAT law was submitted to parliament in May 2018 but not approved. It was resubmitted by the new government and passed a general (first) reading in parliament in August 2019. The submission of a monthly monitoring table of tax payments was uneven. EMAE’s least cost energy-production plan and the Management Improvement Plan (MIP) were not adopted until July 2019. The re-formulated benchmark on the completion of the inception report on the asset quality review (AQR) report was met, and the final report was competed in April 2019 instead of the initial target of end-2017. Meanwhile, the tourism development strategy was launched. The authorities pointed out that the delays in implementing reforms partly reflected their development partners’ lengthy procedures.

Economic Outlook and Risks

12. The economy is projected to recover gradually from last year’s slowdown. GDP growth is projected to remain unchanged at 2.7 percent in 2019 and reach 4.5 percent over the medium term, as externally-financed projects are launched and reforms at EMAE enable more reliable and cheaper power supply. With feasibility studies now completed, externally-supported road construction and a Chinese grant-financed airport expansion will start early next year.3 Inflation is projected to decline to 7.8 percent by end-2019. However, with the introduction of the VAT in 2020, it is expected to increase to 10 percent before easing to 3 percent in the medium term, reflecting the recovery of local food production from weather shocks, expected lower oil prices and energy costs, and fiscal and monetary tightening.

13. São Tomé and Príncipe remains in debt distress due to long-standing external arrears, but public debt is deemed sustainable. The authorities have been in discussions with Angola, Brazil, and Equatorial Guinea to regularize the outstanding external arrears (2.6 percent of GDP), and with Nigeria over a disputed loan. The large arrears of EMAE to its fuel supplier ENCO also reflect the severe liquidity constraints of the public sector. Nonetheless, debt sustainability analysis (DSA) shows that the external public and publicly guaranteed (PPG) debt is sustainable in the medium term under the program—all external PPG debt ratios remain well below the high-risk thresholds throughout the baseline scenario. The recent formalization of EMAE’s arrears to ENCO also achieved a significant discount in present value terms with this repayment schedule to be applied also to any new arrears that may arise until EMAE returns to an operating surplus. As a result, total PPG debt (which includes EMAE’s arrears to ENCO and the government’s arrears to suppliers) is deemed sustainable provided the country continues to borrow externally only at concessional terms at a measured pace, and EMAE’s planned reforms are implemented (see DSA ¶8, and MEFP ¶9). Regarding the external arrears owed by São Tomé and Príncipe to private creditors, the authorities continue to make good faith efforts to reach a collaborative agreement. Regarding non-sovereign external arrears owed to the private creditor and resulting from exchange controls (ENCO’s arrears to its Angolan parent company Sonangol), the authorities continue to make good faith efforts to facilitate a collaborative agreement between the private debtor and its creditor.

14. The outlook is subject to important risks. Limited tax administration capacity could hinder revenue collection and reduce gains from planned revenue-enhancing measures. Policy slippages and additional public outlays due to poor public financial management could put further pressure on already-elevated public debt and international reserves. Delayed EMAE reforms could prolong power shortages, raise arrears accumulation, and elevate risks from ENCO’s associated arrears to its parent company Sonangol. Political instability and low capacity could delay reforms and project implementation as well as the associated external official inflows. In addition, the implementation of the VAT could hinder the decline of inflation, which will be reassessed once the VAT introduction plan is firmed up. On the upside, implementing externally-financed projects such as the airport expansion and road rehabilitation on schedule could spur higher growth than expected (Annex II). Maintaining strong policies can help mitigate the risks.

Program Objectives and Policies

The 40-month program seeks to restore macroeconomic stability, bring the debt down to a sustainable path, and unlock growth potential. Fiscal consolidation supported by debt restructuring and monetary tightening will address pressure on foreign reserves and restore fiscal and external sustainability over the medium term. Structural reforms aim to mobilize revenue, enhance control over public spending, reduce contingent liabilities from SOEs, improve financial stability, and promote inclusive growth to reduce poverty, including through empowering women economically. A floor on pro-poor spending, along with a World Bank social protection program, will protect the most vulnerable. The Fund-supported program will also play a catalytic role and provide positive signals to stakeholders.

