Document of The World Bank FOR OFFICIAL USE ONLY ReportNo. 32078 INTERNATIONALDEVELOPMENTASSOCIATION COUNTRY ASSISTANCE STRATEGY FOR SA0 TOME & PRINCIPE May 2,2005 CountryManagementUnit (AFC15) Africa Region This document has a restricteddistribution and maybe usedby recipients only inthe performanceo ftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization. The date ofthe last Country Assistance Strategywas November 2,2000 CURRENCY EQUIVALENTS Currency Unit = Dobra US$1 = Db 9,699.40 (as of27 April 2005) FISCAL YEAR January 1-December 31 ABBREVIATIONS AND ACRONYMS AAA: Analytical andAdvisory Activities ILO: International Labor Organization AfDB: African Development Bank IMF: International Monetary Fund CAS: Country Assistance Strategy JDZ: Joint Development Zone CFAA: Country Financial Accountability JSAN: Joint-Staff Assessment Note Assessment MDG: MillenniumDevelopment Goals CEM: Country Economic Memorandum MIGA: Multilateral Investment Guarantee CPAR: Country Procurement Assessment Agency Report NEAP: NationalEnvironmental Action Plan CPI: Consumer Price Index NGO: Non-Govemmental Organization CPIA: Country Policy & Institutional NPA: National PetroleumAuthority Assessment NPC: NationalPetroleum Committee DPG: Development Policy Grant OECD: Organisationfor Economic Co- DSA: DebtSustainability Analysis operation & Development EITI: Extractive Industries Transparency OED: Operations and Evaluation Department Initiative OPEC: Organization o fPetroleum Exporting ESW: Economic Sector Work Countries EU: European Union PHRD: Policy and HumanResources FIAS: Foreign Investment Advisory Service Development Fund FONG: Federation o fNGOs PRGF: Poverty Reduction and Growth Facility FRM: Resource Mobilization Department PRSP: Poverty Reduction Strategy Paper GDP: Gross Domestic Product UNDP: United Nations Development Program GEF: Global Environment Facility UNICEF: UnitedNations Children's Fund HIPC: Heavily IndebtedPoor Countries UNEP: UnitedNations Environment HIV/AIDS: HumanImmunodeficiency Programme VirudAcquired Immunodeficiency UNFPA: UnitedNations Fundfor Population Syndrome Activities ICR: ImplementationCompletion Report SSA: Sub-SaharanAfrica IDA: International Development Association TB: Tuberculosis IDF: Institutional Development Fund WBI: World Bank Institute IFAD: International Fundfor Agricultural Development Vice President: Gobind T. Nankani Country Director: A. David Craig Task Team Leader: Eavan O'Halloran CAS team: DorsatiMadani, Allison Berg, K. LiTow Ngow FOROF'FICIALUSEONLY COUNTRY ASSISTANCE STRATEGY FOR SA0 TOME AND PRINCIPE TABLE OF CONTENTS I. ... I1. EXECUTIVE SUMMARY COUNTRY CONTEXT.......................................................................................... .................................................................................... 111 A. Overview ........................................................................................................... 1 B. The PovertyReductionStrategy Paper (PRSP) ................................................ i 3 C. Macroeconomic Framework ............................................................................. D. IMFProgram..................................................................................................... 4 6 F. The Oil Sector ................................................................................................... E. Poverty .............................................................................................................. 7 8 H. Social Sectors .................................................................................................. G. Debt Sustainability and the Enhanced HLPC Initiative................................... 10 I. Infrastructure................................................................................................... 10 13 J. Govemance and Capacity ............................................................................... K. Productive Sectors........................................................................................... 15 16 I11. BANK GROUPASSISTANCE STRATEGY...................................................... A. Implementationo fthe last CAS...................................................................... 18 B. Other World Bank Group Activities ............................................................... 18 22 22 D. Assistance Strategy ......................................................................................... C. Lessons Leamt ................................................................................................ 23 IV. 28 MANAGINGRISKS ............................................................................................ E. Country FinancingParameters .,...................................................................... 31 V. CONCLUSION..................................................................................................... 33 BOXES: Box 1: The Petroleum Revenue Management Law ......................................................... 9 Box 2: Reachingthe MDGs inthe Health and Education Sectors ................................ 11 Box 3: Environment....................................................................................................... 14 Box 4: 17 Non-Lending Activities Carried Out Duringthe Previous CAS........................ Gender Issues in Sao Tome and Principe........................................................... 18 Box 6: Bank Lending Program for the FYO1-05 CAS Period....................................... Box 5: 19 Box 7: Participatory CAS Process ................................................................................. 24 Box 8: Box 10: Donor Coordination and Intemational Assistance ............................................. FY06-09 IDA Financial Assistance Program (inthe form o f IDA Grants) .......25 Specific Activities o f the Bank's Program......................................................... Box 9: 28 29 This document has a restricted distribution and may be used by recipients only in the performance o f their official duties I t s contents may not be otherwise disclosed . without World Bank authorization . TABLES: Table 1: Selected Macroeconomic Indicators. Sao Tome andPrincipe. 2001-2004 .........6 ANNEXES Annex Al: CAS Results Matrix for Sao Tome and Principe................................ 