Report No. 40130-STP Democratic Republic of São Tomé and Príncipe Country Integrated Fiduciary Assessment (In Four Volumes) Volume I: Executive Summary of the Country Integrated Fiduciary Assessment June 2007 Poverty Reduction and QK Procurement (AFTPC) Economic Management 3 QK Financial Management (AFTFM) Africa Region Africa Region Document of the World Bank PREFACE COUNTRY INTEGRATED FIDUCIARY ASSESSMENT This Country Integrated Fiduciary Assessment (CIFA - henceforth the report) is a first of its kind for the Democratic Republic of Sao Tomé and Príncipe. It combines the analysis and policy recommendations from a public expenditure review (PER), a Country Financial Accountability Assessment (CFAA) and a country procurement assessment (CPAR). The PER is the first in ten years and the CPAR is the first ever. The CFAA is based on recent World Bank and IMF work and at the request of the authorities, includes a June 2006 review of the public finance reform program already underway. The report provides the authorities and the donor community with an analytical overview of the financial/fiscal status of the government central budget and the PFM system it uses.1 The goal of the report is to identify the major challenges facing the country in the next three to five years (pre-petroleum era) in public finance management (including public enterprises) as it attempts to implement its National Poverty Reduction Strategy (NPRS) given a tight resource envelop. In doing so, the report lays out its basic findings and priority action plan, developed according to the country's capacity. A parallel Health PER is on course to shed light on the quality and efficiency of budget expenditures in this sector. The report is motivated by the new diminished petroleum reality the country faces and the analysis will touch on the program and goals of the on-going Governance Capacity Building TA project. Moreover, it is expected that the analysis will provide valuable elements of policy dialogue for the elaboration of the Bank's first budget support operation post HIPC completion point. The report is fully aligned with the CAS and the PRSP. The CAS recommends such a fiduciary diagnostic with two goals in mind: (i) assist the country to prepare for the arrival of oil revenues and to strengthen the overall macroeconomic and public sector framework to ensure that it is conducive for the sustainable use of future petro-dollars. (ii) ensure that the authorities and the donors have confidence in the transparency and outlay of the budget ahead of providing budget support to the country2. The exercise also supports the implementation of the first axis of the PRSP. The report is structured into four volumes based on the suggestion of the decision meeting: volume one is the executive summary of the CIFA, volume 2 contains the public expenditure analysis and outcomes. Volumes 3 and 4 include the analytical work on the underlying institutions and systems (CPAR and the CFAA respectively). The report was developed based on discussions with the authorities and the Africa Development Bank. At the time of the launch of this exercise, the Public Finance Management reform process was starting up and the authorities specifically requested that the CFAA address 1 The Bank's last contribution in this area ­ aside from two HIPC-AAPs in recent years ­ was a PER in 1997. 2CAS for Sao Tome and Principe, May 2, 2005, Report No. 32078, pg iv. iv the reform process and provide suggestions mid-stream, for improvements. The authorities had also requested assistance to modernize the public procurement process. The CPAR provides a baseline diagnostic and an action plan to support the government's future reform program. The preliminary results of the findings from the PER and CFAA were shared with the authorities in November 2006. The PER summary results were discussed with the Minister of Planning and Finance and the directors and other staff of the Ministry in a two hour seminar. The PER team also shared its results with the directors of the state owned enterprises. The findings of the CPAR were shared with the authorities in March 2007. The on-going Public Finance Management reform should address many of the concerns raised in this integrated report, but lack of capacity, successive political changes and an attempt to acquire a copy of the Angolan integrated computerized system have slowed the reform progress. 2007-2008 will be key years for the reform and we hope that the present analysis will be a further input into and impetus for the reform process. The World Bank Governance Capacity Building Technical Assistance Credit has supported the reform process since its inception. The report is the results of the efforts of the authorities, the World Bank, Africa Development Bank and the French Cooperation Agency. Within the World Bank, three teams contributed to the production of the report: the PER team, lead by Dorsati Madani (AFTP3); the CFAA team, led by Alain Catalan (AFTFM); and the CPAR team, led by Asha Ayoung (OPCPR). The task team leader for the overall Integrated Fiduciary Assessment was Dorsati Madani (AFTP3). The analysis was started under the leadership of Robert Blake (Sector Manager, AFTP4) and Ali Khadr (Country Director) and finished under the leadership of Yvonne Tsikata (Sector Manager, AFTP3) and Marie-Francoise Marie Nelly (acting Country Director). Trichur K. Balakrishnan (AFTFM) was the reviewer for the Integrated Fiduciary Assessment. The PER team was composed of Natsuko Obayashi (TTL, AfDB), Rafael Munoz Moreno (AFTP3), Maria Vagliasindi (regulatory framework,FEU), Quentin Wodon (AFTPM), Vitor Dinizio (consultant), Nilgun Gokgur (consultant), Alema Siddiky, (consultant), Thilakaratna Ranaweera (consultant), and supported by Maude Jean-Baptiste (AFTP3) and Paula White (AFTP3). Maria Vagliasindi (FEU) and Demetrios Papathanasiou (ECSSD) were reviewers for the Chapter three of the document. Hinh Dinh (Lead economist, AFTP3) provided valuable guidance to the team. The CFAA team was composed of Abdoulaye Coulibaly (AfDB), Yves Guérin (MAE, France), Nestor Coffi (AFTFM), and Robert Cauneau (consultant). The reviewers for the CFAA were Ahmadou Moustapha Ndiaye (LCSFM), Keiko Kabuto (AFTP3) and Eric Nelson (AFTP4). The CPAR team was composed of: Eric Yoboue (lead - AfDB), Yvan Franusic, (consultant), Marcos Ozorio de Almeida (consltant) and the national committee including public and private stake in the procurement reform process. Reviewers for the CPAR team included Pamela Bigart (OPCSP), Françoise Bentchikou (LEGPR), V. Krishnakumar, (AFTPC), Andreas Wildt( MNAPR), Patricia "Trish" Macgowan, (LCSPT). The Government group consisted of a core team in the Ministry of Planning and Finance composed of Mr. Americo D'Oliveira dos Ramos (Director of Budget), Mme. Joana Varela (Director of Treasury), Mme. Ana Silveira (Sub-Director of Patrimony), Mr. Felipe Muniz (Director of Planning), Mme. Ilza Vas (Director of Customs), Mr. Agostinho Fernandes (Director of Taxation), Filipina de Vera Cruz Rocha (Coordinator of the NPRS ­ Poverty Observatory), Mr. Raul Viana (Director of the Inspectorate of Finance), the public finance reform committee and the information technology chief. The advisors to the Minister of Planning and Finance, Mr. v Agapito Mendes Dias and Mr. Zeferino Dos Santos Ceita, contributed greatly to the high quality of the policy discussions as well as the organization and coordination of meetings. The Directors and staff of the four State Owned Enterprises also worked closely with the team. These were the water and electricity (EMAE), port management (ENAPORT), airport management (ENASA), and post (CORREIOS). Meetings with the Central Bank, the Accounting Tribunal authorities, the public finance technical team at the National Assembly, the Directors of Administration and Finance of sectoral ministries (Ministries of Finance, Trade, Education, Infrastructure) and the Coordinator of Governance Capacity Building Technical Assistance Credit (PATRCG) provided valuable information for the analysis. The President of the National Committee of Coordination and Monitoring of the Procurement Reform (CNCS) and the members of the CNCS, the stakeholders from the private sector, the Public Administration and the judicial entities involved in procurement in Sao Tome and Principe (STP) also contributed to the analysis. The CIFA Team would like to extend its deepest thanks to his Excellency Mr. Tomé Vera Cruz, Prime Minister; her Excellency Mme. Maria dos Santos Tebus Torres, Vice-Prime Minister and Minister of Planning and Finance; his Excellency Mr. Manuel de Deus Lima, Minister of Natural Resources and the Environment. We extend our special thanks to the large team of directors and staff at the Ministry of Planning and Finance and at State Owned Entreprises as well as other ministries and authorities which provided us a frank and constructive cooperation. vi EXECUTIVE SUMMARY Context 1. This Integrated Fiduciary Assessment is the first of its kind for São Tomé and Príncipe. It combines the analysis and policy recommendations from a public expenditure review (PER), a country financial accountability assessment (CFAA), and a country procurement assessment review (CPAR). The PER is the first in 10 years and the CPAR is the first ever. The CFAA is based on recent World Bank and International Monetary Fund (IMF) work and includes a June 2006 review of the Public Finance Reform program already under way. 2. The goal of the report is to identify the major challenges facing the country in the prepetroleum era (the next three to five years) in public finance management (including public enterprises) as it attempts to implement its National Poverty Reduction Strategy (NPRS) with a tight resource envelope. In doing so, the report lays out its basic findings and priority action plan developed according to the country's capacity. The summary of the Health PER, undertaken in parallel, is presented in chapter two. 3. The Public Finance Management reform, which was launched in 2005, should address many of the concerns raised in this integrated report, but lack of capacity, successive political changes, and an attempt to seek assistance from Angola have slowed the progress. The next two years (2007­08) will be key years for the reform process, and we hope that the present analysis will be a further input into and impetus for the reform process. 4. This executive summary presents recent economic developments and fiscal sustainability analysis that takes into account petroleum and no-petroleum scenarios, with corresponding analysis on which of the Millennium Development Goals (MDGs) are reachable. The summary reports on revenue and expenditure performance since 2000-01, issues related to the implementation of the public investment program (PIP) and its coordination with the NPRS, and the budget process, including findings from the Health PER, which highlights a lack of allocative efficiency. The summary reports on the financial fragility of state-owned enterprises (SOEs) and the possible fiscal consequences for the central budget, especially regarding the implicit subsidies and tax breaks to (and the hypothetical tariff increases of) the electricity and water company. The summary of reports on the status of the public finance management system (budget preparation, execution, control, governance, and human resources) and the reform process that may address many of the concerns it raises. Finally, the summary presents the findings related to the procurement process, including the legislative and regulatory framework, institutional framework and management capacity, procurement operations and market practices, and integrity and transparency of the system. 