Statement by Mr. Raghani, Executive Director and Mr. Carvalho da Silveira, Advisor to the Executive Director on Democratic Republic of São Tomé and Príncipe October 2, 2019

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

1. Our Sao Tomean authorities would like to express their appreciation to staff and Management for the constructive policy discussions held in March and July 2019 in the context of negotiations for a new arrangement under the Extended Credit Facility (ECF).

2. Upon taking office in December 2018, the new Government faced immediate economic and fiscal challenges, including significant financing pressures. Sao Tome and Principe’s distinctive features, as a fragile small island-state, make development particularly challenging, given the limited capacity and high vulnerability to climate change. Therefore, addressing these challenges calls for a comprehensive approach to development, with a particular focus on growth, as stressed in the Staff Guidance Note on Fund’s engagement with Small Developing States.

3. Given the country’s high fragility, successfully implementing an ambitious reform program requires building capacity and maintaining close engagement with technical partners. In this regard, the Government would like to express its strong interest in the reopening of the resident representative office in Sao Tome. They believe the country would benefit immensely from such engagement.

4. Our authorities are strongly committed to pursue their policy and reform agenda aimed at reinstating macroeconomic stability, addressing structural bottlenecks to boost inclusive growth while bringing down the high debt level. To ensure that their efforts are sustained, they seek Fund assistance over the medium term. As such, they request a new 40- month arrangement under the Extended Credit Facility (ECF). They would also appreciate a one-year extension of the temporary approval for the retention of measures resulting in exchange restrictions and a multiple currency practice subject to IMF jurisdiction under Article VIII, Sections 2(a) and 3.

Recent Developments and Outlook

5. The Sao Tomean economy has continued to grow amid difficult circumstances. In 2018, real GDP moderated to 2.7 percent, compared to 3.9 percent in 2017, mostly influenced by the impact of power outages on business and services, and lower foreign inflows. Inflation, on the other hand, increased to 9.0 percent at year-end, but began slowly falling in the first half of 2019. Although the current account deficit decreased in 2018 to 10.9 percent of GDP, high dependence on imports for private consumption continues to create imbalances and, as a result, international reserves fell to 3.3 months of imports from 4.6 months in 2017. The domestic primary fiscal deficit (DPD) stood at 4.1 percent of GDP in 2018.

6. Regarding debt, the 2019 debt sustainability analysis (DSA) continues to classify the country as being in debt distress due to outstanding external arrears. Nevertheless, Sao Tome and Principle’s debt remains sustainable over the medium-term and the country has the capacity to repay its external arrears over time, as external debt ratios under the baseline scenario remain continuously below the high-risk thresholds. The new Government have re-initiated negotiations with external creditors recently with a view to find an agreement on clearing the arrears, which would improve the country’s debt distress risk.

7. Looking forward, the economic outlook of Sao Tome and Principe is positive. Real GDP is projected to continue growing in 2019 and top 4 percent over the medium-term, driven by the implementation of infrastructure projects as well as lower energy prices. Inflation is expected to decline to 7.8 percent in 2019 and fall further to about 3 percent over the medium-term. Risks to the outlook could stem from domestic and external factors, including limited institutional capacity and high dependency on timely disbursement from development partners. The Sao Tomean authorities are of the view that the start of key infrastructure projects, together with the promotion of small-scale entrepreneurs, women and youth economic empowerment would unleash the country’s potential growth.

Policy Priorities for 2019 and the Medium-Term

Restoring Fiscal Sustainability

8. The new Government aims to ensure a more rigorous budget execution, with a view to achieving the domestic primary deficit target under the program and keeping public debt on a downward path. In this regard, a Council of Ministers’ Resolution Decree Law was adopted in June 2019 to align the budget with program objectives, including the adoption of a monthly expenditure plan for the remainder of the year.

9. In order to meet the 2019 DPD target of 2.1 percent of GDP, the authorities’ fiscal consolidation efforts will focus on both revenue-enhancing and expenditures-controlling measures. On the revenue front, (i) an oil surcharge was adopted, (ii) an agreement was reached with ENCO to transfer the positive fuel price differential, (iii) tax allowances for households have been reduced; and (iv) a new sales tax on telecom has been introduced. In addition, the newly-signed fishing agreement with the European Union and the efforts underway to collect tax arrears as well as income tax, will increase revenue in the near-term. On the expenditure side, wage growth freeze will be preserved, and stricter control will be exercised over spending on goods and services as well as on treasury-financed capital spending.

10. The authorities will pursue structural fiscal reforms over the medium-term to sustain the fiscal consolidation. Prompt steps are being taken for the Parliament to approve the value-added tax (VAT) Law by October 2019, with a view to implementing it in early 2020. In the meantime, the preparative work for the implementation of the VAT is proceeding. As part of the preparation, the authorities will implement an electronic invoicing system in January 2020. They are currently running a pilot exercise with 10 largest corporate tax payers. The e-invoicing will also play a major role in combating informality and tax evasion. The authorities recognize the benefits inherent to the VAT while remaining concerned about the adverse impact of the high rate of 15% on the economy and the most vulnerable. The World Bank recently approved a five-year program aimed at enhancing the social safety net.

