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    Report No.: AB7284

    Second Governance and Competitiveness Development Policy Operation Name

    Operation (DPO2)

    AFRICA Region

    Central government administration sector (100%). Sector

    P130925 Project ID

    Development Policy Operation Lending Instrument



    Ministry of Planning and Finance

    Largo das Alfandegas

    Sao Tome

    Sao Tome and Principe

    Tel: + 239 2226-748

    Fax: +239 2222-182

    April 3, 2013 Date PID Prepared

    Following the corporate review on February 28, 2013, the decision Corporate Review Decision

    was taken to proceed with appraisal and negotiations.

    April 1, 2013 Date of Appraisal

    May 28, 2013 Estimated Date of Board Approval

    1. Country and Sector Background

    São Tomé and Príncipe (STP) is a small island nation with an open economy. An archipelago of just over 1,000 square kilometers, with fewer than 200,000 inhabitants, and a gross domestic product (GDP) per capita of about US$2,500, STP is one of the smallest economies in Africa. The country faces a number of complex development challenges due to its small size and structural external vulnerability, as well as its weak institutional capacity and aid dependence. As in other small island states, STP cannot take advantage of economies of scale in economic production, or in the provision of public goods, while its small domestic labor pool and limited consumer market seriously constrain diversification. This translates into: (i) high marginal costs for public services, infrastructure and utilities; (ii) substantial economic rigidity due to the heavy concentration of production and exports in a narrow range of sectors; and (iii) persistent risks stemming from extreme sensitivity to changes in global market conditions, particularly for strategic imports.

    To address these challenges while promoting accelerated broad-based growth and sustainable poverty reduction, the Government has recently completed its Second Poverty Reduction Strategy (PRSP-II) for the period 2012-2016. An improvement over its predecessor, the PRSP-II stresses the importance of good governance and sound macroeconomic management. The PRSP-II is informed by STP’s experience over the

    past decade, a decade in which the economy registered the highest economic growth since independence in 1975. GDP growth averaged about 5 percent per year between 2001 and 2011, compared to an average of just 1.4 percent during the 1990s. Growth has been driven by rising world cocoa prices (STP’s primary export commodity) and strong tourism receipts (STP’s largest source of export revenue), though payments for petroleum exploration rights and rising private investment inflows, particularly FDI, have accounted for an increasing share of GDP. FDI has been largely devoted to building physical and financial infrastructure in


    anticipation of future oil production, but also reflects the broader growth of the service sector and of tourism in particular.

    Despite a decade of robust growth, poverty remains a serious and pressing concern. Although notable progress has been made in a range of educational and public-health indicators, poverty is high. Real GDP per capita rose by almost 50 percent between 2001 and 2010. Yet, a recent household survey shows that the percentage of people living below the national poverty line stood at over 60 percent in 2010. Strengthening the linkages between growth and poverty reduction consequently presents a critical challenge for STP’s policymakers. The

    World Bank is supporting the authorities to further examine poverty trends in a forthcoming Poverty Assessment for STP.

    Resilience and diversification are critical challenges for development policy. STP’s exports are overwhelmingly concentrated in two sectors: cocoa and tourism. Cocoa exports have decreased by about 70 percent over the past twenty years due to falling production caused by a combination of declining overall productivity and a series of land reforms that shifted production from large to small- and medium-sized producers. Tourism has replaced cocoa as STP’s primary source of foreign exchange, representing about 5

    percent of GDP and over 40 percent of total export earnings. However, due to the small size and limited diversity of the domestic economy, tourism services and FDI projects in general typically have very high import content. While this helps to attenuate the potentially disruptive impact of large foreign-exchange inflows, it also limits the broader income and employment effects that FDI might otherwise generate. STP’s more general reliance on imported consumer goods has generated persistent current-account deficits. These deficits have been financed through a combination of grants and debt relief (amounting to roughly 30 percent of GDP from 2001-11) and rising FDI associated with tourism, oil exploration and related construction (totaling about 25 percent of GDP over 2001-11).

    STP’s government has built a solid reputation for prudent macroeconomic policy and has managed to sustain the momentum of the structural reform process over multiple administrations, paving the way for HIPC/MDRI debt relief and facilitating the strong economic growth rates observed during the past decade. The government has pursued responsible fiscal and monetary policies, enhanced the quality of governance in general and the efficiency of public spending in particular, promoted greater trade openness by reducing import tariffs, and progressively developed the capacity of its natural-resource management agencies in anticipation of the growth of the oil sector. In 2007 STP reached the Completion Point of the Enhanced HIPC Initiative and received a debt relief package equivalent to US$314 million, significantly improving its structural fiscal stance and reinforcing the long-term sustainability of its debt burden.

    The World Bank has supported the reform process, including reforms in public financial management. Previous Bank operations include the US$5 million Capacity Building Technical Assistance project, approved in 2004, the US$8 million Public and Natural Resource Management and Development Policy Operation, approved in 2008, the US$4.2 million Public Resource Management and Governance Reform Development Policy Operation, approved in May 2011, and the First Governance and Competitiveness Development Policy Operation (DPO1) of US$4.2 million, approved in March 2012.