1 Common Issues The overview of public expenditure patterns and composition between 2001 and 2005 highlights a lack of fiscal discipline. There are large increases in current expenditures, for which mandatory expenditures play a dominant role, at the expense of a shrinking development budget. Overall budget execution shows large deviations and composition variance compared with the programmed budget. There is systematic overrun of the current budget and systematic under-performance of the development budget. Deviations in the development budget are the main driver of the central budget deviations. The continuous tensions between receipts and payments in the treasury operations contribute greatly to the divergence between the programmed and executed budgets, because the treasury is forced to practice cash budgeting instead of following a financial program. The authorities are committed to implementing the National Poverty Reduction Strategy (NPRS) and there have been noted budget increases in some priority sectors (health and education). However, the allocative efficiency of the budget is weak because of the dis-connect between the NPRS, the budget and Public Investment Program (PIP). The implementation issues related to the PIP further constrain efficient budget implementation. In the health sector, while total spending has increased, the pattern of expenditures suggests a lack of allocative efficiency and an inequitable use of budgetary resources. To ensure fiscal discipline and sustainability, the authorities need to take into account the financial status of the four infrastructure SOEs and their impact on the central budget. They also need to review their policy options regarding the implicit subsidies provided to the electricity and water company (EMAE). Until mid-2006, the antiquated public finance system had made it difficult for the authorities to maintain fiscal discipline and sustainability. The management laws were antiquated, the overall budgetary practices (preparation, execution and controls) suffered from institutional and human capital weaknesses, the information system was fragmented information, and there was no specific legal framework for governance). To improve the public finance management system, the authorities need to reform the antiquated procurement law, weak institutional framework and management capacity, outdated procurement operations and market practices, and the integrity and transparency of the public procurement system. Main recommendations Key measures would introduce more flexibility in the government's expenditure policies: (i) improving the overall fiscal situation by increasing domestic revenues to enhance the volume of available resources, (ii) ensuring that post HIPC Completion Point, all HIPC debt relief will not be absorbed by mandatory 2 expenditures; (iii) undertaking any new borrowing in highly concessional terms (grants or grant elements over 60 percent); and (iv) improving coordination and harmonization with donors. (ii) exerting tighter control over current expenditures by (i) analyzing and updating civil service rosters and remuneration structure to improve management and control of personnel costs; and (ii) revising the use of the budgetary category "common expenditures"; (iii) review and consider revising the content of the budget category "transfers". (iii) improving cash budgeting process by (i) creating a cash management committee; and (ii) adopting a more transparent and programmed approach to cash budgeting. Assist the NPRS Unit (Poverty Observatory) to become fully functional and create the institutional infrastructure to allow fuller integration of the NPRS goals and the Government's annual policy and budgetary goals. Develop a multi-year macro- economic framework and in the medium term consider adopting a medium term expenditure framework to facilitate the coherence between national development goals and budgetary process. Involve sectors in this process to remedy the weak of sectoral allocative efficiency. A detailed set of suggestions are provided in chapter two to help reform the organization and the structure of the health delivery system. This would improve allocative and economic efficiency as well as equity. To improve the status of the SOE finances and by extension diminish the risk to the central budget, clearing SOE arrears should be an immediate goal of the government. In the longer term, the government should consider adopting strategies for each infrastructure SOEs and corporatizing them. Inviting private sector participation will be key to the eventual restructuring and long term health of these SOEs. The authorities launched a reform of the public finance system in 2005 that encompasses budgetary processes. The following steps are critical to the reform process: (i) Fully implementing the new organic law and its related implementation manuals; (ii) implementing a new accounting plan; (iii) fully implementing the newly adopted budget nomenclature; and (iv) installing and operationalizing the IT system for the new integrated public finance management system (SAFE). In the medium term, a macroeconomic model to provide perspective on financial needs, creating a cash management committee and computerizing production of treasury balance will be important tools. Finally, the country would benefit from a law that would forbid elected officials from holding positions in the public administration. Reform of the procurement system has been a bit slower to start, but the authorities are committed to moving ahead with the reform process. They should consider: (i) adopting a new procurement law and regulations; (ii) adopting standard procurement documents and evaluation reports; and (iii) creating a public procurement department within the Directorate of Treasury and Patrimony. In the longer run, the following measures will be helpful to the reform process: (i) setting up an independent regulatory body; (ii) setting up an information system to collect, treat and publish procurement information; and (iii) developing a national capacity building strategy for procurement. 3 Recent macroeconomic developments suggest a need for continued fiscal and monetary discipline to support growth and control inflation 5. São Tomé and Principe (STP) is Africa's smallest economy with some 166,000 inhabitants, a land area of just over 1,000 square kilometers, an estimated gross domestic product (GDP) of US$114 million in 2005 and a gross national income (GNI) per capita of US$740. As of 2001, 54 percent of the population lived in poverty, and 15 percent lived in extreme poverty. STP faces many development challenges because of its small size and vulnerability to terms of trade and other external shocks. Its economic and social indicators are negatively affected by remoteness and insularity, susceptibility to natural disasters, limited institutional capacity, a narrow resource base, vulnerability to external shocks, limited access to external capital, and entrenched poverty. Social indicators in STP are weak and progress toward achieving the MDGs is slow, with a strong likelihood that most MDGs will not be reached. 6. STP's real GDP growth has reached 4.5 percent in 2004. Growth and inflation picked up momentum in 2005 and 2006 with the expectation of a possible oil discovery, election-related expenditure, and accommodating monetary policy. Starting in 1999, the government implemented structural reforms for economic diversification, deregulation of prices, and some privatization, which helped to revitalize economic growth during 2001­04, but inflation trended up from an average 9.2 percent in 2002 to an average 12.8 percent in 2004, in part because of expenditure pressures arising from the political instability. Growth performance accelerated in 2005 to 5.4 percent based on a services boom (transport and tourism) and a construction boom mainly driven by foreign direct investment (FDI) in tourism in anticipation of a possible petroleum era. Inflation inched up, however, to an average of 16.3 percent in 2005 because of loose monetary and fiscal policies. In 2006, election expenditures further fueled growth to an estimated 7 percent. But lose fiscal and monetary policy in the first half of the year led to high inflation (23.1 percent) for the year, despite fiscal and monetary tightening in the second half of 2006. This high rate of growth is not likely to be sustained if commercially viable petroleum is not found and exploited in the medium term. 7. STP's economy is characterized by twin structural deficits. The external deficit is the result of the country's narrow and insular domestic market and a limited export base. Exports are limited to cocoa and, in recent years, a growing tourism sector. Imports are large and diversified, from food to oil. The non-oil fiscal deficit mirrors the country's external structural deficit. Despite noted improvements in domestic revenue collection, the government changes (six times in four years) and social demands led to stop-and-go policy making, which increased expenditures. These factors have led to high and unsustainable domestic non-oil primary deficits (from a deficit of 2.6 percent of GDP in 2002 to a high of 12.2 percent of GDP in 2004 because of large domestically financed investment and social projects). The deficit decreased to an estimated 8.6 percent of GDP in 2006 thanks to strong fiscal and monetary discipline in the second half of the year. This expenditure pattern has left the country highly dependent on external financing to close the budget gap (per capita aid reached US$218 in 2004) and vulnerable to increased public indebtedness. There are no prospects for any petroleum production revenues before the middle of the next decade (2010s)s, at the earliest. 8. In early 2006, a first exploratory well in the most promising block found petroleum but was deemed commercially nonviable. The next exploratory well is not planned before 2008. If petroleum is found in 2008, petroleum production revenues would not flow to STP's coffers until sometimes during the middle of the next decade. . Until late 2006, oil revenues have been limited 4 to the payment of one oil bonus in 2005 for signing the production sharing contract (PSC) on block 1. This bonus, amounting to US$49.2 million, was disbursed to the National Oil Account in 2005. Another payment of US$28.1 million is expected in early 2007 as a bonus for signing contracts on blocks 2 to 4, but US$15 million of it will have to be used to repay short term loans by Nigeria. Fiscal sustainability in the medium to long term is sensitive to policy choices and petroleum prospects 9. The recent expenditure pattern will not be sustainable in the medium term (2007­10), even with the enhanced Heavily Indebted Poor Countries/Multilateral Debt Relief Initiative (HIPC/MDRI) and currently known signature bonuses. If no new oil bonuses are paid in 2007 or 2008, and corrective fiscal measures are not taken in 2007-08, the fiscal deficits from 2008 on will be difficult to finance despite the financial inflows related to the PIP, private investment and the drawings from the National Oil Account. Increasing revenues may partially help but with the ongoing tax reforms, it is possible that tax revenues would dip in the next two to three years before better tax collection takes effect. In effect, the authorities are already taking corrective fiscal measures in their 2007 budget to control expenditures and continue to do so in 2008 through their current PRGF program. In the longer term (2010­15), if oil is not commercially exploited, maintaining the expenditure patterns of the past few years would further widen the fiscal deficit to unsustainable levels. As oil bonuses run out after 2010 and in the absence of other oil revenues, the overall fiscal deficit after grants and drawings from the National Oil Account will widen to 2.6 percent if GDP by 2015,Most of the deficit will be without financing after 2010. Therefore, if no corrective fiscal measure is taken well before 2010, by improving domestic revenues and by restraining current expenditure, the PIP would bear the brunt of the fiscal adjustment (a cut of 50 percent by 2015). If oil production comes on line in the first half of next decade continuing with the recent expenditure patterns (and fiscal stance) during the interim period is not sustainable. FDI and donor financing will not be sufficient to finance the external gap until oil related revenue flows start, because expectations of the petroleum era will increase domestic demand and imports and widen the current account deficit from 27 percent GDP in 2010 to 50 percent of GDP in 2015. Fiscal sustainability suggests living within the country's available financial means. In other words, it requires adjusting the domestic expenditure envelop to two major financial flows: (i) the actual oil-related revenue inflows to the country and (ii) revenues from donors. In the longer run, successful implementation of the NPRS requires the creation of fiscal space for investment by controlling current expenditures. If the current mix of expenditures does not change, the overall fiscal constraint may fall more heavily on capital expenditure (a 45 percent reduction) because current expenditures will continue to crowd out investment (capital expenditures). To improve non-oil fiscal space and sustainability, the authorities have improved tax revenues markedly over the last few years. In the meantime, foreign aid, the main source of revenues for the government budget, has been volatile. 