11. Emphasis will be also placed on strengthening tax administration and public financial management (PFM). The IMF recommendations to increase tax compliance, promote risk management practices and establish a monitoring framework will be implemented. To prevent the accumulation of arrears and improve the arrears clearance plan, the authorities will use available funds from an overperformance of end-2019 DPD to paydown arrears. Arrears payment plans for SOEs are also being developed and the Treasury is officially the only entity authorized to contract loans. Greater attention will be paid to updating and more stringently enforcing public procurement laws to curb corruption and the misuse of public funds.

12. Addressing Sao Tome’s debt vulnerabilities ranks high in the Government’s policy priorities. The government, in its efforts to bring down the debt level, reiterates its commitment to limit concessional borrowing to 3 percent of GDP and avoid non-concessional loans. Given the large arrears of the public utility company EMAE and its fiscal risks, the authorities have secured a formal agreement between EMAE and its creditor ENCO (national oil company) for a longer repayment plan, which help reduce the present value of total public debt. Appropriate steps have also been taken to implement the recommendations of the Debt Management Performance Assessment (DeMPA).

Supporting the Peg through Tight Monetary Policy and Improved Central Bank Management

13. The authorities are cognizant of the importance of continued fiscal consolidation to control inflation and that of promoting exports to build reserve buffers indispensable to protect the peg. Nonetheless, they share the view that tightening monetary policy could also be useful to achieve these objectives. In this vein, efforts are being made to carry out open market operations and issue central bank certificates of deposits with the support of Fund technical assistance. To preserve foreign exchange, the authorities will limit public spending that requires foreign exchange and elaborate an adequate strategy to further attract remittances and investments from the diaspora. In line with the new Government’s program, the independence and transparency of the Central Bank of Sao Tome and Principe will be strengthened. In this regard, the recommendations of the recent Safeguard Assessment will be effectively implemented, apart from the one related to the creation of a non-Executive Board for the Central Bank given the distortions it may create to the functioning of the institution.

Preserving Financial Stability

14. The authorities will continue their efforts towards safeguarding financial stability. The asset quality review (AQR) of the banking system was finally concluded and the findings and recommendations will be used by the central bank to update its loan classification system as well as strengthen prudential regulations. Consideration will be given to regular stress tests and on-site inspections. Moreover, steps will be taken to introduce a bank rating model and upgrade banking resolution in line with IMF technical assistance’s recommendations.

15. Progress was made on the resolution of non-performing loans (NPLs) while the default rate on newly-issued bank loans is on the decline. To speed up the reduction of the stock of NPLs, the Central Bank is preparing a guidance for rapid write-offs, the loan enforcement process will be strengthened and an arbitration tribunal for out-of-court settlements will be established. Regarding the two failed banks, Banco Equador and Banco Privado, the authorities expect to conclude their liquidation in 2019.

16. Sao Tome and Principe is making strides on financial inclusion. In September 2018, the microfinance law was adopted, and all relevant regulations are expected to be approved this year. A survey on financial inclusion issues was also conducted and, as a result, a national financial inclusion strategy will be formulated and published by end-2019. Under the promotion of small and medium-sized enterprises (SMEs), a legal framework for a collateral registry is being developed with the support of the World Bank and is expected to be operational in 2020. The registry will be instrumental in helping SMEs access to financing.

Promoting Sustainable and Inclusive Growth

17. The authorities will pursue structural reforms to reduce the cost of doing business, improve the investment climate and boost sustainable and inclusive growth. They are restructuring the energy sector to enhance energy provision, contain EMAE’s losses, ensure a more transparent and efficient pricing of electricity to allow cost recovery over the medium- term. They have approved and are now implementing the Least Cost Productions Plans and the Management Improvement Plan. The Government is also committed to adopt the recommendations of the Tourism Development Strategy. Work is ongoing for expediting the upgrade of the payment system for international credit cards, with the assistance of the African Development Bank.

18. Sao Tome and Principe is making good progress towards the Sustainable Development Goals (SDGs). The 2018 Africa SDGs Index Report ranks Sao Tome and Principe tenth out of 51 African countries on overall performance on the SDGs targets. With the support of development partners, the authorities continue to explore ways to close the identified gaps. In this connection, the country hosted a High-level International Conference on “Women’s Economic Empowerment and Financial Inclusion” in July 2019. The resulting action plan will be finalized by December 2019. Moreover, a tourism school will be created, and a youth employment project will be launched with the support of the International Labor Organization (ILO) to address the skill mismatch and promote entrepreneurship.

Conclusion

19. The new Government recognizes the daunting economic challenges the country faces and are cognizant of the need to restore macroeconomic stability and unleash growth potential. They reiterate their strong commitment to their reform agenda which should be supported by the ECF given the balance-of-payment needs. To improve the chances of the program success, the authorities look forward to Fund’s consideration for reopening the resident representative office as well as the timely delivery of hands-on technical assistance from development partners. On behalf of our Sao Tomean authorities, we would appreciate Executive Directors’ support for a new 40-month arrangement under the ECF and a one-year extension of the temporary approval for the retention of measures resulting in exchange restrictions and a multiple currency practice.

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
Author: International Monetary Fund. African Dept.