34 Annex A2-1: Sao Tome and Principe at a Glance .................................................... 38 Annex B2: Selected Indicators o f Bank Portfolio Performance and Management40 Annex B3: IDAProgramSummary...................................................................... 41 Annex B4: Summary o fNon-Lending Services .................................................... 42 Annex B5: Poverty and Social Development Indicators ....................................... 43 Annex B6: Key Economic Indicators .................................................................... 44 Annex B8 (IFC): Statement o f IFC's Heldand DisbursedPortfolio .............................. 46 Annex B8: Operations Portfolio (IDA & Grants) ................................................. Annex 9: Development Partner Involvement inSao Tome andPrincipe ...........47 48 Annex 10: Country Financing Parameters ............................................................ 49 Annex 11: CAS Completion Report..................................................................... 50 APPENDIX: Appendix 1: Debt Sustainability.............................................................................. 62 .11. .. I. EXECUTIVESUMMARY 1. With an estimated GDP of US$60 millionin 2004, the DemocraticRepublicof Sao Tome and Principe (STP) is Africa's smallest economy and one of the poorest countries in the world. Approximately 54 percent o f its population o f 150,000 is poor and 15 percent live in extreme poverty. Social indicators are weak and improving only slowly, with the likelihood that most MDGs will not be reached. After a prolonged period o f economic mismanagement since independence, a series o f economic reforms were implemented starting in 1999. As a result, economic performance improved and the growth rate o f real GDP per capita rose from 3.3 percent to 4 percent between 1999 and 2003. The PRSP was finalized in early-2003 and has been partially implemented to date although full implementationhas been launched in2005l. InJuly 2001, STP held its third multi-party election which was deemed to be fair and was conducted peacefully. Nevertheless, the political economy suffers from instability and, while a more active civil society has gradually taken form, political and civil institutions remain fragile. 2. STP is now at the threshold of a dramatic change with large oil resources estimated in its territorialwaters. The arrival o f oil production, anticipated in 2012, is the most significant economic event facing STP with far-reaching social and political implications. To date, STP has taken several positive and encouraging steps to prepare for the arrival o f oil revenues and to set up transparent oil revenue management mechanisms that set it apart from other resource-rich countries in Africa that have squandered their wealth. While it is too early to judge whether STP will make effective use o f its oil revenues, there is an important window o f opportunity to provide concerted international support to ensure that oil will make a positive impact on poverty reduction. 3. This Country Assistance Strategy (CAS) for STP covers the four-year period from FY06 to FYO9. The CAS supports the implementation o fthe PRSP and sets out the planned lending and non-lending activities o f the World Bank and their intended results. This CAS benefits from a more robust analysis and knowledge base o f the country than existed at the time o fthe previous CAS (FY01-05)2 as a result o f the broader economic and sector work that has been conducted since then and the more intensive dialogue between the Bank and the Government. Above all, the strategy remains tightly focused, building upon on-going activities and enhancing and deepening the strategy laid out inthe previous CAS, as well as building on the lessons leamt from its implementation. The two principal objectives o fthe Bank's strategy are: (i) to support the implementation o f the PRSP and strengthen the areas where the PRSPneeds to be improved, as highlighted inthe JSAN; and (ii) to provide assistance to STP to ensure that it i s sufficiently prepared to maximize the benefits o f future oil revenues. I The PRSP was promulgatedby the President inJanuary2003, and an updateof the strategy was issuedinJanuary 2005. The PRSP was discussed by the Board of the World Bank on April 21, 2005 (Sao Tome and Principe, Joint IDA-IMF Staff Advisory Note on the PovertyReductionStrategyPaper, March3,2005, ReportNo. 31726-STP) andis due to be discussed at the Board of the IMF in mid-May 2005. It was not submitted earlier because the macro-framework was insufficiently * developedto put the povertyreductionstrategyinto full perspective. Country Assistance Strategy for STP, October2000, ReportNo. 21031-STP - 111- ... 4. As STP is a tiny country, the Bank's lendingprogramis naturally small with an indicativeallocationof US$5.5 millionfor FYO6-OS (Base Case). Under the IDA-14 framework, STP i s currently eligible to receive all o f its FY06 IDA allocation on grant terms. The CAS focuses onjust a couple o f selected areas o f intervention to maximize the Bank's impact and to ensure complementarity with other development partners. In particular, an over-riding theme o f the strategy i s that the Bank will assist the Government to "scale-up" for the future era when it will have highlevels o f its own resources from oil. The challenge is to deliver a program o f Bank assistance which encompasses a limited envelope o f financial resources but concentrates on a broader program o f overall support including policy dialogue, AAA, ESW, IDF grants and Trust Funds, as well as the Bank's role inleveraging other donors' resources. 