5 10. STP has made an important effort during the last five years to increase non-oil revenues. The share of total non-oil revenues to GDP trends upward from 27.8 percent in 2000 to a predicted 35.6 percent in 2006. The government seems set to continue with reforms in the country's tax system and collection via adoption of new tax codes (for implementation in 2007 and 2008). 11. The collection of tax revenue over the period 2000­05 has been particularly satisfactory, increasing from 10 percent of GDP in 2000 to 15.1percent of GDP in 2005, compared to Niger's share of tax revenue to GDP (10.4 percent in 2005). The improvement has been especially notable in direct taxes, for which collections have increased from 2.7percent of GDP in 2000 to 4.6 percent of GDP in 2005. A more thorough study of the impact of the draft personal and corporate tax laws would ensure that the authorities understand their economic impacts. 12. Indirect taxes are the main domestic source of tax revenues, representing 51 percent of current revenues (excluding grants) in 2005 compared with 47.6 percent in 2000, and are well above HIPC countries (39.3 percent of current revenues, excluding grants). Indirect tax collection could be improved by reducing the import tax exemptions. Until late 2005, exemptions alone cost dobra (Db) 9 billion per year or 9 percent of the total amount collected by customs. Removing exemptions from SOEs should be studied as an option to reduce this type of revenue losses. 13. Although tax revenues have risen notably over the past five years, foreign aid continues to be the main source of revenues for the government budget. Foreign aid is mainly bilateral, led by Taiwan, Province of China and Portugal, and has provided around US$17 million per year to the budget. This amount finances 50 percent of total public budget and represents 17.2 percent of GDP in 2005, which reflects a high ratio of dependence to external resources when compared with the average of HIPC countries (4.1 percent of GDP). Table 1: Central Government Revenues, as percent of GDP (actual) 2000 2001 2002 2003 2004 2005 2006 (p) Total Non-oil Revenues (inc. grants) 27.8 37.8 29.4 34.4 36.8 34.6 35.6 Current Revenues (tax and non tax revenues) 13.5 14.1 13.6 15.1 17.7 17.4 18.7 Tax Revenue 10.0 11.6 11.4 12.3 13.9 15.1 15.6 Direct taxes 2.7 3.4 4.0 3.0 3.9 4.6 4.3 Profit Tax 1.0 1.5 2.2 1.3 1.7 2.0 1.9 Salary Tax 1.8 1.9 1.8 1.7 2.2 2.6 2.4 Indirect taxes 6.4 7.3 6.5 7.6 8.4 8.9 9.5 Import Duty 3.0 2.9 2.8 3.3 3.4 3.4 3.3 Imported Goods excise tax 3.3 4.2 3.4 3.4 4.4 4.7 4.7 Local Goods excise tax 0.1 0.3 0.2 0.8 0.7 0.8 1.6 Other* 0.9 0.9 0.9 1.7 1.5 1.7 1.7 Non-tax Revenue 3.5 2.5 2.2 2.8 3.8 2.3 3.1 Transfer from state owned enterprises 0.9 1.2 0.7 0.5 0.4 0.3 0.4 Fishing Royalties 1.4 0.4 0.2 1.1 0.7 0.0 0.5 Other** 1.2 0.9 1.3 1.2 2.8 2.0 2.2 Grants 14.3 23.6 15.8 19.3 19.1 17.2 16.9 Budget support grants -- 2.6 0.1 0.3 1.9 1.5 0.6 Project grants -- 17.9 13.2 15.3 13.8 12.8 12.8 HIPC -- 3.2 2.6 3.8 3.4 3.0 3.5 Oil Signature Bonuses -- -- -- -- -- 47.2 45.6 Nominal GDP 592.0 676.1 835.3 929.3 1060.9 1188.7 1526.3 Sources: Ministry of Planning and Finance, Government Fiscal Operations P: preliminary data for 2006 * Other tax revenues include a miriad of smaller taxes: seal tax, assitance seal, property transfer tax, urban property tax. ** Other includes revenues from fines and fees, other non-specified receipts and and the 13 percent markup on the oil sales from a Nigerian oil grant. The non-oil fiscal discipline and sustainability, however, has been affected by (i) stop- and-go expenditure policies, (ii) weak execution of the current and investment budgets. 6 (i) The budget discipline has been affected by stop-and-go expenditure policies over the years. 14. The overview of public expenditure composition and evolution between 2001 and 2005 highlights a lack of fiscal discipline. There are large increases in current expenditures, for which mandatory expenditures play a dominant role, at the expense of a shrinking development budget. During the last five years, frequent political crises (six government changes or reshuffles in four years, a coup d'état in 2003) and talk of the arrival of petroleum revenues fanned public demands for spending on services, roads, and salaries and increased political pressures on the government, which affected budget discipline. Such petroleum-related expectations induced a premature overestimation of the public revenues and therefore expenditures, which were especially visible in 2004. Table 2: Main Expenditure Categories (Budget execution) Unit: Billion Dobras 2001 2002 2003 2004 2005 2006 (est.) (prog.) Expenditure and net lending 335.3 325.6 415.1 548.5 528.7 708.3 Recurrent expenditure 121.9 156.8 183.3 292.5 314.4 387.3 Personel costs 40.5 43.6 55.0 75.7 103.2 124.5 Goods and services 18.8 26.7 43.9 95.8 66.2 79.0 Transfers 13.1 40.7 35.9 65.9 83.2 100.3 Interest on debt 24.8 25.9 26.1 30.1 33.7 38.8 Other 24.8 20.0 22.4 25.0 28.1 44.8 Development expenditure 213.4 168.8 231.8 256.0 214.3 321.0 Public investment programme 194.3 140.0 197.9 234.9 186.4 266.0 HIPC funded expenditure 17.2 22.5 33.6 30.1 27.9 55.0 Public Service Restructuring 1.9 6.3 0.0 0.0 0.0 0.0 Net lending 0.0 0.0 0.3 -9.0 0.0 0.0 In % of GDP Expenditure and net lending 49.6 39.0 44.7 51.7 44.5 46.4 Recurrent expenditure 18.0 18.8 19.7 27.6 26.5 25.4 Personel costs 6.0 5.2 5.9 7.1 8.7 8.2 Goods and services 2.8 3.2 4.7 9.0 5.6 5.2 Transfers 1.9 4.9 3.9 6.2 7.0 6.6 Interest on debt 3.7 3.1 2.8 2.8 2.8 2.5 Other 3.7 2.4 2.4 2.4 2.4 2.9 Development expenditure 31.6 20.2 24.9 24.1 18.0 21.0 Capital expenditure (Public investment programme) 28.7 16.8 21.3 22.1 15.7 17.4 HIPC funded expenditure 2.5 2.7 3.6 2.8 2.3 3.6 Public Service Restructuring 0.3 0.8 0.0 0.0 0.0 0.0 Net lending 0.0 0.0 0.0 -0.8 0.0 0.0 Source: Ministry of Planning and Finance, IMF staff 2006. 15. Overall government expenditure held relatively flat since 2001, while current expenditures increased, reducing the fiscal space for expenses in capital expenditure. Overall, government expenditure has added up to 44.5 percent of GDP in 2005 and an estimated 46.4 percent of GPD in 2006, compared to 49.6 percent of GDP in 2001. Current expenditures represented 18.0 percent of GDP in 2001 compared with 26.5 percent of GDP in 2005, and mandatory current expenditures (including salaries, telecoms, and energy expenditures) have increased from 59 percent in 2001 to more than 70 percent of total current expenditures in 2005. 7 Most of the expenditure components have increased, particularly transfers (rising from 1.9 percent of GDP in 2001 to reach an estimated 6.6 percent of GDP in 2006) and personnel costs (rising from 5.2 percent of GDP in 2001 to 8.7 percent of GDP in 2005). The personnel costs explain about one-third of the total current (and mandatory) expenditure over the last three years. Of the total personnel costs in 2005, 85 percent are constituted by the embassies and four ministries (Education, Health, Defense, and Finance). These ministries also pay the highest variable remuneration 16. The divergence in composition and distribution of personnel costs raise concerns about the fairness and the cost-efficiency of the current personnel remuneration structure. They highlight the need for more in-depth analysis of the civil service structure and compensation package. Authorities can use such an analysis to improve the civil service compensation package while understanding and better controlling its budgetary impact. Specifically, control of the discretionary component of the salaries will provide more transparent and predictable personnel cost estimates while simplifying management of salary calculations. The authorities are attempting to unify two databases to start such an analysis. 17. Development expenditure (including HIPC funds), in turn, has shrunk from 31.6 percent in 2001 to 18.0 percent of GDP in 2005, with an estimated increase to 21.0 percent for 2006. Furthermore, in 2005, only 45 percent of development expenditure budget was actual investment compared with 75 percent in 20001, as the government has increasingly financed current expenditures through the PIP. When this is accounted for, actual public investment in 2006 represents merely 9.45 percent of GDP compared with 23.7 percent of GDP in 2001. Figure 1: The Composition of Expenditure in the PIP, 2000­05 100% 90% 20.50 25.37 28.82 80% 39.43 46.18 54.73 70% 60% 50% 40% 79.50 74.63 71.18 30% 60.57 53.82 45.27 20% 10% 0% 2000 2001 2002 2003 2004 2005 Capital goods Current expenditure Source: São Tomean Authorities 18. Despite the authorities' success in raising non-oil revenues over the same period, they will need to exert more discipline on current expenditure to create fiscal space for pro-poor development expenditures. (ii) Weak budget execution has affected fiscal discipline and sustainability. 8 19. Overall budget execution shows large deviations and composition variance compared with the programmed budget: total expenditure deviation ranges around 30 percent, while total expenditure variance is more than 70 percent.3 20. Overall, data show a systematic overrun of the current budget with the ratio of planned to executed budget peaking at 164 percent in 2004 then falling to a more reasonable 103 percent in 2005. The overruns of the recurrent budget highlight that hard budget constraints were not respected over the last few years.4 This overrun may be explained by three factors: (i) the role of the political institutions in the recurrent budget overrun; (ii) social demands for expenditures in anticipation of petroleum revenues, which led to back-to-back salary increases and similar expenditures; and (iii) telecommunication and electricity costs and payments to the Joint Development Administration, which were used to manage the biddings for the joint maritime petroleum blocks (shared with Nigeria). 21. Conversely, the development budget is underperforming systematically, with the ratio of planned to executed budget a high of 69 percent in 2003, dropping to 51 percent in 2005. Several corresponding factors play a role, including the following: (i) the chronic difficulty of the administration to coordinate donors; (ii) the donors' complex and time-consuming rules and procedures, leading to delayed or cancelled disbursements; and (iii) a low administrative and domestic absorptive level capacity (discussed below). 22. The aggregate deviations of the recurrent budget seem to have improved over the last years (from 33.1 percent to ­4.8 percent in 2005). The investment budget (PIP) is the main culprit for the largest deviations (from 24.6 percent deviation in 2003 to 52.5 percent in 2005), which is affected by the factors explained above. But the high level of the composition variance in both current and investment budgets signals that budget programming is out of sync with execution and that shifting funds between budget lines is a normal practice. 23. The consistent and large overruns of the common expenditure (more than 200 percent of budgeted amount) are due to the fact that the category has been used as a "catch-all" category. It represents 20 to 25 percent of the total current expenditure since 2002. It includes about 50 percent of the expenditures on Goods and Services, including energy costs, making it sensitive to the changes of oil prices and therefore cost of electricity prices.5 The high overrun of 2003­05 was partly explained by the items Water, Energy, and Communications, whose costs doubled between 2003 and 2004 and increased further in 2005. The overall budget discipline would benefit greatly from a more vigilant approach to the programming and execution of the budget line on common expenditures. 3"Total Expenditure Deviation" measures the ratio of the sum across all spending units of the differences between budget and actual spending, to the total budgeted expenditure. The fact that the differences might cancel out each other justifies a similar indicator, the "Composition Variance," for which the differences between budgeted and actual spending are taken in absolute terms. 4The lack of respect for the programmed budget is even more apparent because these overruns were not systematically and legally introduced via amendments of the national budgets and presented to the National Assembly for new approval until 2005. In 2005, when it became apparent that the approved expenditure in some categories would be changed, the government changed its previous practice and submitted an amended (rectificativo) budget to the National Assembly. 