    The Government is consolidating its fiscal position to build resilience and support the currency peg to the Euro. Fiscal performance has improved and the annual domestic primary deficit fell from 8 percent in 2009 to a projected 3.2 percent of GDP by end-2012. The authorities remain committed to improving revenue collection through better enforcement of tax laws (including collection of tax arrears), improved customs administration, and if necessary, the containment of spending. Furthermore, annual inflation has declined from a peak of 37 percent in June 2008 to a projected 8.3 percent by end-2012.


    All in all, despite suffering a succession of shocks, STP has avoided major macroeconomic imbalances over recent years. STPs macroeconomic outlook is favorable, with growth projected to rise to 4.5 percent in 2012, to 5.5 percent in 2013 and to 6 percent in 14. Growth will continue to rely on oil exploration activities, investment in construction, and tourism receipts. Donors will continue to finance capital investments.

    Nevertheless, STP will remain structurally vulnerable to external shocks, which present serious downside risks to its macroeconomic outlook. The prospect of a prolonged global economic downturn has become increasingly likely as aggregate demand in advanced economies (particularly in Europe) and economic growth in key emerging markets both appear to be faltering; this could affect export growth in STP, including tourism receipts, and could also decrease private capital inflows and the availability of donor funds. For example, a decline in FDI (currently projected to remain steady at around 8 percent of GDP during 2013-14), could put pressure on the balance of payments. In addition, a significant increase in global food or fuel prices could lead to slower growth, lower revenue, and the deterioration of the debt profile. Mitigating factors include the government’s commitment to accelerate fiscal consolidation to support its exchange-rate peg to the euro,

    particularly by expanding the tax base and increasing the efficiency of the PFM system. In addition, it will be important to deepen structural reforms aimed at reducing key growth constraints (particularly in the energy sector), improving the business and investment climate, and crowding-in private investment.

    2. Operations Objectives

    The objective of the DPO series is to assist the Democratic Republic of São Tomé and Príncipe to: (i) strengthen economic governance, with a focus on improving the transparency, monitoring and accountability of public and natural resources, improving the management and reporting of statistics, promoting fiscal stability, and strengthening public debt management; and (ii) support broad-based growth by improving the business climate, with a focus on simplifying business regulations and reducing the cost of trading across borders, and by promoting economic diversification.

    The proposed DPO is designed to support the implementation of STP's Second Poverty Reduction Strategy (PRSP-II) for 2012-2016. Given the uncertainties surrounding the outlook for potential oil production, the PRSP-II underscores the importance of accelerating structural reforms to diversify the economy. In this regard, this DPO supports critical reforms aimed at strengthening the links between public expenditure, fiscal sustainability, and sector strategies.

The DPO contributes to the Bank’s Interim Strategy Note (ISN) for STP approved in May 2011.

    Specifically, It contributes to the ISN's pillar one (accelerate sustainable and broad-based economic growth) and pillar two (strengthen governance and public institutions). The proposed DPO is fully aligned with the Bank's Africa Region Strategy. It also abides by the evaluation of the previous Country Assistance Strategy and focuses on a limited set of multi-sectoral activities to catalyze policies for faster growth, a more competitive economy with employment opportunities, and a better delivery of public services.

    The operation is the second in a series of three DPOs. The operation includes 9 prior actions, of which 3 target improvements in the transparency and monitoring of public expenditures; 1 targets the improvement in the management and reporting of statistics; 2 are aimed at promoting fiscal sustainability; 1 targets the strengthening of public debt management; and 2 target the simplification of the process of business regulation. The DPO results matrix is selective and contains indicators that can be obtained without additional costs to the authorities. Consultation with other donors on the measures supported by the DPO has already been engaged.


    3. Rationale for Bank Involvement

The rationale for Bank’s involvement rests on (i) its ability to provide significant resources (US$5.5 million,

    close to 2 percent of GDP) to allow the implementation of the PRSP-II; (ii) its technical contribution to the policy dialogue in the country based on analytical work including the World Bank’s Country Economic

    Memorandum and the Debt Management and Performance Assessment; (iii) the success of the previous budget support operations that supported governance and sector reforms; and (iv) the leadership of IDA among the donor community in the country. The staffs of the World Bank and the IMF have closely coordinated the DPO and the IMF’s Extended Credit Facility (ECF) program to ensure that they complement each other. Public Financial Management (PFM) measures supported by the ECF program are in large part drawn from the Bank supported PFM reform and the reform program underpinning the proposed operation is consistent with the macroeconomic program supported by the ECF.

    4. Tentative Financing

Source: ($m.)


    International Development Association (IDA) 5.5

     Total 5.5

    5. Institutional and Implementation Arrangements

    The Ministry of Planning and Finance will be responsible for overall implementation and coordination of DPO reforms as well as for reporting progress among other concerned line ministries and agencies. Following the authorities’ experience with the implementation of previous DPOs, the review of the program

    objectives will be based on relevant and easy-to-monitor indicators. A half-year review of the program will be carried out. Most of the policy areas of the proposed operation have benefited in the past from the monitoring system in place under previous operations. In addition, the proposed DPO will benefit from the monitoring system of the ongoing IMF ECF, notably on the macroeconomic performance. An Implementation Completion and Results Report will be issued within six months following the closing date of the DPO series.