5. The World Bank's programfocuses on strengtheningthe macroeconomicand publicsector context andbuildingthe requiredinstitutionsand capacityto ensure the sustainableuseoffuture oil revenues. The specific avenues o f support are: (i)continuetheimplementationofon-goingactivities,especiallywithrespecttosocial sector service delivery, capacity-building in public finance management, institutional support to managing the oil sector, and follow-up on recommendations o f the Bank's ESW and AAA. As part o f this, additional financing will be provided to the on-going IDAprojects; and (ii) graduallytoprovidingDevelopmentPolicyOperations (budget support) in move FY07, with the objective of strengthening implementation o f the PRSP, preparing the ground for managing future oil revenues into the budget and maximizing IDA'S impact. Inthe period leading up to providing budget support, the Bank will work closely with the Government to prepare the country's fiduciary fi-amework and institutional capacity for the management and implementation o f budget support. These Development Policy Operations will be triggered by sound macroeconomic, public finance and oil management and will be closely linked to the PRSP Annual Progress Reports and prepared incollaboration with donors. 6. The STP context is subject to several risks. The main risk comes from the potential mis-management o f the influx o f the oil contract signature bonuses and their impact on political stability. The Bank will aim to mitigate this risk through ensuringthat the oil revenue management framework is respected, that the signature bonuses are translated into transparent budgetary allocations and by continued and concerted efforts to build institutional capacity and engage indialogue/consultationwith Government and civil society. Although STP has made some efforts to diversifyits exports, it remains extremely vulnerable to exogenous shocks. To mitigate this risk it is vital to continue the course o f prudentpublic sector finance management, strengtheningcapacity and investing inhuman and institutional capital, all core aspects o f the Bank's program. A further risk is posed as regards the Government's willingness and capacity to pursue reforms in a sustainable and consistent manner. The Bank plans to off-set this risk by working closely with the IMF and other development partners to provide concerted financial and advisory support to ensure that there i s follow-through on the reform program and that there i s sufficient focus on buildingcapacity. The Bank will continue to pursue a frank and open dialogue with the Government about the importance o f reforms in order to increase investment and foreign aid. - iv - 11. COUNTRYCONTEXT A. Overview 1. The Democratic Republic of Sao Tome and Principe (STP) is Africa's smallest economy with an estimated GDP of US60 million in 2004. It is greatly dependent on external financial assistance3and heavily indebted. It i s a small island country with a population o f about 150,000 and a land area o f just over 1,000 square kilometers. STP i s one o f the poorest countries inthe world, with a per capita income o f $320 in 2003, less than the average for Sub-Saharan Africa. It ranked 123`d out o f 177 countries in the UNDP Human Development Index for 20024. According to the most recent household survey (2000/01), 54 percent o f the population i s poor and 15 percent live in extreme poverty. Social indicators in STP are weak and progress towards achieving the MDGs i s slow, with the likelihoodthat most MDGs will not be reached. 2. STP's historical evolution has been very much affected by its heritage as a Portuguese colony. Under Portugal's early rule, STP became first one o f the world's largest producers o f su ar (inthe mid-16th century) and then a major producer o f coffee and cocoa (in the 19t century).a Following the military coup in Portugal in 1974, independence for STP was proclaimed. Transition to single-party Marxist rule was almost immediate and socialist economic policies were implemented. In the face o f economic deterioration duringthe 1980s and pressure from both the population and western donors, political and economic reforms were introduced, a democratic constitution was established and the first multi-partylegislative electionwas heldinJanuary 19915. 3. Since 1991, STP has been transformed from a Marxist one-party state into a form of pluralist democracy. President Fradique de Menezes was elected President for a 5 year term in July 2001, in STP's third multi-party election which was deemed to be fair and was conducted peacefblly. Since then, the country has been ruledby a political cohabitation with the presidency held by a semi-independent candidate and the parliament divided almost evenly between the two main political parties. Nevertheless, for such a small country, the political scene i s very complex. A unity Government exists though it i s shaky and there are frequent cabinet changes and clashes with the President. The political economy suffers from inherent instability due to the vague separation o f powers outlined in the constitution between the Presidency, National Assembly and the Executive Branch o f Government. 4. The approaching oil era is increasing social expectations and exacerbating political tensions. These tensions came to a head in July 2003 with an attempted coup. %le the President and Prime Minister were restored to power after a negotiated settlement a week later, the attempted coup underscored the delicate political and social ' STP has traditionally benefited Erom one of the largest amounts of aid per capita in the world - equivalent to US166 per capita in2002 A morerecentrankingis not available due to data gatheringproblems inSTP. Source: The Economist IntelligenceUnitCountryProfilefor Sao Tome andPrincipe, 2005. situation in the country. A more active civil society has gradually taken form since the democratic reforms o fthe 1990s, but political and civil institutions remain fragile. 5. The economic base is extremely narrow, dominated by services (65 percent o f GDP, mainly public sector), with agriculture and industry (mainly construction) contributing 19 and 18 percent o f GDP respectively. Manufacturing represents less than 5 percent o f GDP and there are no major foreign investments yet outside the tourist sector (although this will change once oil exploitation activities start). The economy is also characterized by a low savings rate, a large public sector suffering from weak institutional capacity, a highreliance on foreign aid and dependency on cocoa production for exports. Tourism shows potential for growth but remains under-developed and constrained by the high malaria incidence. Agricultural productivity is low and farmers suffer from a lack o f agricultural services. On the structural reforms front, the public enterprise reform andprivatizationprogram has made progress, though with some delays. 