5The large majority of electricity production in São Tomé and Principe has a thermal source. Import of gasoline constitutes the largest expenditure for the electricity and water company (EMAE), which in turn has increased its electricity tariffs several times in an attempt to remain economically viable. 9 24. The continuous tensions between receipts and payments in the treasury operations contribute greatly to the divergence between the programmed and executed budgets, because the treasury is forced to practice cash budgeting instead of following a financial program. Cash budgeting implies that priority is usually given to mandatory current expenditures (such as salaries, payment of scholarships, and the like) instead of the programmed and budgeted expenditures (such as investments related to the NPRS action plan). The budget's high dependence on volatile external aid compounds the difficulties of budget management. 25. To reduce the negative effects of cash budgeting on budget execution, the authorities could take the following steps: (i) create a cash management committee and adopt a more systematic approach to cash budgeting (ii) improve the predictability of aid (discussed below); (iii) improve efficiency in the use of government resources by adopting a more transparent and programmed approach to cash budgeting (for example, publish the cash release plan and then execute the actual release for each month according to plan); (iv) improve the allocation of resources by linking cash releases more closely to the government's budget objectives and long- term priorities; (v) limit the number of cash releases to overcommitted ministries or directorates; and (vi) publish budget execution data on a quarterly basis, highlighting deviations. While retaining budgetary discipline, the authorities are interested in the continued implementation of the NPRS action plan. Because the PIP is the main implementation instrument for the action plan as well as a main source of large budgetary deviations, it is important that the authorities remedy (i) the disconnect between the NPRS, the PIP, and the budgeting processes (allocative efficiency) and (ii) the implementation issues related to the PIP. 26. The national authorities have clearly expressed their commitment to implement the NPRS, and the budget has dedicated increased funds to the health and education sectors in the past few years. However NPRS seems disconnected from national policy instruments such as the Grandes Opções do Plano (GOPs), the policy document that the government attaches to the annual budget.6 Moreover, the `policy measures' set out in the GOPs are not clearly reflected in the PIP which should be the main tool to implement the measures with cost implications. The set of indicators included in the NPRS document has not yet been adopted by the PIP management. Consequently, it is not possible to monitor and assess the interventions derived from the NPRS and materialized through the PIP. Similarly, at the sector level, the NPRS does not seem to have been adopted in practice by the ministries as the main policy reference in the preparation of their investment proposals. 27. Furthermore, STP's budget was not classified using the standard functional nomenclature (COFOG) for the period 2001-2006 (estimated). This shortcoming affects the scope of our analysis. Nonetheless, we developed three simple alternative measures to analyze the connection between the NPRS and budget execution. The three alternative methods are: (i) to aggregate the different sectors/ministries by general function similar to functional nomenclature and; (ii) 6The main policy documents that presently inform, or should inform, the budget preparation are the National Poverty Reduction Strategy (NPRS), the Grandes Opções do Plano (GOPs) and the Programa do Governo. GOPs map out the policy options, segmented in `options' or pillars, that the government intends to implement in line with the budget for the next year. Hence, GOPs besides the constitutional obligation of submitting it yearly to the National Assembly, accompanying the Budget Law, is a very useful document for the public and the decision-makers, as it serves as a bridge between the overall policy targets, specifically the targets set out by the NPRS, and the budget. The `policy options' laid down in GOPs are supported by detailed stated `policy measures', which are a mix of actions with financial implications, decisions and tasks to be carried out by the administration. 10 aggregate the data by NPRS priority sectors/ministries; (iii) to use the ad-hoc "pro-poor" definition used by the government, encompassing the ministries of education, health and work and solidarity.7,8,9 Care should be given in interpreting all three measures as the clear beneficiaries of these expenditures can not identified. 28. The main findings raise concerns about the quality of expenditures. The coherence between policy goals (NPRS) and the budget allocations needs to be strengthened. We note two other dichotomies in performance: (i) in the level of current vs. development expenditures; and (ii) in the differentiated performance between sectors health/education compared to agriculture/infrastructure sectors. There are also sector specific issues related to policy and budget coherence as well as programmed vs. excecuted budget. These are discussed in the context of the review of public expenditure in health (in the last section of this chapter). 29. The analysis finds: The share of the social expenditures (mainly Education, Health, and Labor) in the total current expenditure has been a steady 30 percent since 2001 ­ that is ­ before the adoption of the NPRS, showing the long term government's commitment to social sectors. The overall the weight of the NPRS-related sectors captured a sizable share of total public expenditure but seems to decrease between 2002 (57.6 percent) and 2005 (44.8 percent). The budget for 2006 plans an increase. Such an evolution is disappointing given the fact that the year 2002 sets the initial momentum for the strategy for poverty reduction, following the approval of the Poverty Reduction Strategy Paper by the government. The current and development budgets have performed differently over the past few years. Current expenditures for the NPRS priority sectors have increased over the 2002-2005 period, with continued increase predicted for 2006. The performance of the development budget has been more volatile, with a decrease in 2002-2005. The measure "pro-poor expenditures" based on the economic classification of public expenditure, confirms the dichotomy between current and development expenditures. The decrease in the execution of the development budget is due to a number of political challenges and institutional difficulties related to securing funds and implementing the PIP program. The political constraints are related to the July 2003 coup and multiple government changes that have contributed to delays in receiving donor funds and implementation of 7These `general function categories are: (i) general administration and political institutions (national assembly, local administration, presidency of the republic, Prime Minister's Office, Principe, Foreign Affairs (excluding embassies), and Justice); (ii) social sectors (media, labour and vocational training, education and culture, youth and sports, health, natural resources and environment, infrastructure and land); (iii) economic sectors (finance excluding debt, economy, agriculture and fishing, trade, industry and tourism); and (iv) other sectors (defense, public debt, common expenditure, embassies, other). 8The NPRS priority sectors are Ministry of education and culture, Ministry of Health, Agriculture, Justice and Infrastructure. 9As there was no standard functional classification , the Authorities developed this ad hoc "pro-poor" definition in 2004 to address the concern that the macroeconomic program with the IMF (Staff Monittored Program ) should protect pro-poor expenditures while controlling current expenditures. The pro-poor expenditure (recurrent and capital) is derived from the economic classification in some selected ministries (Education, Health and Labour and Solidarity). This category was developed in coordination with the IMF, and with input from the World Bank. The list is included in the IMF report `IMF (2005), Staff Report for the 2005 Article IV Consultation'. 11 projects. The institutional difficulties in implementing the PIP are discussed in a section below. The analysis of the NPRS priority sectors reveals the differentiated performance of the major sectors: a) Education and justice show an overall upward trend while health is stable over the period. Agriculture has shrunk dramatically while infrastructure shows large annual variations. b) The Health sector, after gaining some weight in 2003 in comparison to 2002 remains stable ever since (around an average of 10 percent of GDP over 2003- 2005). c) Agriculture shows a steady fall in its participation in both the total public expenditure and the GDP between 2001 and 2006 (est.), while infrastructure shows annual variations. These outcomes in Agriculture and Infrastructure is despite the fact that both are considered priority sectors in the NPRS and essential in fostering wide-based economic growth. Several factors may explain these outcomes. One explanation is that the donor executed projects in these two sectors are not properly recorded in the central budget execution system due to weak management and follow-up of PIP and inconsistent reporting by donors. Another related factor may be low execution of projects rate due to delayed or cancelled donor funds or weak national implementation capacity. However, in the case of Agriculture, it should be noted that it is not just the low execution rate of the public expenditure (both recurrent and development) that explains the disappointing outlays in Agriculture. In fact, the funds allocated to the Ministry of Agriculture show a consistent tendency to diminish over the last years, thereby reflecting a policy choice which contradicts the priority role given to this sector in the NPRS. Figure 2: Weight of the NPRS-related sectors in the total public expenditure 25.0 20.0 Justice 15.0 Education % Health 10.0 Infrastructure Agriculture 5.0 0.0 (est.) (prog.) 2002 2003 2004 2005 2006 Justice 0.8 1.6 1.8 1.5 1.0 Education 11.1 14.4 10.0 16.2 17.5 Health 10.9 13.6 12.8 13.5 11.9 Infrastructure 23.7 22.4 13.9 10.3 19.4 Agriculture 14.5 5.6 2.6 3.3 0.5 The institutional difficulties in implementing the PIP: 30. The PIP is highly dependent on external bilateral financing, making its implementation vulnerable to delays in aid disbursements and donors' bureaucratic requirements and its execution 12 rates low. On average, 70 percent of the total financing of the PIP over the last four years came from external sources. Bilateral financing dominates with Taiwan (Province of China) and Portugal as major partners. To improve predictability of aid, the authorities should (i) encourage further donor coordination and harmonization of financial and procurement requirements, (ii) create a cash management committee and adopt a more transparent and programmed approach to cash budgeting; and (iii) move ahead with the Public Finance Reform and especially reform of the national procurement law and processes that will enhance donor confidence in the national procedures and facilitate flow of aid. Over the medium term, the authorities should consider adopting a medium term expenditure framewoThree important organizational issues constrain PIP's management. Fist of all, the PIP expenditure process is cumbersome and involves too many actors. This slows down the implementation of projects. Secondly, the absence of planning departments in the spending ministries. This leaves the Directorate of Planning of the MPF without a regular interlocutor to discuss the budget implications of the sector policies, the elaboration of the public investment program and its implementation.10 Finally there is insufficient guidance from the Directorate of Planning and the NPRS Unit (or Poverty Observatory) for the sectors to prepare their investment proposals in line with the poverty reduction strategy and a lack of appropriate tools to prepare and select the investment proposals in line with the NPRS objectives as the current information systems are not adequate11. 