Democratic Republic of São Tomé and Príncipe and the IMF
Country's Policy Intentions Documents
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São Tomé and Príncipe—Letter
of Intent and Technical Memorandum of Understanding
Mr. Horst Köhler
International Monetary Fund
700 19th Street, N.W.
Washington, D.C. 20431
Dear Mr. Köhler:
1. This supplementary letter of intent, which updates and completes the memorandum of economic and financial policies of January 9, 2002, takes stock of the implementation of the staff-monitored program (SMP) of the authorities of São Tomé and Príncipe during the first half of 2002, describes the prior actions that have been put in place to correct the nonobservance of some of the program benchmarks, and presents the macroeconomic objectives for 2002 and 2003, as well as the expected measures envisaged by end-2002. Taking account of the prior actions that have been implemented, as well as the objectives and measures that are envisaged, the authorities request the extension of the SMP through end-December 2002.
2. In order to correct the observed slippages in the execution of the program supported by the International Monetary Fund under the Poverty Reduction and Growth Facility (PRGF), resolve governance problems in the management of the petroleum sector, and reestablish the credibility of economic policy, the authorities adopted in January 2002, a SMP within the context of a macroeconomic framework covering 2002. However, government spending overruns continued during the first half of 2002, prior to and after the early-March 2002 legislative elections. Therefore, in spite of revenue collection efforts, the end-March and end-June 2002 quantitative benchmarks on the government's primary budget surplus, net bank credit to the government, net domestic assets of the central bank, and net international reserves of the central bank were not observed. In addition, two structural benchmarks—the submission of a draft budget for 2002 to the National Assembly and the publication of a report on the independent external audit of large government contracts—were not observed.
Implementation of the SMP during the first half of 2002
3. Economic activity continued to recover during the first half of 2002, owing to the strong expansion in food production, construction, trade and tourism; real GDP growth is projected at 5 percent in 2002, as in the initial SMP. Due to the adjustment of water and electricity rates, and the continued expansion of government spending, the end-of-period inflation rate increased to 10.5 percent at end-June 2002, compared with 9.4 percent in 2001. In the first half of 2002, the dobra stabilized against the U.S. dollar and depreciated against the euro, resulting in a 1 percent depreciation in real effective terms.
4. In the fiscal area, the nonobservance of the quantitative benchmarks on the primary budget surplus at end-March and end-June 2002 was explained by expenditure overruns, which in turn were attributed to (i) the civil service unions' call for salary increases, (ii) higher government energy costs (due to increases in petroleum product retail prices and water and electricity rates), and (iii) higher-than-expected expenditures related to the legislative elections. Nevertheless, the tax collection efforts of the new government bore fruit during the second quarter, raising government revenue at end-June 2002 above targeted levels.
5. Monetary developments during the first half of 2002 were marked by a 20 percent growth of the money supply and a 23 percent growth of credit to the economy. The central bank maintained the reserve ratio at 22 percent and its reference interest rate at 15.5 percent; the commercial banks also kept their deposit rates at about 14 percent and their lending rates around 34 percent. The authorities have not adopted the decree-law authorizing the central bank to issue monetary regulation bills to organize a money market. Net bank credit to the government increased by 12 percent of the beginning-of-the-year money stock, as the treasury made substantial drawings on its deposits at the central bank to finance a larger-than-targeted budget deficit. In these circumstances, neither the quantitative benchmark at end-June 2002 on net bank credit to the government nor those on the net domestic assets of the central bank and on the net international reserves of the central bank were observed.
6. None of the attempts to restructure and recapitalize the insolvent commercial bank (Banco Comercial do Equador—BCE) were successful. In these circumstances, the central bank, which had already suspended the BCE's banking license at end-June 2001, reactivated its bankruptcy proceedings against the bank in São Tomé's court in April 2002. A court ruling is scheduled for end-October 2002.