A. Address Balance of Payments Pressures and Restore Fiscal Sustainability

15. Fiscal adjustment is critical to addressing balance of payments pressures and ensuring sustainability (Text Table 2). The programmed adjustment aims to bring the DPD down from 4.1 to 2.1 percent of GDP in 2019. Revenue measures planned for the second semester, including the collection of tax arrears and oil price differential from ENCO (1 percent of GDP), an oil tax surcharge (¼ percent of GDP), a reduction in tax allowances and an increase in sales tax on telecommunication in anticipation of the VAT introduction, would raise around 2 percent of GDP and offset the shortfall in import and direct tax revenue in the first half of the year, while non-tax revenue, including from new fishing license agreements, would add around 0.6 percent of GDP (MEFP ¶16). Expenditure savings are achieved from restraining personnel costs, maintaining rationalization of utility consumption, and cutting non-priority capital expenditure, which accounted for over one percent of GDP in 2018 (MEFP ¶17). To avoid a reemergence of demand pressures on foreign reserves and to ensure the DPD target is met, discretionary spending will be held back until expected resources become available, while off-budget expenditures, which amounted to ¾ percent of GDP last year, will be prevented through strengthened public financial management. The DPD target will be tightened if budget support is not disbursed to limit domestic borrowing.

Text Table 2.

Financial Operations of the Central Government, 2018–20

(Percent of GDP)

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

Exclude oil related revenues and a fraction of the oil surcharge for ENCO debt repayment, grants, interest earned, scheduled interest payments, capitalization of BIRD, and foreign-financed capital outlays.

16. Revenue mobilization and fiscal consolidation will continue over the medium term to entrench fiscal and external sustainability and help raise social spending and investment (Table 2). The DPD gradually falls and turns into a slight surplus by the end of the program through a combination of revenue mobilization and expenditure restraint. A floor on social spending and a five-year $10 million social protection program supported by the World Bank will further help mitigate the impact of consolidation on the poor (Annex III). New external borrowing will be limited to concessional loans capped at three percent of GDP annually to allow a steady decline in public debt, as shown in the DSA.

Table 1.

Democratic Republic of São Tomé and Príncipe: Selected Economic Indicators, 2015–22

(Annual change in percent, unless otherwise indicated)

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Sources: São 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.

Total public and publicly guaranteed debt as defined in DSA, which includes EMAE’s arrears to ENCO (and excludes the government’s arrears to EMAE due to consolidation). The 5th review had “...” because this concept was not used then.

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.

Democratic Republic of São Tomé and Príncipe: Financial Operations of the Central Government, 2015–22

(Millions of new dobra)

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

Revenue is measured on a cash basis.

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.

Excludes oil related revenues and a fraction of the oil surcharge for ENCO debt repayment, grants, interest earned, scheduled interest payments, foreign-financed capital outlays, and capitalization of regional organizations per definition in TMU.

Includes loan from Angola in 2016 and 2017.

Includes use of IMF program support.

Table 2b.

Democratic Republic of São Tomé and Príncipe: Financial Operations of the Central Government, 2015–22

(In percent of GDP)

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

Revenue is measured on a cash basis.

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.

Excludes oil related revenues and a fraction of the oil surcharge for ENCO debt repayment, grants, interest earned, scheduled interest payments, foreign-financed capital outlays, and capitalization of regional organizations per definition in TMU.

Includes loan from Angola in 2016 and 2017.

Includes use of IMF program support.

Table 3.

Democratic Republic of 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.

Democratic Republic of São Tomé and Príncipe: Monetary Survey, 2015–20

(Millions of new dobra)

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