31. The domestic factors for low execution rates and absorptive capacity are administrative and financial. First, the projections of the availability of external resources on a yearly basis need to be more realistic.12 Second, the earlier approval of the state budget would provide the funds for the PIPs to be launched earlier in the year. Third, expediting approval or endorsement of credit agreements with foreign entities would help the country secure funds more quickly,13 because it has to go through a long clearance process involving the National Assembly, the Presidency of the Republic, and the General Attorney.14 Fourth, adopting financial programming at the treasury would ensure the regular inflow of domestic resources.15 Finally, counterpart funds, covered by the state budget, are not always released on a timely manner, likely because of cash shortages, which cause delays in the project implementation. 32. Institutionally and technically, for the PIP to be implemented in a more efficient and systematic manner, several factors need to be addressed: (i) creation of planning departments in 10 In practice, such role is often fulfilled by the sectoral Ministers' direct advisers, but they have multiple responsibilities, diverting them from a regular monitoring of the sector investment program. 11They lack consistency (development and recurrent expenditure use different classifications) and integration (PIP is linked neither to the recurrent expenditure nor to the NPRS). The old database used in the management of PIP does not respond to the information needs raised by the NPRS. The existing functional classification could in theory provide an alternative, but it is too aggregated to allow a direct matching with the NPRS objectives. Therefore, the `project fiche' filled up by the sectors does not contain the required information for that purpose. 12Another signal showing the tendency to overestimate the availability of external resources is given by the amount requested to finance the NPRS and the actual spending capacity: NPRS financial requirements of US$168 million for the period of 2006­08 imply an yearly investment average of US$56 million, well above the actual annual average of only US$23 million over the last four years. 13Currently, approval or endorsement of credit agreements goes through the National Assembly, the Presidency of the Republic, and the General Attorney. This process can be lengthy. 14Apparently, the Ministry of Planning and Finance has lately assumed a more active stance to accelerate the ratification process. 15In turn, this is explained by a number of factors, such as poor programming, unpredictable disbursements by donors, and difficulties in collecting taxes. 13 the sectoral ministries that will engage the sector in the programming and execution of the investment projects; (ii) full activation of the NPRS Unit (Observatory of Poverty) to supervise implementation of the NPRS action plan and synchronize the PIP with NPRS and to monitor its outcomes and outputs; (iii) reform of the budget execution process; (iv) improved project selection criteria to avoid politically driven earmarking; (v) institutional setup that would combine the efforts of the Directorate of Planning, the NPRS Unit, and the Directorate of Statistics to make operational the set of indicators included in the NPRS, develop new ones if necessary, and monitor and evaluate them periodically and (vi) a system wide Monitoring and Evaluation (M&E) and information system is needed. 33. The ongoing public financial management (PFM) reform ­ supported by the World Bank Governance Capacity Building Technical Assistance Credit (GCB-TA)- foresees a series of reform that would help improve the programming and execution of the PIP. This would include creation and staffing of sectoral planning units responsible for the sectoral development and implementation of the PIP. A more comprehensive information system to support the PIP's management, including monitoring and evaluation, should be adopted in line with the ongoing budget unification (as part of the PFM reforms). The Directorate of Planning plans to upgrade the present limited information system that is used to collect and process basic financial information for the PIP's preparation. The functional classification of the new budget nomenclature will help correct the disconnect between the structure and content of the NPRS document and the structure and composition of the state budget. It will also help identify the pro-poor expenditures more easily. A new procurement law is to be drafted to facilitate budget implementation. In the health sector, while total spending has increased, the pattern of expenditures suggests a lack of allocative efficiency and an inequitable use of budgetary resources. 34. Total spending (including private and externally sourced spending) in the sector rose from US$9.9 million in 2001 to US$14.4 million in 2005, a 45 percent increase. Domestic public spending more than doubled from US$2.7 million to US$6.6 million in the same period, highlighting the government's commitment to the sector and the important role of foreign aid in the financial sustainability of the sector. Overall per capita expenditure of the total national health system increased from US$72.5 in 2001 to US$96.6 in 2005. The central budget more than doubled its contribution from US$19.9 per capita to US$44.3 per capita. 35. The progress made in improving the average life expectancy (now an average of 65.6 years) and reducing infant mortality and morbidity are positive signs during the past five years. Results are above African averages, but there is room for improvement, as shown in the highly successful malaria program that reduced mortality of children under five from 89 to 60 per 10,000 in just two years. Table 3: General Epidemiological Indicators (per 1,000 inhabitants for 2000­05) 2001 2002 2003 2004 2005 Gross rate of birth 35.60 35.20 34.90 34.40 33.90 Gross rate of mortality 8.50 8.30 8.10 7.80 7.60 Rate of infantile mortality 82.70 82.40 81.50 80.70 79.80 Effective rate of population growth 1.97 1.97 1.97 1.96 1.95 Life expectency at birth 63.80 64.20 64.70 65.10 65.60 Source: Fonte: INE 2006. 14 36. Despite progress, the current health system suffers from a conjuncture of human, technical, and physical constraints that lead it to respond essentially to the most prevalent transmissible diseases, such as malaria, cholera, and acute diarrhea. Furthermore, the lack of a national integrated information system impedes a thorough analysis of inputs, outputs, and outcomes of the health system as well as policy development, implementation, financing, and evaluation. 37. The supply of health services is structured in seven sanitary areas (primary care) and one hospital. These services do not respond efficiently and equitably to the population's care needs. Although expenditures in health have increased, there is weak allocative efficiency and a disconnect between the government's planning and goals (as outlined in the NPRS and by the MDGs) and the amounts budgeted and executed. for instance, the NPRS and the sectoral strategies highlight the need for improved primary care, but 61 percent of the expenditures are used by the central hospital. Furthermore, as in the case of the overall budget expenditures, sectoral investments are being crowded out by current expenditures­­some 40 to 50 percent of the budget dedicated to sectoral investment are instead used for current expenditures. 38. Weak economic efficiency and equity are evident in the significant cross-district differences in allocation of expenditures per capita. In 2005, the district of Caué had the highest per capita expenditures (US$14.64), while the district of Agua-Grande (capital) had the lowest (US$2.12). Although per capita expenditure has risen over the last few years, this growth has not been equally shared, with wide variations across districts. In 2005, expenditures for the district of Caué grew by 1 percent, while those for the district of Agua-Grande (capital) grew by 34 percent. Correspondingly, access and use of health services are unequal. Use of the main hospital diminishes in reverse proportion to the distance to the town where patients reside. Conversely, the districts of Caué and Lomba, where use of primary care is the highest, use less hospitalization and ambulatory care. 39. The authorities need to reform the organization and the structure of the health delivery system to improve allocative and economic efficiency as well as equity. This reform should include five measures. The first measure aligns expenditures on primary health care to match the NPRS and national strategy. The second measure sets up an integrated system-wide monitoring and evaluation system to facilitate follow-up (including a financial accounting system). The third measure adopts the principle of equity in terms of cost recovery: update and unify the co- payments across all health care centers. The fourth measure addresses the actual functioning of the health system: (i) review the Health Care Plan (carta sanitaria); (ii) define reference networks among the health units providing care; (iii) improve physical access, (iv) introduce a patient triage system; (iv) review the process used to determine whether a patient is transferred to Portugal at the government's expense; and (v) decentralize budget implementation to provide more flexibility and control to the ministry (after adequate training of the sectoral staff). The fifth measure considers an alternative to the dependence of the sector on foreign aid, such as an eventual health system funded by the users (such as national health care system). To ensure fiscal discipline and sustainability and to create fiscal space for investments, the authorities need to pay urgent attention to the financial status of the four infrastructure SOEs and review their policy options regarding the implicit subsidies provided to the electricity and water company. 40. The four infrastructure SOEs­­water and electricity (Empresa de Água e Electricidade, EMAE), port management (Empresa Nacional de Administração dos Portos, ENAPORT), airport management (Empresa Nacional de Aeroportos e Seguranca Aérea, ENASA), and post (Empresa 15 de Correios, CORREIOS)­­jointly employed a total of 527 employees or 15 percent of the total employees in the public sector and generated combined annual revenues close to US$16 million­ ­that is, 14 percent of the country's GDP in 2005.16 The SOEs are heavily indebted, are financially fragile, and have difficulties sustaining the current level of services. In the case of EMAE, the financial difficulties are largely due to the increasing cost of imported fuel and lack of investment in distribution technology and more efficient or alternative electricity production technology. For all SOEs, the operating and financial expenses far exceed their gross sales; they have little access to investment or maintenance funds to maintain their equipment and machinery to continue providing even the present limited coverage and quality of service. Their combined liabilities had reached US$13,664,889 by the end of 2005. 41. The government, as sole owner of the SOEs, carries all the risk on behalf of these enterprises. Furthermore, it needs to calculate the contingent liabilities and set aside reserve funds if the water and electricity company (EMAE) were to sign the pending Power Purchase Agreement with an Independent Power Producer (IPP). The government has to either assume these liabilities and bail out the SOEs by injecting equity or encourage private participation in these enterprises to ensure continuity of service. 42. The SOEs indirectly provide the central government with additional fiscal space. STP's treasury is run on cash budgeting and, therefore, delaying payment for SOE services (especially EMAE services) allows it to use the available funds for more "immediate" expenditures. This delay in payments by the central government in turn causes the SOEs to face serious cash flow problems and accumulate tax, supplier, and wage arrears. 43. The authorities accept the fact that reforms are necessary, but the reform process needs to include cogent and well-targeted policies to improve enterprise performance while reducing risk to the central budget and the economy. In the short run, to improve the financial situation, an SOE Unit should carry out the process of complete stock-taking, which will help SOEs settle its arrears with the government and its interarrears among SOEs. Settling arrears would involve the following actions: (i) assess, program, and repay inter-SOE and SOE-government arrears; (ii) adopt a policy to avoid the build up of arrears; and (iii) budget indicative amounts in ministerial budgets to pay for SOEs' services. 