7. In the petroleum sector, in May-June 2002, the government completed a legal review of the contracts signed in 2001 with the help of the World Bank. Following this legal review, the new government decided to renegotiate four contracts before launching the oil exploration licensing round in the Joint Development Zone with Nigeria. The four contracts are as follows: (i) the technical assistance contract with the U.S. company, Exxon-Mobil; (ii) the option contract on petroleum exploration and production signed with a Norwegian company (PGS); (iii) the contract giving a U.S. company (Environmental Remediation Holdings Company—ERHC) overriding royalties on the petroleum produced, as well as a percentage of the signature bonuses and of the production shares accruing to São Tomé and Príncipe; and (iv) the memorandum of understanding with the Nigerian government on the special regime area of the Joint Development Zone. However, the government has not yet published the implementing decrees for its petroleum legislation, nor has it submitted to the National Assembly the bill organizing the management of petroleum resources and instituting the reserve fund for future generations.
8. With respect to structural measures, in order to contain the wage bill, the government implemented the civil service reform and downsizing program, retrenching 265 civil servants out of about 4,500 and 158 workers at the water and electricity utility (EMAE) out of about 400. The severance payments necessitated by the retrenchment program, which were financed by the European Union's structural adjustment facility, amounted to about Db 8 billion. Later, in order to make up for the nonobservance of structural and quantitative benchmarks and to extend the SMP into the second half of 2002, the government signed a contract with an internationally reputable firm on September 30, 2002 for an independent external audit of three government contracts and tenders of more than US$500,000.1 The government also submitted a draft budget for 2002 (as described in paras 11 to 13 below) to the National Assembly, which approved it at end-July 2002. Moreover, in applying the automatic mechanism for adjusting water and electricity rates in line with production and distribution costs, the government raised electricity rates by 16 percent and water rates by 27 percent in January 2002. However, under social pressure, it returned these rates to their December 2001 levels, starting in July 2002.2 Furthermore, the authorities have not held quarterly meetings with donors on the monitoring of public investment.
Macroeconomic framework and fiscal policy for the second half of 2002 and for 2003
9. The SMP for 2002 was revised to take account of the slippages observed during the first half of the year. The main macroeconomic objectives of the government are to (i) limit the end-of-period rate of inflation to 9 percent, compared with 9.4 percent in 2001; and (ii) narrow the external current account deficit (including official transfers) to 10 percent of GDP from 16 percent of GDP in 2001. The improvement in the external current account reflects the mobilization of interim assistance under the Initiative for Heavily Indebted Poor Countries (HIPC Initiative). In the medium term, the inflation rate should be reduced to 7 percent in 2003 on an end-of-period basis, and to 3 percent by 2005; the external current account deficit should widen to 31 percent of GDP in 2003 and to about 380 percent of GDP by 2005, as a result of imports of goods and services associated with investments in petroleum exploration and development. Real GDP growth should remain at 5 percent per year during the period 2003-05. To attain its goals and, notably, to limit inflation, the government will pursue prudent fiscal, monetary, and exchange policies, and implement a number of structural reforms.
10. In the area of fiscal policy, the objectives are to reduce the primary budget deficit (excluding foreign-financed investment) from 10 percent of GDP in 2001 to 5 percent of GDP in 2002, and to contain it within 8 percent of GDP in 2003, including HIPC Initiative-financed expenditures. By end-December 2002, the government will submit to the National Assembly a draft budget for 2003 consistent with the objectives mentioned above and in line with the other fiscal data indicated in paragraphs 11 to 13 below. The government will not accumulate new domestic or non-reschedulable external payments arrears during the period of the staff-monitored program.
11. Government revenue is projected to stabilize at about 22 percent of GDP during 2002-03. The authorities will simplify the general sales tax and extend its coverage (at the single rate of 2 percent) to domestic goods and services (hotels, restaurants, telecommunications, and maintenance and repair services), starting in October 2002. The government will continue to strengthen the tax inspection and audit departments of the tax directorate and the customs administration, and will continue its efforts to reduce tax and customs exemptions.
12. Primary expenditure will be contained within 27 percent of GDP in 2002 (up 1 percentage point of GDP from the initial projection) and within 30 percent of GDP in 2003, compared with 33 percent of GDP in 2001. The government has granted a general salary increase averaging 17 percent, effective July 1, 2002. Given the downsizing in the civil service, the wage bill will be limited to 9 percent of GDP in 2002 and 2003 (compared with 9.6 percent of GDP in 2001).