6. STP faces many special development challenges because of its small size and vulnerability to terms of trade and other external shocks. Its economic and social indicators are negatively affectedby some o f the basic challenges that afflict many small island states which include remoteness and insularity, susceptibility to natural disasters, weak institutional capacity, a narrow resource base, vulnerability to exogenous shocks, limited access to capital, and entrenched poverty. STP reached the Decision Point o f the enhanced HIPC Initiative in early 2001 and i s expected to reach Completion Point by mid-20066. However, its vulnerability to exogenous shocks could impact negatively on the overall debt sustainability o f the country. Notwithstanding the HIPC relief, the debt burdenis stillhigh: STP's debt ratios to exports and Government revenues remain among the highest inthe world. 7. STP is now at the threshold of a dramatic change with large oil resources estimated in its territorial waters. The arrival of oil production, anticipated in2010, is certainly the most significant economic event facing STP with far-reaching social and political implications. There i s a strong possibility that the resources and revenues accruing to STP will be very large indeedrelative to its size7. Such rapid revenue inflows into a country present the usual set o f challenges - Dutch disease, lack o f absorptive capacity, pressure on the reform program, and risks o f greater inequality. While the actual oil revenues are not expected to accrue until 2012, STP i s already feeling the impact o f oil through the oil contract signature bonuses that have recently been agreed. Inthe second quarter of 2005 STP is expected to benefit from an oil contract signature bonus for the first block o f exploration in the order o f $49 million (equivalent to 90 percent o f GDP), which will be partially applied to the 2005 budget'. A new round o f biddingwas finalized in late 2004 on 5 further blocks but the award o f these blocks has not yet beenmade (it is still unclear when they will be made or for how many blocks). ' The exact timing will be linkedto one full year of satisfactory implementationof the PRGF arrangement with the IMF. Initial analysis suggeststhat STP will produce 142barrels per capita per year, compared to 25 inAngola, 76 in Gabon and * 26 inCongo-Brazzaville. Of the $49 million, $9.3 millionwill bepaid to the Joint Development Authority (between STP andNigeria) on account of arrears accumulatedduring 2001-04 and $13 million is programmed for spendingtoward the 2005 budget. The remaining $27 million will be depositedinthe government's national Oil Account held with the New York FederalReserveBank. In accordance-withthe Oil RevenueManagementLaw, these funds will beusedgradually over the nextseveralyears. - 2 - B. ThePoverty Reduction Strategy Paper (PRSP) 8. The PRSP was finalized by Government in late-2002, promulgatedby the Presidentin January 2003 andwas partially implementedin the 2003-2004 budgets (see footnote 1). InJanuary2005, the Government prepared a set o f annexes to the PRSP main document which provided updates on the previous two years o f macroeconomic performance, indicators and implementation infrastructure, as well as a summary of the new petroleum revenue management law, and a summary o f the PRSP implementation experience in 2003-2004. The PRSP and its related Joint Staff Advisory Note (JSAN) were discussed by the Boards o f the World Bank and IMF in April and May 2005 respectively. 9. The PRSP sets an ambitious policy agenda - with an overall cost o f about US$210 million for the first seven years of implementation. It lays out a strategic plan for poverty reductionbased on five pillars: a) Reform o f public institutions, capacity building, and promotion o f a policy o f good govemance; b) Accelerated andredistributive growth; c) Creation o f opportunities to increase and diversify income for the poor; d) Humanresource development andaccessto basic social services; e) Adoption o fmechanisms to monitor, assess andupdate the strategy. 10. An Action Planis attachedto the PRSPto putthese strategic pillarsinplace, which has the following objectives: (i) a GDP growth rate o f 5 percent starting in attain 2003; (ii) by half the percentage o f the population living in poverty by 2010, and reduce reduce this figure to less than 1/3 by 2015; (iii) the entire population with access provide to basic services by 2015 and help improve their quality o f life; (iv) considerably reduce the social and gender gap between districts in Siio Tom6 and between these and the Autonomous Region o f Principe, as well as between urban and rural populations; and (v) promote andbuildinstitutional capacity and a policy o fgood govemance. 11. The PRSP's medium-term macroeconomic outlook assumes an average growthrateof 4.3 percentduring2005-07, a declining inflation rate andbroadly stable nominal interest rate, supported by strong fiscal consolidation. The outlook also encompasses control over public expenditures while safe-guarding pro-poor spending, a prudent monetary policy, a flexible exchange rate and the implementation of a comprehensive structural reform agenda that includes a new investment code to promote private investment. 12. The full PRSPis a resultof an extensiveconsultativeprocessby stakeholders. The process was managed by a steering committee chaired by the Prime Minister and consisting o frepresentatives o f government and civil society. Numerous workshops were organized for civil society, political parties and other stakeholders in the six districts on the island o f Sao Tome and on the island o f Principe. A PRSP unit was set up inthe Ministryof Planning and Finance to ensure the implementation and monitoring of the PRSP: a key role o f this unit is to coordinate the various activities o f all the Ministries, as well as private sector and civil society, under the overall framework o fthe PRSP. 13. The Monitoring and Evaluation Framework of the PRSP. The JSAN indicates that the PRSP provides a fairly comprehensive set o f indicators and targets for monitoring and evaluating the sectoral strategies, especially in education, health and infrastructure. The set o f medium- and long-term targets broadly tallies with the MDGs. Some o f the poverty targets, however, are more ambitious - particularly the 50 percent drop inpoverty targeted by 2010 - and will require major sustained efforts and financial support. It is recognized that efforts are needed to enhance the quality and availability o f indicators and to strengthen statistical capacity. The Government is targeting the strengthening o f its PRSP unit to enhance implementationand monitoring. 