PROGRAM INFORMATION DOCUMENT (PID) CONCEPT STAGE. First Governance and Competitiveness Development Policy Operation (DPO1) Region

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1 PROGRAM INFORMATION DOCUMENT (PID) CONCEPT STAGE Report No.: AB6864 Operation Name First Governance and Competitiveness Development Policy Operation (DPO1) Region AFRICA Sector Central government administration sector (100%). Project ID P Lending Instrument Development Policy Operation Borrower(s) DEMOCRATIC REPUBLIC OF SÃO TOMÉ AND PRÍNCIPE Implementing Agency MINISTRY OF FINANCE AND INTERNATIONAL COOPERATION Ministry of Finance and International Cooperation Largo das Alfandegas Sao Tome Sao Tome and Principe Tel: (239) Fax: (239) Date PID Prepared October 24, 2011 Estimated Date of Appraisal December 12, 2011 Authorization Estimated Date of Board May 31, 2012 Approval 1. Key Development Issues The Democratic Republic of São Tomé and Príncipe (STP) is a small and fragile state and one of the smallest economies in Africa. The country faces many development challenges due to its small size and insularity, limited institutional capacity, and aid dependency. STP s development shortcomings translate into low productivity and low export levels as well as vulnerability to external shocks. As in other small island states, STP cannot exploit economies of scale in the provision of infrastructure, services, and economic activities. All these features translate into: (i) high costs per unit of government and utility provision services; (ii) limited flexibility of the economy to adapt to shocks due to a non-diversified export base and a dependence on external financing; and (iii) few opportunities for risk diversification within the domestic market. The incidence of poverty remains high and, as of 2001, 54 percent of the population lived in poverty. To face large poverty, the authorities have been implementing a Poverty Reduction Strategy since The Government is preparing a new Poverty Reduction Strategy ( ) which focuses on pro-poor growth and improved results monitoring. This strategy is expected to be adopted after the new poverty profile is completed (expected by December 2011). Economic diversification remains a challenge for STP, as its narrow export base is composed of two products: cocoa and tourism. Cocoa exports have decreased by about 70 percent in the past twenty years associated to lower production (partly explained by lower productivity after the Portuguese left the country 1

2 in 1975 and a series of reforms including a land distribution program that transferred production from large to small/medium-sized producers). Tourism has replaced cocoa as the primary source of foreign exchange, representing about 5 percent of GDP and over 40 percent of total exports earnings. STP is very open and imports most of the goods and services consumed, reflecting the country s dependence on outside sources to satisfy its internal demand. A current account deficit has been financed with grants and debt relief (around 30 percent of GDP over ), and rising FDI (including signature oil bonuses) in tourism, construction and oil exploration (around 25 percent of GDP combined over ). Oil signature bonuses and SDR allocation under IMF programs have increased international reserves to US$37.9 million at end-2010 (equivalent to over 4 months of imports), compared to US$24.7 million in STP authorities have demonstrated a satisfactory track record in maintaining prudent macroeconomic policies and implementing structural reforms that are sustainable over the medium-term, which allowed STP to receive debt relief and to achieve significant economic progress over the last decade. Structural reforms aimed at: (i) pursuing prudent fiscal and monetary policies; (ii) strengthening governance and the efficiency of public spending; (iii) liberalizing the economy by reducing trade barriers (particularly import tariffs) and by privatizing a number of public enterprises including the telecommunications company; (iv) building human capital by implementing new strategies in health and education; and (v) building institutional capacities, especially in the nascent petroleum sector. These reforms had positive results. For example, in 2007, STP reached the Completion Point of the Enhanced HIPC Initiative and received debt relief in the amount of US$314 million. A commitment to reforms and a buoyant external environment, characterized by a booming activity in the tourism and construction sectors and the arrival of signature oil bonuses, led to a high economic growth that averaged almost 6 percent during 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 (CBTA) project, approved in 2004, the US$8 million Public and Natural Resource Management and Development (PNRMD) Development Policy Operation (DPO), approved in 2008, and the US$4.2 million Public Resource Management and Governance Reform (PRMG) DPO, approved in May Notwithstanding STP s achievements, the country remains vulnerable to a variety of shocks. For example, the sharp rise in international fuel and food prices in 2008 impacted adversely on STP s economy through inflationary pressures (costly imports) that affected the poor and vulnerable. The World Food Program (WFP) estimated an increase in the number of vulnerable people (those for whom food is inadequate or at the limit) that need its support by percent. In addition, the on-going international economic and financial slowdown has limited the capacity of the Government to consolidate fiscal sustainability through reduced external financing. Following the international slowdown, a sharp decline in FDI, tourism-related investment, foreign assistance, and oil signature bonuses that did not materialize slowed down GDP growth to 4 percent in 2009, and the annual domestic primary fiscal deficit increased to 8.2 percent of GDP in The Government is consolidating its fiscal position. Fiscal performance has improved since 2006 and the annual domestic primary deficit fell to 4.8 percent of GDP in 2010, and is projected to decrease further to 3.5 percent of GDP by end 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 12.4 percent by end Inflation is expected to reach single digits in All in all, despite suffering a succession of shocks throughout , STP has avoided major macroeconomic imbalances. STP's macroeconomic outlook is favorable, with growth projected to rise to 5.5 percent in 2012 and to 6 percent during Growth will continue to rely on oil exploration activities, investment in construction, and tourism receipts. Donors will continue to support capital investments. 2