44. In the medium to longer term, additional actions would include the following: (i) the SOEs should become corporate and commercial entities; (ii) consider incentive-based contracting; (iii) the nascent regulatory body of the country will need to be strengthened and, if necessary, the coverage of the regulatory law adjusted to ensure proper supervision of all the infrastructure corporations; (iv) the possibility of separating water from electricity functions should be analyzed; (v) a capacity building strategy should be adopted, including the option of twinning the SOEs and their staff with international SOEs; and (vi) the SOE Unit could take on more technical and complex tasks. 16In 2005, GDP was US$72 million. 16 Box 1: The Case of EMAE (Empresa de Água e Electricidade) The government needs to address the financial impact of EMAE's large implicit subsidies and tax breaks on the central budget and review its policy choices, especially because increasing tariffs would affect poverty markedly. The implicit subsidies received by EMAE are related to the price it pays for its fuel to ENCO (Empresa Nacional de Combustiveis e Oleos, the petroleum import and distribution company) and the import duty exemption (5 percent). In October 2006, ENCO sold fuel to EMAE at a price of 37 percent below the world market price. In 2005, the total value of the implicit subsidy could be as high as US$1.43 million. In 2005, tax breaks equal an estimated US$1.85 million, again lower because of the lower cost, insurance, and freight (CIF) import price. The option to increase tariffs to break even is socially and politically difficult to implement in the short run. In 2005, in the absence of taxes and subsidies from ENCO, the average increase in electricity should have been 73 percent. If taxes are applied, this average increases to 114 percent. If we assume keeping both subsidies and tax breaks in place, EMAE would have to increase its tariffs by 40.7 percent just to break even. Nonetheless, these estimates provide an interesting set of policy choices. EMAE's losses in 2005 amount to US$5.1 million when the implicit subsidies from ENCO, the tax breaks, and operating losses are included (US$3.28 million, excluding operating losses). This compares with a budget for recurrent expenditure for education of US$7.1 million, and recurrent spending for health of US$2.7 million in 2005. The existing electricity consumption subsidies are not efficiently targeted toward the poor. The poor targeting performance of the electricity consumption subsidy is driven by the comparatively low connection rates to electricity among the poor as opposed to the population as a whole. Analysis shows that an alternative to benefit the poor is to provide connection subsidies. In practice, however, the mechanism to provide eligibility for connection subsidies will determine how pro-poor connection subsidies really are. The government may wish to (i) adopt a more transparent and competitive way to review its approach to allowing private investment into the electricity production subsector; (ii) review the efficiency and targeting of current pro-poor programs, including targeting pro-poor subsidies in electricity to consumption versus connection; (iii) further examine the policy choices regarding implicit subsidies to EMAE versus other social programs. Until mid-2006, the antiquated public finance system (management laws, overall budgetary practices, fragmented information system, and low human capacity) had made it difficult for the authorities to maintain fiscal discipline and sustainability. 45. The government launched a PFM reform in 2005 to remedy these weaknesses and modernize the system. The efforts of the government in reforming it public finance management system is supported by a World Bank Governance Capacity building TA credit (GCB-TA) launched in 2005. The implementation of the reforms experienced delays, partially due to government changes and four elections in the first 9 months of the 2006. Difficulties in obtaining the new financial management software (promised by Angola) have also contributed to a long delay in the reform process. 46. The ongoing reforms include a recently adopted base financial management law. Installing and operationalizing an integrated computerized budget are expected to improve the institutional and legal processes (programming, execution, and control) of the budget (discussed more in details in the accompanying CFAA). Nonetheless, much more of the reform remains to be done, and this discussion on public finance management will feed into the reform process. 17 Box 2: Governance capacity building TA credit The Governance Capacity Building Technical Assistance Credit (GCB-TA) of US$5 million has three components: i) support of the Public Finance Management reform, ii) strengthen the Oil Revenue Management and iii) support PRSP implementation. The public finance component of the credit concentrates on the expenditure side of the budget in agreement with another donor who is to provide support for the reforms needed in revenue side (Tax and Customs Directorate mainly). The project has an integrated view of the reform, including the entire budgetary cycle (budget planning, execution and control). It includes revisions of the legal and institutional frameworks as well as training staff. Consequently, it also supports improvements in the directorates of planning and reform of the antiquated procurement law. So far, the GCB-TA has supported: i) a new public finance organic law, approved in 2006 that adopts new modern budgetary codes, including for the first time a functional classification ii) the set up of an integrated budget implementation IT system that links the directorate of Budget and the directorate of Treasury in a single budget execution system; and iii) provide assistance on Public Finance Management to the national institutions involved in the supervision of petroleum revenues. For the remaining of the life of the credit, this component of the project will assist the Government to i) draft a new procurement law, ii) set up an accounting department and draft a public accounting plan, iii) improve the investment budgeting, iv) initiate a Medium Term Expenditure Framework, and v) improve the IT system to produce public accounts, integrate the central bank, and improve its security. Until the end of 2006, the legal and regulatory framework was outdated, but a new organic law was adopted in December 2006 47. Until the end of 2006, the PFM of São Tomé was based on the Organic Law 1/86 of 1986. This law defined the rules of management and structured the current system based on the development and implementation of the budget, but without conforming to international standards, in particular in terms of accounting practices. The 1986 law did not address the many weaknesses of the budget elaboration calendar. It did not support an ad hoc budgetary formulation based on a genuine economic macroframework, did not reinforce the process of budget execution (particularly in terms of control), and did not support a coherent operation of PFM system. 48. The new organic law adopted in December 2006, developed with the support of World Bank technical assistance and in consultation with the IMF, reforms the PFM system, including its institutional and organizational aspects and is expected to contribute to a more transparent and effective use of public resource (see CFAA for details). However, the law still needs to incorporate a calendar for budget elaboration and approval, specify the need for a Medium Term Expenditure Framework (MTEF), clarify on the internal control procedures and include aspects related to foreign financed operations and payroll management. Budget preparation has been based on a dual budgetary process and has suffered from institutional and human capital weaknesses. 49. The current budget and investment budget have been developed separately, even though they are presented in the shape of a single document. Budget classifications did not conform to the international standards, in particular, with regard to functional classification and the coding of poverty reduction expenditures. The people involved in the process have little motivation and the sectoral ministries are not fully implicated in the process. Coherence with the NPRS is weak and 18 a multiyear horizon is not considered, because the budget does not include all flows. Although the organic law of 1986 presented a clear and detailed calendar, the National Assembly was not able to carry out a true study of the draft budget. Moreover, the process of budget preparation had suffered important delays in the past few fiscal years. In the document of the state budget, the budget used an accounting balance, not a real balance. Finally, the budget document was not exhaustive. 50. The process of evaluating the fiscal revenue and expenditure is affected by weak institutional capacity. The budget directorate (DB) carries out these evaluations, but neither the budget nor the tax directorates have the capacity to analyze the tax data effectively or assess potential tax revenues fully. As in other countries, current expenditure planning is limited by the budgetary constraints, while capital expenditure planning is dependent on external financing. 51. Budget elaboration suffers from the fact that the budget execution is globally weak and the assessment of the past expenditures is hampered by lack of information, in particular, those financed by external funds. The limits on the budgetary authorizations are not respected. The link between the fiscal exercise that is ending and the fiscal year that is starting is not ensured, the budgets are not pluriannual, and no vote has been held for the supplemental budget. Although the 1986 law envisaged it, it was only in 2005 that the National Assembly adopted a rectifiable budget law. 52. The new financial management law and the new budget nomenclature­­based on the Classification of Functions of Government (COFOG) and including the functional classification­ ­were adopted in late 2006. They will help budget preparation and presentation between current and investment budgets. Further improvements in the law, such as adopting a calendar for budget elaboration and adoption, will improve efficiency and timeliness of the system (see CFAA). The participation of the sectoral ministries needs to be boosted. Furthermore, adopting a medium-term macroframework will guide the budget process. Budget execution has been affected by the absence of modern processes and procedural manuals, especially in the case of treasury and accounting; insufficient human, technological, and financial resources; and a fragmented information system. 53. The collection of budget revenues, undertaken by the treasury, taxation, and customs directorates, has experienced notable success. For future legal and institutional reforms to further improve this record, it would be beneficial to ensure that the revenue directorates are covered by the new organic law and participate in the on-going PFM reform. The customs administration informally applies the international standards; however, lack of an accounting system makes tracking and optimizing tax collection difficult. Furthermore, the capacity to estimate paid and unpaid taxes is weak. Therefore, the amount of actual unpaid taxes is unclear at best. The tax system is primarily declaratory and the directorate does not have the legal instrument, operational budget, or human capacity to identify and pursue delinquent debtors properly. The agents do not have procedural manuals to follow or an adequate operational budget to undertake collection properly, which affects collection rates. 54. The expenditure system of providing funds to the sectoral ministries on a monthly basis is poorly synchronized with the resource mobilization schedule. The main risk is that the managers do not have the reliable forecast that would allow them to efficiently execute their budget. The actual budget execution is done based on the daily availability of funds (cash budgeting) without any real financial programming. 19 55. The current expenditure and capital expenditure procedures are cumbersome and frequently circumvented. The risk is that the practice of paying for services before they are provided may remain in force. The technical process of payroll management seems to be under control in the current practice. It will be necessary, however, to draft a procedure manual and unify the two existing civil service databases to increase transparency of the payroll process, improve the efficiency of the payroll system, and potentially save on the overall remuneration envelop of the public sector. 