13. The government will ensure that spending levels on education represent 9 percent of GDP in 2002 and 12 percent of GDP in 2003, compared with 11 percent of GDP in 2001, and that spending levels on health care represent 13 percent of GDP in 2002 and 2003, compared with 11 percent of GDP in 2001. By end-December 2002, the government will also finalize and adopt, in consultation with the World Bank, a three-year public investment program (PIP) for 2003-05 that will conform to the priorities laid out in the interim poverty reduction strategy paper (the priority sectors being human resource development and infrastructure maintenance).
14. The government will also reactivate the conducting of quarterly meetings to monitor public investment, with the participation of the main donors represented in São Tomé and Príncipe, in order to improve transparency in monitoring the execution of PIP projects. It will prepare and publish, by end-December 2002, a report on the independent external audit of the three government contracts and tenders of over US$500,000 during the period 1998-2000, with a view to improving government procurement, preparing a mechanism to control and monitor the execution of foreign-financed investment projects, and ensuring the centralization of all project accounts under the financial control of the treasury.
Monetary and exchange rate policy
15. The central bank will pursue a prudent monetary policy aimed at reducing the inflation rate to 9 percent by December 2002, on an end-of-year basis, and will continue to keep the central bank's reference interest rate above the inflation rate observed during the program period. The resumption of disbursements of nonproject external assistance, including the advance on oil contract signature bonuses extended to São Tomé and Príncipe by the Nigerian government in July 2002 (see para 19), interim assistance provided under the HIPC Initiative, and the reduction of the primary budget deficit, should make it possible to reduce net bank credit to the government by 33 percent of the beginning-of-year money stock during 2002. Credit to the private sector should increase by 28 percent and broad money by 23 percent in 2002 (the latter of which corresponds to a growth rate of 3 percent in the second half of the year). Gross international reserves of the central bank should increase to US$22 million, or 4.8 months of imports, by end-2002.
16. The central bank will continue to strengthen bank supervision and keep a close oversight on the banking system, with a view to ensuring smooth financial intermediation, the profitability of the banks, the quality of their lending portfolios, and the continued compliance of the banks with prudential and solvency ratios. The central bank will organize by end-December 2002 the liquidation of the BCE without further financial support from the central bank or the treasury. The central bank will also continue to enhance its inspection services and its internal control over its operations, with technical assistance from the Fund. In April 2002, the central bank published and posted on its website for the third consecutive year the report on the audit conducted by an independent, internationally recognized firm, which certified its 2001 accounts. The central bank will continue to have its accounts certified every year by independent external auditors.
17. Regarding the exchange rate, the authorities will ensure that their flexible exchange regime (based on signals from the market) operates effectively, thereby allowing them to maintain the gap between the official exchange rate and the parallel market rate at a very low level. In this context, the central bank will not attempt to influence the exchange rate offered by commercial banks and will limit its intervention on the exchange markets strictly to reaching its international reserves objective. However, on the occasion of the tenth anniversary of the central bank, the authorities have started to reflect on the relative merits of their flexible exchange rate regime versus those of a fixed exchange rate regime within the context of monetary integration with neighboring countries.
Structural and sectoral policies
18. Regarding structural measures, the government will apply, during the period of the program, the mechanism for adjusting retail petroleum product prices in line with import prices and distribution costs, as well as the new mechanism for adjusting water and electricity rates to reflect production and distribution costs. Having already liberalized trade and reduced customs tariffs, the government will submit to parliament, before end-December 2002, a new bill revising fundamentally the investment code, specifically by eliminating all preferential tax regimes, with the exception of that applying to the free trade zone. Concerning the business climate, the government will continue to enhance the incentives for private sector activity and investment, particularly by strengthening the legal, regulatory, and judicial systems. It will also pursue the financial restructuring of EMAE, with a view to its eventual privatization. In this regard, it will elaborate, by end-December 2002, an appropriate accounting and budgeting system, new, enhanced procedures for the collection of revenue, and a medium-term strategy and investment program. The review of the SMP will examine expost the financial impact of the July 2002 reduction of electricity and water rates, and of the compensatory measures taken in 2002 to improve the management of EMAE's operations account, with the aim of identifying necessary corrective measures, including a possible adjustment of rates.