14. The JSAN underlines that the PRSP provides a reliable framework for reducing poverty. Its main strengths are that it provides a poverty diagnosis and a comprehensive private-sector-led development strategy, pays special attention to cross- cutting issues, notably governance, and identifies detailed indicators to monitor progress inpoverty reduction. The JSANhighlightsthat there are several areasofweakness inthe PRSP and that these could be strengthened through the following actions: (i) prioritize sectoral strategies and make them fully consistent with the annual fiscal budget and the overall medium-termpoverty alleviation strategy, (ii) launch an in-depth analysis o f the impact o f potential oil revenues on the economy; and (iii) make an assessment o f the redistributive effect o f the proposed reforms, including taxation, land redistribution, and privatization. 15. Furthermore, the JSAN underlines the importance o f further work in securing good governance and fighting corruption, especially in the context o f rising oil revenue. Trade policy i s also singled out as needing attention, particularly given the emphasis o f the PRSP on the need for non-oil investment and the diversification o f production and exports. In conclusion, the JSAN highlights two major issues: (i) Government must the succeed in attracting a substantially higher level o f private investment and additional donor support to achieve the desired high GDP growth rate targets until oil production starts; and (ii)capacity must be strengthened to ensure full implementation and monitoring o fthe PRSP. C. Macroeconomic Framework 16. After a prolongedperiodof economic mis-managementsince independence,a series of economic reforms were implemented starting in 1999. These aimed at: (i)pursuingprudent fiscal and monetary policies; (ii) improving the efficiency o f public spending; (iii) liberalizing the economy by reforming the tariff structure, preparing for a liberalization o f the telecoms sector and privatizing a number of public enterprises (iv) accelerating sectoral reforms by developing new strategies in health and education; and (v) strengthening human and institutional capacities, especially in the nascent petroleum sector. - 4 - 17. As a resultof these reforms, economic performanceimprovedwhich resulted in a more stabilized economy, sustained output growth and lower inflation. The growth rate o f real GDP per capita rose from 3.3 percent to 4 percent between 1999 and 2003. The growth dynamic relied on a series o f reforms supported by the IMF and the Bank, an improvement inworld cocoa prices, and growth inthe tourism and construction sectors. Inflation was also brought under control and the CPI dropped from 12.6 percent in 1999 to 9.2 percent in2002. In2003, the increase in energy prices, post-coup social expenditures and civil service salary increases contributed to a rise o f the inflation rate to 9.6 percent. 18. In 2004, real GDP growth is estimated to be slightly lower (3.8 percent)than 2003 as the expected increase in petroleum related economic activities did not materialize. The overall fiscal deficit i s estimated to have increased from 17 percent o f GDP in 2003 to 26 percent in 2004. The external current account deficit (excluding grants) is expected to rise to 61.5 percent o f GDP in2004, from 54.4 percent in2003, on account o f new infrastructure projects and the sharp rise in the oil import bill due to increases in international oil prices. This increase in oil prices in 2004 has affected the already fragile economy, particularly because o f the increasing financial difficulties o f the sole electricity and water company (EMAE) that is the main consumer o f imported gasoline. Unable to pass through prices, EMAE has reduced its production load and introduced rolling brown-outs, effectively rationing electricity since fall o f 2004. The lack o f electricity has reduced the productivity o fbothpublic and private sectors. 19. In the monetarysector, the CentralBank reliedon heavy interventionin the foreign exchange markets to avoid a sharp depreciationof the dobra and absorb the excess liquidityfrom the large fiscal deficits and the rapid expansion o fbank credit to the private sector. The Central Bank response led to a drawing down o f gross official reserves from 4.5 to 3.2 months o f imports o f goods and services. 20. Annual GDP growth is envisaged to slow down in 2005 (to 3 percent) in response to tight financial policies under the IMF's planned PRGF program (see paragraphs 22-23), but pick up during the following two years to reach 5.5 percent by 2007 on account o f expanding economic activity in the services sector and petroleum- related investments. End-year inflation i s projected to drop from 14.6 percent to 9 percent by end-2007, while current foreign exchange reserves levels are ensured (3.2 to 3.5 months o f imports o f goods and services). The overall external balance would continue to show large deficits in 2006 and 2007. This would mirror sizable current account deficits after grants (stemming from higher imports o f crude oil and oil sector- related investment goods), which would be partially financed by a mix o f foreign direct investment, foreign aid andthe gradual use o frevenue from the oil bonus payment. 