56. The information on the execution of foreign-financed projects and programs is still incomplete. Although multilateral partners tend to report within a satisfactory time frame, information on bilateral cooperation is of variable quality. This leads to poor tracking of the execution of the investments financed by external resources, affecting the management of public expenditure. It is critical for the authorities to (i) set up a functional, integrated tracking system at the Directorate of Planning or the NPRS Unit to improve the predictability of funding for the investment budget; and (ii) encourage donors to report on their project or program executions in a more timely and systematic manner. 57. Until the end of 2006 and the adoption of the new organic law, the Directorate of Treasury and Patrimony (DTP) did not have an accounting unit and did not perform any proper budget accounting. The role of the treasury division has been to pay the expenditures that have been approved by the Directorate of Budget (the sole agency authorized to approve expenditures). On a daily basis, approved payment vouchers are transmitted to the Central Bank, which also serves as the cash-clerk of the state. The division of the patrimony supervises the purchases and the sales of the goods of the state using an antiquated procurement process (discussed below). 58. The current accounting system is obsolete. Present government accounting includes recording, on a daily basis, expenditures and revenues undertaken by the Central Bank; no treasury balance is prepared. It is impossible to monitor the amounts outstanding and payable based on accounting rules. Balance sheet accounting is not conducted. Because there is no accountant bookkeeping, no treasury balance is established and no reports are available from one fiscal year to the next. Asset accountability does not exist so the government does not know with certainly the composition of its real or movable patrimony, its stock of nondurable goods and materials, or the state of its medium- to long-term debt. Therefore, it is not possible to establish some link between the possessions and the general balance sheet. 59. Ongoing public finance reforms envisage the provision of funds based on financial programming rather than monthly installments. The directorates of customs and taxation are to undertake reforms to address legal, institutional, and training needs. In expenditures, the authorities should respect budget procedures and not pay in advance for services and goods. The Directorate of Budget would benefit from a manual clarifying the modalities and procedures for the civil servant payroll management. Unifying the two existing databases containing the civil service employee rolls will help consolidate the civil service roster and the overall public service remuneration envelop. Developing and adopting a double-entry accounting system is critical to better budget management and a clear picture of the government's financial position. The proper functioning of the directorate of accounting, already created by the adoption of the new organic law, would be a definite improvement of the budget management process. Also, the budget management process will benefit from more exhaustive reporting of the budget execution. 60. The information systems used until mid-2006 were specific to each directorate of the Ministry of Planning and Finance (MoPF). They replicated the techniques used for manual follow-up because regulations that defined the roles and responsibilities of each directorate and a 20 procedures handbook did not exist. Furthermore, the personnel qualified in data processing were not readily available. The data-processing tool was not networked, and the directorates of budget and of treasury were not connected. The services of the directorates of budget and treasury shared data on diskettes from several computers to obtain the total status of budget execution. The individual information systems of the customs and tax directorates should be upgraded. They are expected to be included in the integrated computerized budgetary system that is planned as part of the current PFM reform. This new system will allow real-time data availability to the resource managers. 61. The authorities developed and implemented a small test model of the integrated computerized budgetary system (called SAFINHO) in late 2006, used it to program the 2007 budget, and will continue to use it to execute the budget. SAFINHO includes the new nomenclature and connects the directorates of budget and treasury. The government will need to decide whether to expand this model to a fully integrated system or to adopt the model promised to them by the Angolan authorities. Budget controls appear to be one of the weakest links of the budget execution process. 62. Internal control has been particularly weak, sometimes nonexistent. The treasury does not have a true internal control system and the internal controls at the customs have been quasi- nonexistent. The Inspectorate General of Finance (IGF) has been relatively active in the past two to three years, having audited public companies, entities in the public administration, and private companies (tax control). Its capacity and resources are limited, however, and its work plan is often altered based on requests by the MoPF. 63. The external control is provided by the Accounting Tribunal and the National Assembly. The Court of Accounts undertakes a priori, a posteriori, and concomitant control (audits of government entities and services). It will need to audit the general accounts of the state, which have not been compiled for the past 15 years because of the lack of accounting capacity of the MoPF. The National Assembly economic and financial commission reviews the draft budget and makes recommendations to the plenary, which must examine and approve the annual budget law. The commission receives the reports of the Court of Accounts. The National Assembly, however, does not follow budget execution because of the lack of technical capacity and the absence of the general accounts of the state. 64. The ongoing PFM reforms will further institutionalize the practice of internal audits. The functions of internal and external audits need to be more coherent, particularly with regard to the exact distribution of the tasks and prerogatives of control. The authorities should consider creating an internal audit system within the treasury. The IGF's organic law needs to be clarified on ex-ante and ex-post controls, and on the jurisdiction for tax control of private enterprises to ensure a more efficient and integrated PFM system. The government should consider progressively removing the a priori control of the Court of Accounts on procurement and developing the capacity within the executive branch for this review process. The Court of Accounts, the MoPF, and the National Assembly should agree on how to address delays in auditing the general accounts of the state: (i) do an overall review, or (ii) choose data from a few recent years to review. This would require the MoPF to compile an overall document or a few years worth of data for the general accounts. The National Assembly must set up a permanent training program for its members on budget follow-up and control. 21 Budget decentralization is accepted as a necessary reform, but sectoral, regional, and local authorities will need to receive training and the regional administration may need to be simplified for a successful outcome. 65. The principle of decentralization of the budget execution in favor of the sectoral ministries is accepted and included in the PFM reform process; however, it may be difficult to implement properly in the short term without defining the role and responsibilities of the sectoral financial and administrative directorates (DAFs) or building sector level capacity. 66. At the local level, São Tomé has six districts that, in theory, have autonomous budgets managed by locally elected people. However, the district budgets are fed by central government funds and a few local taxes, and the districts' civil servants are paid by the central state budget. 67. The complexity of the regional administration of the island of Principe makes it difficult to distribute operational and investment budgets and keep track of their execution. The administration of the regional budget (transferred from the central state budget) is by a large regional administration (11 administrative agents answering to 4 authorities). One entity houses customs, taxes, and treasury. The low human capacity of the civil service is a key contributor to the problems of the public management system. 68. Weaknesses in human capacity were noted throughout the budget elaboration,, execution, management, and control. Capacity building has been envisioned in the context of the ongoing reforms. Beyond this targeted training, a long cycle (several months) of global training in PFM is necessary. The target group, in the first instance, should be civil servants and managers in the various directorates of the MoPF. A second group could be the National Assembly representatives who control the budget. Adding anticorruption laws to the legal arsenal of the country will strengthen budget transparency and discipline. 69. There are no anticorruption laws in the legal arsenal of the country. Although a 2006 presidential decree ratified the 2003 UN Convention on Corruption and the government presented an anti­money laundering law to the National Assembly in 2006, in practice, the fundamental preconditions to combat financial fraud are not present yet in the institutional fabric of the country. 70. In the current system, the Accounting Tribunal and the Attorney General's office research alleged financial fraud; however, there is no national entity to fight corruption. The elected officials face a high risk of conflict of personal (vested) and public interests. 71. An important prerequisite to fight corruption is a law that (i) limits elected officials' ability to participate in private companies that contract with the government; and (ii) prohibits elected officials from holding government positions, particularly as senior civil servants. To improve the PFM system, the country needs to reform its antiquated procurement law, weak institutional framework and management capacity, outdated procurement operations and market practices, and the integrity and transparency of the public procurement system. 22 72. The joint procurement assessment undertaken by the authorities, the African Development Bank (AfDB) and the World Bank using the Organisation for Economic Co- operation and Development/Development Assistance Committee (OECD/DAC) methodology has revealed a weak procurement system in four pillars: (i) Pillar 1­­the legislative and regulatory framework, mainly because of the absence of a modern procurement law and standard procurement documents; (ii) Pillar 2­­the institutional framework and management capacity, because of the lack of procurement planning and the nonexistence of a regulatory body; (iii) Pillar 3­­the procurement operations and market practices, because of a weak procurement capacity in contracting entities and a weak private sector; and (iv) Pillar 4­­the integrity of the public procurement system, because of limited internal and external control mechanisms, absence of complaint mechanisms, and nonexisting publications of procurement opportunities. 73. Because of the unavailability of data on procurement in the country, the mission was unable to measure the performance of the system. The performance is a measurement of the application of the regulations and the prevailing procurement practices in the country, which depend on data on specific procurement transactions. To measure performance, STP's procurement system needs a comprehensive and efficient mechanism for collecting data and publishing statistics about procurement activities within the country. An action plan has been developed to identify priority activities for the coming two years to improve the quality of the system. The legislative and regulatory framework needs to be updated. 