Public Information Notice No. 00/35

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

May 16, 2000

On April 28, the Executive Board concluded the Article IV consultation with São Tomé and Príncipe.¹

Background

Following a decade of very large macroeconomic imbalances and declining real per capita income, São Tomé and Príncipe achieved a good measure of macroeconomic stability and significantly liberalized the economy in 1998-99, under a staff-monitored program. The government's strategy was based on strong fiscal consolidation efforts, a tight monetary policy in the context of a flexible, market-based exchange rate regime, and vigorous structural reforms aimed at liberalizing the economy and streamlining the public sector. As a result, the primary budget balance turned around from deficit to surplus, inflation lowered, the exchange rate stabilized, and real GDP growth picked up. However, São Tomé and Príncipe's economic performance remains fragile, the debt burden is particularly heavy and unsustainable, and poverty is widespread.

In 1999, São Tomé and Príncipe faced a substantial weakening of its external position, reflecting a sizable deterioration in the terms of trade, a decline in cocoa production and exports, and higher investment-related imports. However, progress in economic liberalization began to alleviate structural rigidities, and the impact of the decline in cocoa production on economic activity was more than offset by a rapid expansion in trade, construction, and tourism, following increased foreign direct investment in hotel facilities. As a result, real GDP growth averaged an estimated 2.5 percent in 1998-99, compared with 1.2 percent in 1996-97. The implementation of tight financial policies contributed to a substantial reduction in inflation, with the 12-month rate of consumer price inflation falling to 13 percent in December 1999 from more than 80 percent at end-1997. The external current account deficit (including official transfers) widened from 4 percent of GDP in 1997 to 25 percent of GDP in 1999, but a strengthening of the capital account through increased projects loans and direct foreign investment allowed gross international reserves of the central bank to stabilize at the equivalent of three months of imports.

In the fiscal area, the primary budget balance (excluding foreign-financed investments) turned around from a deficit of 2.2 percent of GDP in 1997 to a surplus of 1.3 percent of GDP in 1999, as higher tax revenue collection more than offset spending overruns. Monetary policy remained tight, as the central bank maintained the reserve requirement ratio at 22 percent and its discount rate 4 percentage points above inflation. On the structural front, the government liquidated a savings and loan institution, partially privatized the national petroleum products distribution company, and significantly liberalized trade and prices. Regarding governance issues, the authorities dealt decisively with a treasury bond fraud attempt uncovered in 1999 and hired a reputable firm to conduct an independent external audit of the central bank's foreign assets accounts as at end-1998.

The PRGF-supported program for 2000-02 aims at reducing the rate of inflation to 3 percent in 2001-02 and at containing the external current account deficit (including official transfers), which is projected to widen to 41 percent of GDP by 2002 because of increasing oil exploration investment. Real GDP growth is projected to rise to 4 percent by 2002, allowing per capita income to rise by 1.7 percent a year and helping to reduce poverty. In the fiscal area, the primary budget surplus (excluding foreign-financed public investment) would rise from 1.3 percent of GDP in 1999 to 5 percent of GDP in 2002 through tax administration measures aimed at raising revenue and containing domestically financed primary expenditures, while giving priority to health and education services. Fiscal consolidation should allow the treasury to increase its deposits at the central bank. Monetary policy will aim at reducing inflation and strengthening the international reserves position of the central bank in the context of a flexible exchange rate system. Key structural measures include (a) the implementation of a civil service reform and retrenchment program; (b) the implementation of a new public enterprise reform and privatization program; (c) the enhancement of transparency, accountability, and good governance, including in the central bank, the budget, and oil exploration operations; and (d) the preparation of a comprehensive poverty reduction strategy.

The authorities are committed to reducing poverty, improving the living conditions of the most vulnerable groups of the population, and strengthening the effectiveness of education and health services. They have adopted an interim poverty reduction strategy paper (PRSP) and launched a participatory process with civil society, with a view to finalizing a full PRSP by end-December 2001.

Executive Board Assessment

Executive Directors commended the São Tomé and Príncipe authorities for their satisfactory performance under the government policy framework in 1998 and the staff-monitored program in 1999. Directors observed that the strengthening in the fiscal position, the substantial lowering of inflation, and the narrowing in the spread between the official exchange rate and the parallel market rate of the currency were the result of sound macroeconomic policies, which had been implemented despite a sizable deterioration in the terms of trade during 1999. They also noted that the government had liberalized the price, trade, and exchange regimes, adopted a civil service reform program, and started the implementation of a public enterprise divestiture program.

However, Directors stressed that, while real GDP had increased, São Tomé and Príncipe's economic situation remains fragile--with its debt burden relative to exports being the heaviest in the world--and vulnerable to terms of trade fluctuations and the availability of foreign assistance. In the circumstances, they underscored the importance of consolidating the gains achieved in macroeconomic adjustment, accelerating the implementation of structural reforms, and developing a comprehensive strategy to diversify the economy and reduce poverty.

Directors emphasized the need to strengthen public finances further, and urged the authorities to adhere strictly to the fiscal policy stance agreed for 2000 and preserve the integrity of the budget by including all public investments in the budget and the public investment program. In this regard, they indicated that it is essential to strengthen control over expenditure commitments and contain nonpriority primary spending, including the wage bill, while providing adequately for education and health. It is also important to strengthen implementation capacity in the public sector. In addition, given the ambitiousness of the program, prioritization of policies is important to encourage improvement in social indicators. The consensus achieved among the authorities, labor unions, and the three main political parties on a cautious budget and wage policy for 2000, and on a comprehensive civil service reform agenda, has helped improve national ownership and ensure greater commitment to the successful implementation of the program.

Directors commended the authorities for the strong revenue collection performance in 1998-99, and for the elimination of all exports taxes and the adoption of a comprehensive customs tariff reform in early 2000. Noting the revenue shortfall expected from these trade liberalization efforts, they stressed the need to continue efforts to broaden the tax base and improve revenue collection.

Directors endorsed the tight monetary policy stance for 2000 and stressed the need to introduce open-market operations in July 2000 as intended. The large reduction in the spread between the official exchange rate and the parallel market rate was welcomed, and the central bank was encouraged to continue its efforts to unify the markets in the context of a flexible exchange rate regime.

Directors underscored the importance of carrying out the envisaged structural measures, including the full implementation of the civil service reform program, public enterprise reform and privatization, an overhaul of business legislation and regulation, and a strengthening of the judiciary in the area of contract enforcement. They also emphasized the need to enhance good governance, accountability, and transparency in public finances, central bank operations, and particularly oil operations.

Directors encouraged the authorities to strengthen the country's human and institutional capacity in economic management, with donor assistance, including in the areas of civil service reform, the privatization program, oil policy, and statistics and program monitoring. They also stressed the importance for the authorities and concerned donors to conduct the necessary household surveys and poverty assessments and develop an adequate series of social and poverty indicators in a timely manner, in order to prepare and implement a full-fledged poverty reduction strategy by end-2001, as intended, following a participatory process involving civil society.

Directors urged the authorities to regularize all domestic and external payments arrears and remain current on external debt-service obligations. They also encouraged the authorities to improve the quality and timeliness of external debt data and pursue prudent external debt management and borrowing policies in order to avoid a further increase in the external debt burden. Directors noted that São Tomé and Príncipe will continue to need financial assistance from the international community to help cover its financing needs during the period of the Fund-supported program. In view of the heavy and unsustainable debt burden, they stressed the importance of fully implementing the authorities' reform program in order to establish the required track record for debt relief under the enhanced HIPC Initiative.