Abstract
First Review Under the Extended Credit Facility and Request for Augmentation of Access, Rephasing of Access, and Financing Assurances Review-Press Release; Staff Report; and Statement by the Executive Director for the Democratic Republic of S�o Tom� and Pr�ncipe
Introduction
1. The authorities of São Tomé and Príncipe (STP) would like to express their appreciation to the Fund for the relentless support received in implementing the ECF supported program during these unprecedented times. In this vein, the recent disbursement under the Rapid Credit Facility approved in April 2020 was not only critical in helping withstand the health, social and economic fallout of the COVID-19 pandemic but also in catalyzing assistance from other development partners.
2. The authorities remain fully committed to pursuing their reform agenda and addressing structural bottlenecks in line with the Extended Credit Facility (ECF) supported program. They, however, request an augmentation of access in the amount of SDR 1.48 million (10 percent of quota) to help them cover the immediate balance of payment needs, sustain efforts in addressing the adverse effects of the crisis and pave the way for a quick economic recovery in key sectors when the pandemic fades out.
Recent Developments
3. Following 90 days of the state of emergency, the government decided to develop a strategy to phase-out confinement to reach a balance between preventive measures of sanitary nature and the gradual return of economic activity in the country. With this view, a state of public calamity was declared from June 16 to July 31, 2020, along with a 3-stage de- confinement plan. Considering the limitations of the health system and testing capacity, many of the measures will remain in place, including the curfew, social distancing, public gathering, and the mandatory use of masks. Although STP recorded a total of 746 cases, of which 588 recovered and 14 died as of July 21, 2020, the government considers that the outbreak is broadly under control as the number of average daily new cases declined drastically.
4. An early implementation of containment measures has helped the authorities halt the spread of COVID-19 and limit the number of fatalities. However, the situation continues to take a heavy toll on economic activity and put a fragile island state like STP in dire straits while also exacerbating the country’s vulnerability to economic and climate shocks. Real GDP is anticipated to drop to -6.5 percent in 2020 from 1.3 percent in 2019, as a result of disruptions in the tourism and service industries, global supply chains as well as delays in externally financed projects. This will be the deepest contraction in decades. The slowdown in economic activity is hampering fiscal revenues, which together with COVID-19 related expenditures, are putting considerable pressure on public finances. Therefore, the fiscal deficit is expected to increase from 1.8 percent of GDP in 2019 to 6.3 percent at year-end 2020. Inflation lowered to 7.7 percent in 2019 and should rise slightly in 2020. In addition, while palm oil export is projected to continue to grow, the current account deficit is anticipated to expand further in 2020 notably on the back of lower external demand.
Outlook
5. While cognizant of the high uncertainty surrounding the macroeconomic projections given the nature of the pandemic, the authorities remain cautiously optimistic about the outlook. They foresee real GDP growth to resume partially at 3 percent in 2021 and firm up at around 4.5 percent over the medium-term as tourism activities resume and key infrastructure projects start to bear fruit. Nonetheless, they stand ready to take additional measures and seek more external support should downside risks materialize.
Performance under the ECF
6. During the period under review, program performance has been solid, with all end-December 2019 performance criteria (PCs) met and most structural benchmarks (SBs) implemented, albeit with some delays. These include significant achievements in fiscal consolidation, gender equality and completion of some structural reforms such as the adoption of the VAT Law. Given the disruptions caused by the pandemic, most end-March and end-June 2020 benchmarks could not be completed. Regarding the missed end-March indicative target for the Domestic Primary Deficit (DPD), in particular, it can be explained by the increase in personnel costs resulting from the hiring of new staff for the health sector, the promotion for the military approved by the previous government, and the hiring and upgrade in salaries of teachers to meet the required education ratios and fill schools financed by donors. On the latter, the authorities stress that it is often challenging to align competing objectives required by different development partners.
Policy Response for 2020 and Beyond
Fiscal Policy
7. The authorities’ short-term priority remains to mitigate the social and economic impact of the pandemic and set the stage for a quick recovery without losing sight of medium-term macroeconomic stability.
8. Vigorous fiscal consolidation efforts have helped reduce the DPD to 1.8 percent of GDP in 2019, from 4.2 percent of GDP in 2018. In 2020, due to the impact of the pandemic on fiscal performance, the year-end DPD was revised upward to 6.3 percent of GDP. To help meet the target, the authorities are determined to retain the positive fuel price differential, the temporary tax deferrals and solidarity tax surcharge on civil servants; worker retention and recruitment incentives, and other measures introduced late 2019 to support domestic revenue mobilization. These will be complemented by grants from the World Bank (WB) and African Development Bank (AfDB). On the other hand, the authorities will continue to rationalize public expenditure to make room for COVID-19 spending while maintaining fiscal discipline, particularly on the wage bill. In this vein, the government will continue to timely publish information on public procurement contracts and monthly COVID-19 related expenses, including the beneficial ownership information of companies receiving the contracts.