    6. Risks and Risk Mitigation Measures

The following risks are presented in order of potential severity.

    External conditions present a complex set of risks. The effects of the ongoing European sovereign debt crisis may threaten external aid flows and further depress tourism revenues. As an extremely small and open economy STP is highly sensitive to changes in global fuel and food prices. Mitigation efforts include reforming public financial management and enhancing expenditure controls, and the government has made considerable progress in recent years in improving its fiscal balance and increasing its available resource envelope to counter external shocks. The deposit of signature bonuses into the National Oil Account has been instrumental to shoring up the government’s fiscal position while also attenuating the potentially disruptive budgetary impact of large and variable oil-sector revenues. The proposed series complements these efforts by supporting reforms that will further strengthen economic management and improve the capacity of public institutions, including those concerned with the oil sector. Moreover, the series will strengthen the framework for donor support, augmenting the resources that could be mobilized in the event of an external shock. Finally, a severe deterioration of external conditions could threaten the government’s


ability to maintain its currency peg against the euro. However, this risk is substantially mitigated by STP’s

    relatively large international reserves and a 25 million euro credit line from Portugal, and by the ongoing implementation of the government’s fiscal consolidation agenda.

Despite the considerable progress achieved in strengthening public administration, weak institutional

    capacity could slow the pace of reforms. This risk is addressed in the program design by prioritizing a limited number of sectors and by its emphasis on harmonizing donor support to minimize the burden on the government’s limited institutional resources. To alleviate capacity constraints over the long term, Word Bank and IFC staff are providing technical assistance to key public agencies, and the government is seeking additional support from its development partners to help refine its economic planning and public-policy management capabilities by training public officials in critical skill areas.

    Political disagreement could alter the pace of structural reforms, but is not expected to affect the content of the reform agenda. STP is a competitive multiparty democracy; enduring political consensus cannot be taken for granted, and transfers of power are a natural part of the political process. Further measures to mitigate political risks include the early adoption of key policy reforms and the broad political consensus around the measures supported by this operation which are designed to improve public financial management, accelerate economic diversification, and maintain macroeconomic stability.

    Finally, fiduciary risks regarding the use of public funds persist as a result of weak internal and external controls. This risk is being mitigated through the public financial management reforms currently underway, designed to increase transparency and accountability in the management of public resources.

    Overall, the risks to the operation are also being mitigated by the high degree of Government ownership of the proposed measures and its commitment to advance its Poverty Reduction Strategy, as well as by an active and supportive policy dialogue with Bank, IFC, and IMF staff.

    7. Poverty and Social Impacts and Environment Aspects

    Policies supported by this DPO series, and DPO2 in particular, are likely to generate positive poverty and social impacts. On the one hand, the operation’s resources will provide the government with crucial fiscal space, allowing it to maintain expenditures on essential services while pursuing its longer-term poverty-reduction objectives as set forth in the PRSP-II. Indeed, the 2013 Budget identifies pro-poor budget codes and projects them to increase over the previous year. On the other hand, the reforms supported by this DPO will help to consolidate recent progress in the critical area of macroeconomic stabilitypreliminary

    estimates suggest that the projected reduction in inflation rates will raise the incomes of both the poor as well as the non-poor. Meanwhile, data on business registration suggests that the streamlining of regulatory procedures supported by this DPO series has led to an increase in business formalization, which is expected to promote job creation over the medium-term and also help the government to broaden its tax base, an essential step to reduce the country’s aid dependency.

    Overall, creating a more secure, stable and investment-conducive economy will generate important income and employment effects, extending the benefits of growth to a wider share of the population. For instance, the PFM reforms supported by this operation are expected to enhance the efficiency and effectiveness of public resources, improving the delivery of essential public goods and services on which the poor often rely most heavily. This operation supports measures that promote transparency and efficiency in the budget process (including the management of natural resources), thus increasing the value-for-money of public spending.

    The conclusion of an environmental screening of the proposed reforms is that reforms are not likely to be significant from an environmental point of view. Policy actions supported by the proposed operation are not


likely to have significant positive or negative effects on the environment, forests, or other natural resources.

    The policies supported under this grant address primarily institutional reforms. The focus of the reforms is

    on transparency and accountability or public resources, on the efficiency of public expenditures, and on

    promoting good governance. If environmental impacts arise, they are expected to be beneficial for STP.

    8. Contact Point

World Bank

    Contact: Mr. Marco Antonio Hernández

    Title: Country Economist

    Tel: +1 202 473-6802

    Fax: +1 202 473-8466


    Location: Washington, D.C.


    Contact: Mr. Agostinho Bernardo

    Title: Director of the Cabinet, Ministry of Planning and Finance Tel: +239 2221083


For more information contact:

     The InfoShop

     The World Bank

     1818 H Street, NW

     Washington, D.C. 20433

     Telephone: (202) 458-4500

     Fax: (202) 522-1500




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