74. Public procurement in STP is governed by Decree-Law No. 48.871 of 1969 for public works and Decree No. 341 of 1972 for goods and services. This legislation has been inherited from Portugal's colonial rule. In 1971, Decree No. 555/71 modified some aspects of Decree-Law No. 48.871, which is itself an update of the first Decree for public works, which dates to 1906. This legislation is not comprehensive, and areas that have not been dealt with in the legislation are left to the discretion of the MoPF and the procuring agencies. There is a lack of documentation, such as implementing regulations, standard bidding documents, and manuals to guide the contracting entities and bidders alike. 75. In the present legislation, the provisions on procedures related to procurement methods, advertising, time limits, competition, bid documentation and technical specifications, bid evaluation and award criteria, submission, receipt and opening of bids, as well as the complaints mechanism and access to courts are dealt with in a superficial manner. In addition to the above, when compared with internationally accepted principles, the weaknesses in the legislation are as follows: (i) negotiations are conducted with the lowest bidders; (ii) the complaint mechanism is not independent and effective and does not suspend the process until a decision is made after the complaint; (iii) requirements stipulate that international bidders be established locally or represented by local companies; (iv) the classification of suppliers in registries is maintained by the MIOP, for civil works companies, and by the Ministry of Commerce, for the other suppliers. 76. The role and responsibilities of key actors in the procurement system is not clearly defined. The institutional framework is not clearly defined, and only one entity deals with policy and implementation. There is not an independent entity for policy, internal controls, and external audits. A serious conflict of interest is evident in the role of the Court of Accounts, which gives no objection on contract awards, plays the role of internal controls for the MoPF, and carries out the external audits for the country. 23 77. A new procurement law should be drafted according to international standards and adopted. The law should include separate provisions for consultancy services and outline clear responsibilities for policy, controls, and implementation for clarity and ease of use by contracting entities and the private sector. It is important that relevant implementing regulations and standard documentation (bidding documents, evaluation reports, manuals of procedures, and guides) be established for an efficient application of the law and that these regulations and documentation are accessible to the public at large. 78. The authorities, supported by the World Bank, are starting this reform process by hiring a legal expert to draft the new procurement law. The weak institutional framework and management capacity needs to be strengthened. 79. The procurement, budget, and financial management systems do not interact in a way that allows procurement decisions, once taken, to trigger the corresponding actions on the budget and financial side. There is no long-term procurement planning, and the country lacks the capacity to plan its procurement needs. This is caused by, but not limited to, the following: (i) inexistent procurement planning procedures; (ii) the lack of an information exchange between procurement, budget, and financial management systems; and (iii) deficient statistics collection and treatment. Procurement needs are not used for budget formulation or for the subsequent revision of the annual budget. The lack of planning and integration between budgeting and procurement processes leads to the government's inability to predict cash flows to make timely payments and reduce the extra costs associated with delaying contract completion. It leads to cancellations when funds are diverted to other more pressing expenditures, which results in increased costs and inefficiencies in the use of public funds. 80. There is no independent normative or regulatory body for procurement in STP and, thus, the legal and regulatory framework does not cover what should have been its main responsibilities and functions. The nonexistence of such a body within the central government that can effectively provide a range of functions to support consistent development, maintenance, and application of the legislative and regulatory requirement of the national procurement system has resulted in a procurement system that is outdated and ineffective in handling procurement. Because of the lack of separation in the execution of regulatory functions, conflicts of interest do arise in the national procurement system. 81. The STP national procurement system does not have a system to collect and disseminate procurement information. It lacks well-trained, qualified focal points within the administration that can manage the procurement system and monitor public procurement implementation. 82. To strengthen the institutional framework and management capacity, the following actions are needed: (i) provide in the new procurement regulations a mandatory procurement planning requirement for each contracting entity; (ii) integrate procurement planning in the budget cycle, (iii) set up an autonomous regulatory body, which should be independent of execution and have financial and administrative autonomy to perform its duties and have a board of directors composed of members of not only the administration (the executive and the legislative branches) but also the private sector and the civil society to boost the confidence of the private sector; (iv) set up an information system, under the supervision of the regulatory body, to collect, treat, and disseminate procurement information internally for managerial and control purposes, and externally for transparency and accountability of the public sector; and (v) develop a national strategy to develop capacity within the government and the private sector participants. 24 Procurement operations and market practices need to be modernized. 83. Public procurement requires performance from the public sector and private sector participants. A functioning and competitive private sector is key to the public procurement system in a well-functioning system. To be an effective partner, the private sector must have confidence in the competence of the contracting entities at all levels within the system to implement and administer the public procurement system according to the legislative and regulatory framework. The competence of the staff is measured by the operational effectiveness and efficiency of the public procurement system. 84. The general level of expertise of the procurement staff in the ministries is adequate to do the simple functions of bidding, but it is inadequate to operate in a modern procurement system environment. In addition, access to professional staff who can provide advice and knowledge is limited. No procurement-oriented competencies have been established by the government for the staff to work in this area. 85. There is a serious problem in setting up and harmonizing recordkeeping for the bidding and contract management phases. Most of the recordkeeping is done at the DTP, but many independent entities do not file their procurement documents using the same filing procedures (for instance, the one handling civil works procurement in the Ministry of Education). Therefore, tracking procurement information is cumbersome. This has an added impact on the poor functioning of internal and external control systems. 86. STP's private sector is unable to respond to procurement opportunities. This response is essential for a well-functioning public procurement market. Other problems include the following: (i) there are no effective mechanisms for partnerships between the private and public sectors, (ii) there is limited capacity of the private sector to respond to public procurement, and (iii) there are systemic constraints in the environment inhibiting the private sector's capacity to access the procurement market. 87. There are great deficiencies in the area of "contract administration and dispute resolutions," which is essential to managing the outputs of a public procurement system because it provides oversight on quality and timely performance and early access to information needed for good management. Appropriate procedures to resolve such disputes in a timely manner are necessary for service delivery and successful implementation. This is an area that the Government of STP has little expertise, because untrained staff are administering the contracts. The size and characteristics of the country do not help in dealing with disputes between the government and the private sector, especially when the procurement market is so small. Companies prefer not to contest contract awards so that they do not affect their prospects for future opportunities. 88. To modernize the procurement operations and market practices, the following actions are needed: (i) provide training to all staff both in the government and the private sector, (ii) set up a harmonized recordkeeping system, (iii) establish a dialogue between the private sector and the government so that the private sector has an opportunity to make itself heard regarding the government's practices that tend to undermine the competitiveness of the private sector, and (iv) ensure that the General Conditions of Contracts include good contract management procedures. The integrity and transparency of the public procurement system (control and complaint mechanism) needs to be improved. 25 89. STP's national procurement system lacks the mechanisms and capacity for independent control and audit of procurement operations to provide for accountability and compliance and ensure a well-functioning public procurement system operating with integrity. It does not have an efficient complaint mechanism system to allow participants to lodge complaints or to challenge decisions with administrative and judicial review bodies that have appropriate levels of independence and legal power to impose corrective measures for violation of the legal and institutional framework. In addition, fraud and corruption, including conflicts of interest, are not properly addressed in legislation to create a sound and fair environment for public procurement operations. 90. To improve the integrity and transparency of the public procurement system, the following actions are needed: (i) strengthen the internal control system of the executive branch of government; (ii) revise the mandate of the Court of Accounts to remove conflicts of interest and enable it to carry out effective ex post independent auditing to pinpoint misconduct and corruption by public officials and suppliers; (iii) give the mandate to the regulatory body to deal with complaints, enforce the remedy concerning the private sector, and follow up on remedies with the administration; (iv) involve the private sector in handling complaints; and (iv) include adequate provisions in the procurement law to address corruption, fraud, conflicts of interest, and procedures to enforce them. Implementing the jointly developed action plan in procurement reform will help the authorities modernize the procurement system. Undertaking these reforms, however, will mean taking account of reform-related risks. 91. Although successive governments have expressed their commitment to reform the national procurement system, effective and timely implementation of the reform activities could be affected by weak institutional capacity, including the lack of skilled human resources, insufficient technical and financial assistance, lack of continuous political support, and resistance of the staff. 92. To ensure successful implementation of the action plan, to the following actions are needed: (i) build political support and convince the key stakeholders, who are the key ministers, as well as legislators, the private sector, and civil society of the demands that the reform will bring and of the benefits derived from its implementation; (ii) create and strengthen independent watchdogs (independent press, private sector associations, and so on) to support the reform process; (iii) increase funding support by the development partners to ensure effective implementation of the reform; (iv) counter possible staff resistance by increasing training and conducting an internal marketing of the results of the reform process to improve the governance capacity and the technical capacity of the staff; and (v) include key institutions such as the National Assembly, the Prime Minister's Cabinet, and the Court of Accounts as active stakeholders in the reform process. 26 s. omtsu nce nce nce C Fina Fina Planning Fina affairs. 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