19. With respect to oil exploration issues, the government will continue to ensure transparency in the conduct of future operations. While awaiting the launch of a call for bids on the exploration licenses for the oil blocks in the Joint Development Zone with Nigeria, the government contracted in July 2002, a US$5 million short-term advance from the Nigerian government (with a zero interest rate), to be repaid against the possible signature bonuses for oil exploration contracts expected for São Tomé and Príncipe in 2003. This advance will be maintained in the treasury's deposits at the central bank and will contribute to the strengthening of international reserves during the period of the extended SMP. The government will consult with the staff of the IMF and will request technical assistance from the World Bank on oil sector contracts and resource management. With the support of this technical assistance, the government will install and make operational, by end-March 2003, an administrative division charged with the management of oil resources, and, by end-September 2003, it will submit to the National Assembly a bill organizing the management of oil resources and establishing a reserve fund for future generations.
20. Regarding other governance concerns, the government will continue to fight fraud and corruption. In the case of the treasury bond fraud attempt uncovered by the authorities in February 1999, the two officials implicated were dismissed and prosecuted. With respect to the judiciary, the government intends, with the assistance of Portugal, to strengthen and modernize the courts and tribunals and train magistrates by end-2002. In 2003, it will establish the Auditor General's Office and prepare criminal, civil, and business laws and codes. Eventually, the government will also establish an arbitration court for commercial disputes.
21. With the support of the donor community, and in consultation with civil society, the government expects to finalize a poverty reduction strategy paper (PRSP) in the coming months to supplement and update the interim paper of April 6, 2000. This strategy is expected to include programs to improve human resources (i.e., education, primary health care, access to drinkable water, etc.). It will be supplemented by an analysis of the costs of implementing the poverty reduction policies and sectoral strategies, which, in order to ensure long-term economic growth, shall remain compatible with macroeconomic stability.
22. The resources freed under the enhanced HIPC Initiative will be used to fund poverty-reducing expenditures, particularly in the priority sectors of education and health. To guarantee a transparent and effective mechanism for controlling and monitoring these expenditures, the government established, in November 2000, a special treasury subaccount at the central bank, into which interim assistance under the enhanced HIPC Initiative shall be lodged. Furthermore, a monitoring and control committee responsible for ensuring the transparent and effective expenditure of resources provided by the enhanced HIPC Initiative assistance was established in January 2001 with the participation of civil society and donors. The government will publish, by end-October 2002, an independent external audit of expenditures financed in 2001 by the treasury's special HIPC Initiative account at the central bank.
23. The government will intensify efforts to improve the quality and timely production of statistical data, provide the Fund with the basic data required in connection with Article IV consultations, and strengthen program control and monitoring. It completed a statistical survey of households, and it will prepare a series of social welfare and poverty indicators to be monitored in the context of its poverty reduction policy. In addition, the government will continue to ensure that the monthly monetary survey is available within four weeks following the end of each month.
External sector and financing assurances
24. In the external sector, the government will pursue its objective of reducing the external current account deficit by applying the macroeconomic and structural adjustment policies described in this letter, and without resulting to restrictions on current transactions.
25. Overall, the external current account deficit (excluding official transfers) is projected at US$29.4 million (or 54 percent of GDP) in 2002. Taking into account the amortization of external public debt (US$6.2 million) and the target for improving the central bank's international reserves position (US$6.6 million), the gross external financing requirement for 2002 rises to US$42.2 million. This financing requirement will be partially covered by grants and concessional project loans (US$18.9 million), food aid and other grants (US$3.7 million), flows of private capital (US$3.0 million), the second tranche of the Public Resource Management Credit from the World Bank (US$2.5 million), the first tranche of the structural adjustment credit from the AfDB (US$0.8 million), the structural adjustment grant from the European Union (US$1.1 million), and the bridge advance payment made by the Nigerian government on possible oil contract signature bonuses (US$5.0 million). A residual financing gap of US$7.2 million will remain, which the authorities wish to cover through interim assistance from multilateral creditors under the HIPC Initiative. However, pending a new PRGF arrangement and a new Paris Club rescheduling, São Tomé and Príncipe will accumulate new arrears to its bilateral creditors. The authorities will conclude all bilateral agreements under the Paris Club's May 2000 rescheduling before end-October 2002 and seek comparable treatment from other bilateral creditors.