21. The gross external financing requirements are projected to reach $73.5 millionin 2005, falling to approximately$43 millionin 2006-7. It is assumed that the financing gap for 2005 would be closed if the Government succeeds in carrying out the following: (i) increase domestic tax revenues and control expenditures; (ii) the secure programmed levels o f bilateral and multilateral grants (including HIPC), loans and non- project lending; (iii) renegotiating Paris Club commitments; and (iv) execute the - 5 - graduated payment schedule programmed for Nigeria and the Joint Development Authority (JDA) debts. The financial gaps re-appear in 2006 (approximately $8.6 million) and 2007 ($6.4 million) for which the country would benefit from concessional lendingor grants. Table 1: Selected Macroeconomic Indicators, Sao Tome and Principe, 2001-2004 2001 2002 2003 2004 Est. (Inpercent ofGDP,unless specified) Real GDP (Annual % change) 4.0 4.1 4.0 3.8 Consumer Prices (annual average) 9.5 9.2 9.6 12.8 Current account balance " -63.1 -53.9 -54.4 -61.5 Net present value of total debt " 1,200.9 1,142.5 1,024.5 899.7 Total revenue and grants 63.1 53.9 54.4 59.3 Total expenditure 79.4 67.6 75.0 85.4 Non-interest current expenditure 28.8 33.0 33.1 46.3 Overall fiscal balance 31 -20.4 -17.2 -16.9 -26.1 Change inbroadmoney (inpercent) 36.7 26.9 41.8 7.4 Interest rate (inpercent) 4' 15.5 15.5 14.5 14.5 Source: IMF (httu://www.imf,or~/extemal/nu/sec/un/2004iun0432.litm).Notes: 1/ Excluding official transfers; 2/ In percent of exports of goods and non-factor services, calculated as a three-year backward-looking average; 31 (commitment basis, excluding grants and oil signature bonuses, includingHIPC 4/ Commercial bank reference rate, end of period. . Note: Please see Annex B6 for macro-economic projections D. IMF Program 22. After successfullycompleting an IMFStaff MonitoredProgramin 2002 and 2003, the Government i s currently finalizing an agreement on a PRGF program. The program i s gearedtowards re-establishing the conditions for high and sustained economic growth over the medium term. An early goal is to correct the fragile budgetary situation and widening macroeconomic imbalances resulting from the relaxation o f the fiscal and monetary policies to implement the 2004 budget. These imbalances came about as the 2004 budget had anticipated petroleum bonus signature which then did not materialize but spending was not adjusted in line. The expectation is that the PRGF will catalyze needed financing from other international financial institutions (notably the African Development Bank) and donors to further accelerate investment and economic growth. 23. The program aims to place public finances back on modern and sound groundswhile protectingpro-poor expenditures. The tax revenues are to be increased via introduction o f new tax policy and tax administration reforms. Measures are also predictedto improve public expenditure management and control expenditure growth. In the monetary sector, to achieve the dual goals o f controlling inflation and protecting foreign exchange reserve levels, net domestic assets o f the Central Bank will be supervisedclosely and private sector credit growth will be restrained. Inthe real sector, the Government is encouraged to adopt the new investment code to improve the business climate, In the public sector, the Government i s to further liberalize the economy by finalizing the telecoms market liberalization. It will address the finances and status o f - 6 - some state enterprises within a strategic reform framework, especially as regards EMAE. It will also undertake a review o f the performance and status o f the public airport and seaport, with a view to potential public-private partnerships. The PRSP acknowledges that attainment o f its poverty reduction objectives will depend critically on maintaining macroeconomic stability. The 2005 updated annex to the PRSP i s consistent with the financial policies underpinningthe PRGFprogram. E. Poverty 24. The PRSP paints a stark picture of poverty. The 2000-2001 UNDP/ILO/World Bank survey o f living conditions and the UNDP poverty reviews show that 54 percent o f the population lives in poverty; 39 percent are poor and 15 percent are extremely poor. Simulations suggest that between the late 1980s and 2000/01, the share of the population in poverty may have increased by 6 percentage points, from 48 percent to 54 percent. The PRSP seeks to reduce the percentage o f STP's population living inpoverty by halfby 2010 and by more than two thirds by 2015. These goals are very ambitious and, if current trends persist, are unlikely to be reached. Preliminary analysis indicates that the country would need to grow at an average rate higher than 8 percent per annum (i.e. almost twice the average growth rate projected for 2005-07) during the next decade to meet the PRSP's ambitious poverty reduction targets. Even assuming an ambitious growth rate o f 6.5 percent per year from 2004 to 2010, the share o f the population inpoverty would only be reduced by about a fourth to 40 percent, well short o fthe target inthe PRSP. While a higher growth rate is attainable, it would be contingent upon the authorities succeeding in attracting higher levels o f private investment and additional donor support. 25. It is difficult to gauge social and poverty data over time as the analyses are sparse and very weak. Analysis suggests, however, that several years of economic growth since 2000 have led to a slight improvement in income with per capita GDP increasing from US$290 in 2000 to US$320 in 2003. The distribution o f arable land to small farmers has helped strengthen income prospects for those poor who have branched successfully into production o f foodstuffs for the domestic market. Expenditure policies aimed at ensuring that priority has been given to spending in critical social areas and resources freed under the HIPC interim assistance are being allocated toward social sectors and poverty-reductionrelatedprograms. 26. Poverty is concentrated in rural areas and is higher among female-headed households and among households whose head works in agriculture. The high incidence o f poverty in rural areas has led many former rural workers to move to urban centers where they live in slums. Other socioeconomic groups identified as most vulnerable to poverty include low-level civil servants, fishermen and vendors and senior citizens living alone (over 60 years old). Survey data suggest that a large household size, a lack o f education or employment, and geographic location are all key determinants o f poverty. The average size o f a household i s inversely proportional to its income; thus the average household with 6.43 persons is extremely poor, while families with 3.78 - 7 - members are considered not poor. Exacerbatingthe income and economic dimensions o f poverty is a weak sense o f community and social capital inthe country. 