9. Over the medium-term, steps will be undertaken to (i) finalize the remaining work for the implementation of the VAT by mid-2021; (ii) forcefully monitor tax payment by large taxpayers; and (iii) strengthen tax administration and public financial management (PFM) in line with IMF recommendations. The WB is currently supporting the authorities’ efforts to strengthen the management and transparency of the country’s procurement system.
10. The authorities welcome the Debt Sustainability Analysis (DSA) which indicates that the external debt is sustainable, but with high risk of debt distress. They reiterated their commitment to prudent debt management and keep engaging all remaining creditors in an open and transparent manner with a view to regularize arrears and restructure all outstanding debt. They have requested participation in the G20 Debt Service Suspension Initiative and are hopeful that this could free up needed resources to help deal with the pandemic. Looking ahead, the authorities strongly believe that there is a need to put in place a new holistic approach to debt relief for small economies such as STP highly vulnerable to exogenous shocks.
Monetary and Exchange Rate Policy
11. The authorities are cognizant of the importance of coordinating fiscal, monetary, and financial policies to limit the negative impact of the pandemic. The central bank will continue to closely oversee system-wide liquidity to prevent liquidity tension and stand ready to tight monetary policy to safeguard the peg. New steps are being taken to strengthen the monetary policy framework, including the extension of liquidity forecast framework to three months and issuance of central bank certificate of deposits with the IMF’s technicalassistance. The recommendations of the recent Safeguard Assessment will be effectively implemented, except the one related to the creation of a new structure with 2 Deputy Governors and 4 non-Executive Board members for the Central Bank. This structure is not adapted to the country’s circumstances and may distort the functioning of the institution.
Financial Sector
12. The findings and recommendations of the asset quality review (AQR) of the banking system are currently being used to update the loan classification system and strengthen prudential regulations, including for recapitalizations. Prudential standards and reporting requirements will remain unchanged to ensure the financial sector is resilient in the face of vulnerabilities caused by COVID-19. Stress tests will be conducted, and efforts are underway to strengthen off-site and on-site inspections.
13. The central bank agrees that progress on Non-Performing Loans (NPLs) resolution needs to be accelerated. To speed up the reduction of the stock of NPLs, the Central Bank is preparing a regulation to allow banks to more rapidly and efficiently address write-offs. The judicial loan enforcement process will be strengthened and an arbitration tribunal for out-of-court settlement established by December 2020. Concerning the two failed banks, the authorities are developing a concrete action plan, which will be swiftly implemented to speed up the resolution of Banco Equador and attract investors for Banco Privado. They expect to conclude the liquidation of both banks by the end of 2020.
Structural Reforms
14. In line with their National Sustainable Development Plan 2020–2024, the authorities are determined to continue reform efforts to unlock growth potential, improve competitiveness, address impediments to job creation and investments, and strengthen resilience to shocks. An assessment is in progress to understand the extent and nature of the impact of the COVID-19 crisis in the STP and support timely economic recovery planning under the assistance of United Nations Development Programme (UNDP).
15. The authorities concur with staff on the high importance of reforming the public utility company EMAE and the energy sector to ensure public debt sustainability, in line with the adopted Least Cost Productions Plans and the Management Improvement Plan. In this respect, specific time-bound measures are also being taken to enhance energy provision, contain fiscal risks posed by EMAE and ensure a more transparent and efficient pricing of electricity to allow cost recovery over the medium-term. Going forward, a steering committee chaired by the Prime Minister is being put together to monitor progress and ensure effective implementation of reforms.
16. With the support of development partners, several initiatives are underway to enforce legislations and close gender gaps, notably compulsory quota on women in the Parliament, gender budgeting pilots in selected ministries, gender inclusive curriculum in schools,financial literacy programs, amongst others. At the same time, the authorities also envisage some reform measures to improve capacity and resilience to climate change and address inefficiencies in the labor law and judicial system, which should help reduce legal process delays and costs. Work is ongoing for expediting the upgrade of payment system by end 2020 as well as removing the country from the European Union Air Safety blacklist.
Conclusion
17. The São Tomean authorities reiterate their strong commitment to the implementation of the ECF-supported program. Continued engagement and timely delivery of financial support and hands-on technical assistance, from development partners will be essential to sustain efforts aimed at mitigating the impact of the pandemic, safeguarding macroeconomic stability as well as support a quick recovery.
18. In light of the above, the authorities seek the Executive Board’s approval for the completion of the first review under the ECF, the front-loaded augmentation of 10 percent of quota and rephasing of access.