26. To cover its financing needs, the government will continue to seek grants and loans on highly concessional terms only. In this respect, it will neither contract nor guarantee any new external nonconcessional borrowing (with a grant element of less than 50 percent) having a maturity of more than one year. Furthermore, the government will neither contract nor guarantee external borrowing with an initial maturity of less than one year—with the exception of the bridge advance payment of US$5 million on oil contract signature bonuses that was contracted with the Nigerian government in July 2002. With a view to normalizing its relations with its major external creditors and donors, São Tomé and Príncipe will remain current on its nonreschedulable debt-service obligations during the program period. The government acknowledges that the nonaccumulation of new nonreschedulable external payments arrears is a continuous benchmark.
27. To ensure the successful implementation of the SMP, the government has taken a prior action, namely, the signing of a contract with an internationally reputable firm for an independent external audit of three large government contracts and tenders for the period 1998-2000.
28. To ensure monitoring of progress in implementing the SMP, the government has established quantitative benchmarks for end-September and end-December 2002 (Table 1), as well as structural benchmarks (Table 2). The government will also communicate any information that Fund staff may request in order to ensure the control and monitoring of progress in implementing economic and financial policies and the measures required to achieve the SMP's objectives. A technical memorandum of understanding describing the quantitative benchmarks of the program is attached (Attachment).
29. During the period of the SMP, the government will neither introduce nor intensify restrictions on payments or transfers in current international transactions without Fund approval; it will neither introduce multiple exchange rate practices nor enter into any bilateral payments agreements incompatible with Article VIII of the Fund's Articles of Agreement; and, lastly, it will neither introduce nor intensify import restrictions for balance of payments reasons.
30. The government is convinced that the policies described in this letter of intent will permit it to achieve the objectives of its program, and it stands ready to take any other measures needed in this regard. During the period of the SMP, the authorities will consult the Managing Director of the Fund on any measures that would be suitable to adopt, either on their own initiative or at the request of the Managing Director.
31. In any event, the authorities of São Tomé and Príncipe will review performance under the SMP with the Fund staff no later than end-February 2003. On that occasion, they would like also to conclude the discussions with the Fund on a medium-term program that could be supported under a PRGF arrangement. Finally, the authorities hope that São Tomé and Principe will reach the completion point under the enhanced HIPC Initiative as soon as possible.
Yours very truly,
1The projects are (i) the rehabilitation of a road between Neves and Santa Catarina; (ii) the construction of 66 apartments in São Tomé; and (iii) the rehabilitation of urban roads and of the drainage and sewage system in São Tomé.
2To compensate for the reduction in billings resulting from these new rates, EMAE has undertaken to reduce its costs of production and distribution (including production losses), to enhance its revenue collection, and to provide incentives to induce several electricity-using companies with independent electricity generators to become clients of the company once again.
September 30, 2002
1. The purpose of this memorandum is to describe the quantitative benchmarks adopted for monitoring the execution of the staff-monitored program (SMP) and to establish the list of data and information to be submitted to Fund staff for program-monitoring purposes. This SMP is outlined in the memorandum of economic and financial policies (MEFP) for 2002, attached to the letter of January 9, 2002 from the Minister of Planning and Finance to the Managing Director of the International Monetary Fund, which is updated by the supplementary letter of intent of September 30, 2002. The quantitative benchmarks for the SMP are listed in Table 1 of the aforementioned supplementary letter. These definitions may be reexamined in the next review of the SMP.