3 STP's outlook is, nonetheless, vulnerable to external shocks. On the one hand, the likelihood of a prolonged global economic downturn has increased as aggregate demand in advanced economies and key emerging markets are faltering, and this could affect export growth, including tourism receipts, and could also decrease private capital inflows and donor funds. Mitigating factors include the Government's commitment to accelerate fiscal consolidation to support the exchange rate peg to the Euro, particularly by expanding the tax base and increasing the efficiency of the public financial management system. In addition, it would be important to deepen structural reforms aimed at reducing bottlenecks in the economy (particularly energy and telecommunications), improving investment climate, and crowding in private investment. 2. Rationale for Bank Involvement The rationale for Bank s involvement rests on (i) its ability to provide significant resources (US$4.2 million or about 2 percent of GDP) to allow the implementation of the Government s reform program; (ii) its technical contribution to the policy dialogue and the public financial management (PFM) reform in the country based on analytical work including the recently completed Country Economic Memorandum; (iii) the success of the previous budget support operation, the Public and Natural Resource Management Development Policy Operation (which closed in June 2010), and the Capacity building Technical Assistance Project (which closed in September 2010) that supported PFM reform, PRSP implementation, and governance in the oil sector; and (iv) the leadership of IDA among the donor community in the country. 3. Proposed Objectives The objective of the DPO is to assist the Government of São Tomé and Príncipe to: (i) promote macroeconomic stability and improve public sector performance, with a focus on improving the transparency and monitoring of public expenditures, improving the management and reporting of public accounts, promoting fiscal stability, and strengthening public debt management; and (ii) support broadbased growth by improving the business climate, with a focus on simplifying business regulations and reducing the cost of trading across borders, and by raising tourism prospects. 4. Preliminary Description The proposed DPO is designed to support the implementation of STP's Government Program for , whose objectives are aligned to the new Poverty Reduction Strategy (PRSP II) for , expected to be adopted in December Given the uncertainties surrounding the outlook for potential oil production, the Government Program for and the PRSP II under preparation underscore 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 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. 3

4 The operation is the first in a series of three DPOs. The operation includes 8 prior actions, of which 2 target improvements in the transparency and monitoring of public expenditures; 1 targets the improvement in the management and reporting of public accounts; 2 are aimed at promoting fiscal sustainability; 1 targets the strengthening of public debt management; 1 targets the simplification of the process of business regulation; and 1 targets the reduction of the costs of trading across borders. The Ministry of Finance and International Cooperation (MoFIC) will be the executing agency of the reform program supported by this DPO. Other line agencies will support the ministry. The MoFIC and the Bank have agreed to monitor progress in the program supported by the development policy operation in the content of the Implementation Completion and Results report for this grant. 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. 5. Poverty and Social Impacts and Environment Aspects Actions supported by the DPO are expected to have positive poverty and social impacts. This operation aims to help the authorities to better target public expenditures. Reforms suggested to consolidate macroeconomic stability and to improve the business environment by streamlining regulations would facilitate private sector activities, raising incomes and creating jobs. Furthermore, the strengthening of public financial management is expected to enhance the efficiency and effectiveness of public resources in the delivery of development services. As spelled out in the MDGs, weak PFM systems and poor governance are perceived to be critical causes of poverty since weaknesses in PFM lead to inefficiencies in public spending and fiscal losses, which affect the Government s ability to deliver public services to the poor. In this regard, the proposed DPO support measures that promote the transparency and efficiency of the budget process, allowing more say in the services received by the population. The DPO also promotes better internal and external controls of the budget expenditure process, ultimately resulting in increased value for money. These actions, complemented by actions to strengthen capacity in the public accounting system would contribute to improved management of public funds, in line with authorized expenditures and poverty reduction priorities, thus increasing the effectiveness in public spending and benefitting the entire population. 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. 6. Tentative Financing Source: ($m.) BORROWER/RECIPIENT 0 International Development Association (IDA) 4.2 Total 4.2 4

5 7. Contact Point Contact: Mr. Marco Antonio Hernández Title: Country Economist Tel: (202) Fax: (202) Location: Washington, D.C. For more information contact: The InfoShop The World Bank 1818 H Street, NW Washington, D.C Telephone: (202) Fax: (202) pic@worldbank.org Web: 5

Central government administration (80%); Sub-national government administration (20%) Operation ID

Central government administration (80%); Sub-national government administration (20%) Operation ID Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized PROGRAM INFORMATION DOCUMENT (PID) APPRAISAL STAGE 31 March 2016 Report No.: AB7818 (The