Public Information Notice No. 02/17

Public Information Notice: IMF Concludes 2001 Article IV Consultation with São Tomé and Príncipe

February 28, 2002

On January 30, 2002, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with São Tomé and Príncipe.¹

Background

During the fourth quarter of 2000 and the first three quarters of 2001, fiscal slippages, delays in structural reforms, and governance problems took São Tomé and Príncipe's PRGF-supported program off track. Key quantitative performance criteria and benchmarks on government financial operations were not observed at end-December 2000 or end-December 2001. Despite strong revenue mobilization, spending overruns, partly financed out of an unprogrammed signing bonus related to an oil exploration option contract, resulted in a primary budget deficit of 3 percent of GDP in 2001, compared with a targeted surplus of
2.7 percent of GDP under the program. Although monetary policy remained tight in 2000-01, the budget deficit caused net bank credit to the government to exceed its quantitative performance criteria in December 2000 and June 2001. Also, none of the structural performance criteria and benchmarks were observed, with the exception of the benchmarks on retail prices of petroleum products and the submission to the Fund of monthly monetary data. In addition, the negotiation of oil sector contracts in 2001 lacked transparency, including a contract with the Environmental Remediation Holding Company (ERHC) in May 2001 that awarded a substantial share of potential oil revenue to the private company.

The authorities have requested the staff to monitor an economic program covering the six months ending on June 30, 2002. The staff-monitored program (SMP) is intended to correct the slippages incurred in 2001 and reestablish a good track record of policy implementation. To make up for the delays in the implementation of structural measures, the authorities have implemented three prior actions for the SMP: (1) the adoption of a rate adjustment mechanism for water and electricity; (2) the implementation of the civil service reform and downsizing program; and (3) the adoption of terms of reference for an audit of three large government contracts and bids. In addition, the authorities requested assistance from the World Bank in the area of oil sector policy, including a cost-benefit analysis of their settlement with the ERHC and a study on the negotiation procedures for government contracts signed in 2001 in the oil sector.

Under the SMP, the authorities' macroeconomic objectives are to reduce end-of-year inflation to 7 percent in 2002, and to narrow the external current account deficit (including official transfers) to less than 1 percent of GDP in 2002. Real GDP growth is projected to reach 5 percent in 2002. In the fiscal area, the program aims at turning around the primary budget balance (excluding HIPC Initiative-financed social spending) from a deficit in 2001 to a small surplus in 2002, while safeguarding spending on health and education. Monetary policy will remain tight, with broad money projected to increase by 12 percent in 2002, consistent with projected nominal GDP growth. Net bank credit to the government is targeted for a substantial reduction.

Key structural reforms proposed under the SMP include (1) the submission to the National Assembly of a draft government budget for 2002; (2) the publication of an audit report on three large government contracts and bids; and (3) the application of mechanisms by which retail prices of petroleum products and water and electricity rates are adjusted to reflect changes in costs.

Executive Board Assessment

Executive Directors regretted that during 2001, the PRGF-supported program went off track, with large government spending overruns, the emergence of governance issues related to oil-sector contracts, and delays in the implementation of several structural measures. Nevertheless, economic activity continued to recover thanks to a strong pickup in food crop production, construction, trade, and tourism; inflation stabilized; and improvements in tax collection and customs reform led to a large increase in government revenue.

Directors welcomed the authorities' commitment to implementing strong corrective measures during a six-month staff-monitored program, and urged them to implement the program vigorously, in order to correct the slippages which occurred in 2001, and reestablish a track record of good policy implementation. More generally, it will be crucial to work with renewed commitment toward the sustained implementation of the economic reforms laid out in their interim PRSP, to achieve lasting poverty reduction and reduce the substantial risks that São Tomé and Príncipe faces, in view of its fragile economic and social situation, its heavy reliance on external assistance, and the monoculture of cocoa, and its limited administrative capacity.

Against this background, Directors urged the authorities to maintain their resolve to strengthen fiscal discipline, particularly in view of the possible onset of disbursements of sizable oil-related compensation payments. The commitment to continued strong revenue mobilization efforts and to expenditure restraint, while increasing outlays for education and health, is welcome, but Directors noted that achieving the fiscal targets will require a prudent management of any oil-related revenue, as well as continued wage moderation following the recent civil service reform.

Directors expressed concern about administrative capacity constraints on the efficient use of the interim HIPC Initiative assistance for poverty reduction purposes. They underscored the need to establish control and monitoring mechanisms of public spending, with a view to ensuring an efficient and transparent use of HIPC assistance and other budgetary resources. They also urged the authorities to make good use of the technical assistance they are receiving from the World Bank, the European Union, and France in the area of public resource management.

Directors welcomed the central bank's commitment to maintain a prudent monetary policy and a flexible exchange rate regime and to refrain from interfering in the commercial banks' exchange operations. They urged the central bank to closely monitor bank lending activities and portfolio performance, and to work toward an orderly recapitalization and takeover by a financial institution of good standing of the insolvent Banco Comercial do Equador (BCE). The authorities were also urged to step up legal efforts aimed at combating terrorist financing.

Subject to successful implementation of the staff-monitored program, Directors noted that the authorities' renewed commitment to undertaking vigorous macroeconomic and structural policies is an encouraging basis to start early discussions on a medium-term program that could be supported under the PRGF arrangement, with a view to reaching the HIPC completion point. Directors highlighted, in particular, the importance of ensuring an orderly and transparent use of potential oil revenue, and, in this connection, they urged the authorities to take adequate actions following the results of a critical review of the contract signed with the Environmental Remediation Holdings Company (ERHC) and of the procedures followed in the negotiation of oil-sector contracts in 2001. The authorities should also ensure cost coverage of water and electricity tariffs and of the prices of petroleum products. More broadly, Directors looked forward to a consistent implementation of reforms aimed at economic diversification and at enhancing the role of the private sector in the economic development of São Tomé and Príncipe.

Directors noted that São Tomé and Príncipe now regularly provides the core minimum data to the Fund for the purposes of surveillance and program monitoring. They encouraged the authorities to address remaining weaknesses in the compilation of real sector and balance of payments statistics, with the help of technical assistance.

Directors encouraged the authorities to cooperate closely with Bank and Fund staff in the months ahead in maximizing the prospects for an early resumption of the PRGF-supported program and for access to interim assistance under the enhanced HIPC Initiative. In view of the country's limited administrative capacity, this collaborative effort should aim, in particular, at minimizing the risks of slippages in policy implementation by taking timely and proactive measures if needed.