27. The PRSP rightly considers that combating social exclusion is fundamental for reducingpoverty. It identifies women, the elderly andthe young as being inneed o f special support. Looking ahead, the JSAN o f the PRSP highlightsthat further analysis o f poverty i s needed. Inthis respect, the Government is pushing ahead on conducting two surveys aimed at improving household and expenditure data. The analysis should focus on a review of income and coping strategies at the household level across provinces, including the allocation o f Government and donor resources, access to basic infrastructure, and vulnerability to food insecurity and natural disasters. As part o f its support, the Bank will provide assistance for further breaking down the poverty profile into key components. The UNDP is providing assistance on strengthening the data quality and availability. The surveys' results are to be used to monitor progress toward reaching the PRSP goals and MDGs. F. The Oil Sector 28. By 2012, it is expected that STP will become an oil producing nation with significant revenues. In2001, STP andNigeria reached agreement onjoint exploration for oil in waters claimed by the two countries. In April 2003, the Joint Development Zone (JDZ), was opened for bids by international firms. The JDZ was divided into 9 blocks and negotiations on block one were finalized in the first quarter o f 2005 for $123 million, o f which STP is to receive 40 percent ($49 million - see footnote 7) andNigeria the other 60 percent. A new round o f bidding was finalized in late 2004 on 5 further blocks but the award o f the blocks has not yet beenmade. 29. The oil era is a key development opportunityfor STP. Revenues from oil, gas and mining companies, in the form o f taxes, royalties, signature bonuses and other payments should be an important engine for economic growth and social development. But, as experience from other countries has shown, good governance and good economic management are crucial to sustainable development. STP must follow through on its commitment o f putting oil revenues to effective use, while balancing the use o f non- renewable revenues for current and future generations. It has made considerable efforts towards good governance and transparency in the sector by adopting a best practice petroleum revenue management law (see Box 1) and indicating its willingness to implement the Extractive Industries Transparency Initiative (EITI) process. A rapid and full implementation o f the petroleum revenue management law should allay some o f the anxiety owing to the strong correlation petroleum riches have tended to have with negative patterns o f political and economic governance elsewhere in Africa and the world. So far, it has initiated the implementation o f its petroleum revenue management law by contracting the FederalReserve Bank o fNew York as its custodianbank. 30. In June 2004, Nigeria and STP signed a declaration regardingtransparency and governance in the JDZ shared by the two countries. The parties agreed to full - 8 - public disclosure of all transactions inrespect o f the oil companies' activities inthe zone, in particular the revenues accruing to the two countries. The Joint Development Authority (JDA) is required to make public the basis for all awards o f interest inthe JDZ. Inthe first halfof 2004, the Government created aNational PetroleumCommittee (NPC) which i s under the tutelage o f the President and addresses sectoral policies and political issues. The NPC includes NGO and private sector representatives. The Government also created a National Petroleum Agency (NPA) to provide the NPC and the government with legal, technical and economic analysis and to act as the regulatory entity in the sector, The establishment o f these institutions and the eventual implementation o f the petroleum revenue management law represent important steps towards successful management o f the oil sector. Box 1: The PetroleumRevenueManagementLaw OnDecember 29,2004, President de Menezes of STP signed into law a Petroleum Revenue Management Law that sets a high international standard for control o f petroleum revenues and transparency. The law, which was adopted unanimously by the National Assembly in late November 2004, details the rules for the receipt and use of the petroleum funds to best serve the country's long term economic development goals that include poverty reduction and good governance. These goals are based on the Poverty Reduction Strategy Paper o f the country. The law focuses on creating mechanisms to promote transparency in the management o f oil revenue. It creates an oil fund to be held by an international custodial bank and outlines the yearly amounts o f the revenues to be usedfor national expenditures and the portionthat is to be retained for a permanent reserve for when the petroleum resources have been exhausted (Fund for the Future). The law mandates two audits each year, one by the auditor-general and the other by a reputable international audit fm to be selected by public tender. The receipt and use o f all petroleum funds are to be public information and easily accessible to the population. The law proposes to limit the confidentiality o f oil contracts and to introduce an obligatory register o f all documentation related to the oil sector, which will be open to the public. The level of transparency written into the law, the willingness of STP to implement the principles of the Extractive Industries Transparency Initiative (EITI), together with the June 2004 signing by President de Menezes and President Obasanjo o f Nigeria o f the Abuja declaration provide a unique opportunity to set an example o f success for the management and use o f the petroleum resources. Given the historical experience o f countries dependent on non-renewable resources, STP's law is considered best-practice. The World Bank and the IMF, along with UNDP, University of Columbia and other donors, provided expert assistance to STP throughout the development and adoption o f the Petroleum Revenue Management Law. These actors are also providing support to the implementation o f the law. 31. Apart from good governance, oil revenues will also require good economic management. The volatility o f signature bonuses and o f actual