A. Quantitative Benchmarks
2. The quantitative benchmarks are based on the following variables at end-September and end-December 2002:
3. The primary balance of government financial operations is defined as the difference between total government revenue and primary spending, excluding foreign-financed investment. It is assessed in light of the government budget execution statement prepared every month by the Directorate of Budget and Directorate of Treasury in the Ministry of Planning and Finance. At end-June 2002, this balance was assessed at Db -15.5 billion, broken down as follows:
4. Total government revenue is assessed on a cash basis in the table of government financial operations prepared by the Directorate of Budget and Directorate of Treasury. Total revenue at end-June 2002 was estimated at Db 55.0 billion, broken down as follows:
5. Primary spending (excluding interest payments) by the government, excluding foreign-financed investment, is assessed on a commitment basis. Primary spending, excepting foreign-financed investment at end-June 2002, was estimated at Db 70.5 billion, broken down as follows:
6. Changes in net banking system credit to the government are assessed according to the monetary survey prepared by the central bank. At end-June 2002, outstanding net credit to the government was assessed at Db 8.2 billion, broken down as follows:
7. Changes in the net domestic assets of the central bank are assessed according to the monetary survey prepared by the central bank. At end-June 2002, the net domestic assets of the central bank were assessed at Db -7.6 billion, broken down as follows:
8. Changes in the net international reserves position of the central bank are assessed according to the monetary survey prepared by the central bank. Reserve assets are central bank liquid assets in convertible foreign currencies held by nonresidents, and that are immediately available. Assets that are pledged or otherwise not available, including (but not limited to) the assets used as collateral (or security for third-party liabilities), are excluded from the reserve assets. Reserve liabilities are defined as short-term central bank claims on nonresidents, including use of Fund resources. At end-June 2002, the net international reserves of the central bank were assessed at US$13.1 million, broken down as follows:
9. The nonaccumulation of new external payments arrears is a continuous benchmark of the SMP. Government external payment arrears are defined as all unpaid external public debt obligations, according to the data established by the central bank's foreign debt division, with the exception of arrears pending rescheduling arrangements. During the first six months of 2002, the stock of external debt arrears was estimated at zero.
10. The benchmarks related to external debt are (i) ceilings on new nonconcessional borrowing contracted or guaranteed by the government with an initial maturity of more than one year,1 and (ii) the ceilings set for changes in the stock of amounts due but not paid on external debt contracted or guaranteed by the government with an initial maturity of less than one year.2 The concessionality of loans is assessed according to the currency-specific reference interest rate published by the Development Assistance Committee of the Organization for Economic Cooperation and Development (OECD). For loans of terms of no less than 15 years, the ten-year average of commercial interest reference rates (CIRR) for the currency in which the loan is denominated will be used. For loans of shorter terms, the six-month average will apply. A loan is deemed to be on concessional terms if, on the initial date of disbursement, the ratio of the present value of the loan, calculated on the basis of the reference interest rate, to the nominal value of the loan is less than 50 percent (in other words, a grant element of at least 50 percent, excluding IMF resources). By way of example, the reference interest rates at mid-August 2002 were as follows (six-month average):
For currencies with no available reference interest rates, the SDR rate will be used. Debt reschedulings and restructurings are excluded from the ceilings set on nonconcessional lending. The government of São Tomé and Príncipe will consult with Fund staff before contracting obligations if it is uncertain whether said obligations are included in the performance limits.
11. The automatic benchmark adjustment mechanism mentioned in footnote 2 of Table 1 concerns (i) the ceiling on changes in net credit to the government; (ii) the ceiling on changes in net domestic assets of the central bank; and (iii) the floor on changes in the net international reserves of the central bank. Discrepancies will be assessed by comparison with the data on disbursements for (i) oil contract signature bonuses; and (ii) program assistance (including nonproject short-term advances), which are shown in a memorandum item at the bottom of Table 1. If a discrepancy is positive (disbursements greater than projected), the ceilings will be revised downward and the floors revised upward. If a discrepancy is negative (disbursements smaller than projected), the ceilings will be revised upward and the floors revised downward.
B. Program Monitoring
12. Within two weeks following the end of each month, a monthly evaluation report will be prepared on the monitoring of quantitative and structural program benchmarks. This report will be used to assess the progress of SMP execution.
13. The technical committee charged with monitoring the program will regularly fax or e-mail the data necessary for program monitoring to the IMF's African Department. These data are included in the list in Table 3 of the MEFP, dated January 9, 2002, (see São Tomé and Príncipe: Letter of Intent, Memorandum of Economic and Financial Policies, and Technical Memorandum of Understanding, January 9, 2002).
14. The technical monitoring committee will also provide the African Department with any information it deems necessary or that Fund staff may request for program-monitoring purposes.
1This benchmark applies not only to the debts defined in point 9 of the Directives Regarding External Debt Performance Criteria adopted on August 24, 2000, but also to debt contracted or guaranteed that has not yet been disbursed.
2The term "debt" is defined in accordance with point 9 of the Directives Regarding External Debt Performance Criteria adopted on August 24, 2000.