oil revenues may create an unstable budgetary pattem and economic performance. This carries the risk o f an over-expansion o f government and o f the mis-allocation o f resources, which intum could be compounded by STP's lack o f absorptive capacity, leading to poor quality projects and implementation. The risk o f Dutch disease i s expected to be mitigated through proper use o f the Fundfor the Future. - 9 - G. Debt Sustainability and theEnhanced HIPCInitiative 32. STP's debt ratios to exports and Government revenues are among the highest in the world, reaching close to 1,000 percent. STP reached the Enhanced H P C Initiative Decision Point inDecember 2000 and expects to reach Completion Point by September 2006. At the time of HIPC Decision Point, the debt relief to be provided under HIPC was estimated at US$97 million in end-NPV terms. Since then, STP has received interim relief from IDA, the African Development Bank, the OPEC Fund and the European Uniong. The latest Debt Sustainability Analysis (DSA) in Appendix 1 to this CAS indicates that the debt situation has worsened compared to the estimates made at Decision Point. Assuming that STP reaches its Completion Point in September 2006, the D S A results indicate that the NPV o f debt to exports ratio after the full delivery o f enhanced HIPC assistance would stand at 274 percent as o f end-2004, as compared with 142 percent projected inthe decision point document. 33. ReachingHIPC CompletionPointwill require maintaininga track recordof compliance with the IMF's planned PRGF program and a successful implementationof the PRSP, as well as implementingthe social, financial management and governance reforms laid out inthe Decision Point document. The Government has progressed steadily towards the implementation of those reforms during 2003-04. The first year progress report o f the PRSP implementation shall be prepared in time for the HIPC Completion Point board date (expected September 2006) 34. The updated PRSP includes an action plan in which ensuring debt sustainability is part of the strategy. In this regard, the Government created in late 2003 an extemal debt management unit at the Central Bank. The unit still needs to develop its analytical capacity and establish systems for the regular dissemination o f debt statistics to the public. Debt Relief International i s providing support to STP to manage its debt and to buildcapacity indebt management. H. SocialSectors 35. Since its independencefrom Portugalin 1975 and duringthe 1980s'STP had among the better social indicators in sub-Saharan Africa. Extemal terms o f trade shocks, declining investment in the social sectors, deteriorating economic performance and weak capacity led to a worsening o f the socio-economic conditions o f the population. Basic social services deteriorated significantly, leading to deterioration in health and education outcomes. There was a substantial decrease in public spending for the social sectors inthe mid-1990s but spending levels have recovered since then. Although public expenditure on health and education i s relatively high- accounting for about 30 percent o f expenditure - it i s marked by large inefficiencies. Performance o f the sectors is poor, capacity limitedand access to services remains low. Recently,Pans Clubreschedulinghas metwith some delays due to hesitationonthepart of some members onrescheduling until the EMFprogramis approvedbyits Board. - 10- 36. Today, social indicators are weak. It i s estimated that 15 percent o f children under five are underweight, 29 percent are stunted and 4 percent are wasted. Infant and child mortality rates are highat 75 (out o f 1,000) and 95 (out o f 1,000) respectively. Life expectancy i s 66 years and maternal mortality i s estimated to be 122 per 100,000 live births. Malaria i s a major public health problem, affecting over 80 percent o f the population and is the number one cause o f death. Education services are insufficient, poorly functioning and of low quality. School drop-out rates and repetition rates are high, availability of teachers and teaching materials is scarce and education outcomes are dismal. The delivery o f social services i s constrained by very limited Government capacity to plan and implement social strategies and programs and a weak incentive framework that has a negative impact on the performance o fpublic service providers. As part o f the Household Survey o f 2000/01, households mentioned affordability as a barrier to both education and health. Box 2: Reaching the MDGs in the Health and Education Sectors Analysis o f the potential o f STP reaching the healthMillenniumDevelopment Goals (MDGs) suggests that they are at least partially achievable: The first MDGis to reduce child mortality by two-thirds by 2015, signifying the achievement o f a drop in infant mortality from 75 per 1,000 live births (ptlb) in 2002 to 30 ptlb in 2015; to achievement o f a drop in mortality among children under five from 95 ptlb to 38 ptlb, and to increase measles vaccination coverage from 69 percent to 100 percent inthe same period. Based on the progress achieved toward the first two indicators over the past decade (a decline in mortality o f only 16.9 percent), the MDG goal i s likely out of reach. The vaccination rate, however, is already highand full coverage i s achievable by 2015. The secondMDGgoal is to improve maternal health to reduce by three-quarters, between 1990 and 2015, the maternal mortality ratio (MMR), as measured by the MMR and the proportion o f births attended by healthpersonnel. Data on the MMR are scarce and unreliable; however, the proportion o f births attended by health personnel i s on the rise, and if the supply o f service continues to improve, the MDGcouldbe achievable. The final health MDGgoal is to halt by2015 andto beginreversingthe spread o fHIV/AIDS. The incidence in STP o f HIV/AIDS i s still relatively low, presenting the country with a window o f opportunity to prevent its spread. Although the fight against HIV/AIDS is a priority o f the government, it still has to be translated into practice by providing resources and ensuring the involvement o f all other sectors. Implementation o f the NationalAIDS Strategic Plan should be pursuedas a matter ofnational urgency. As regards the education MDGs, the status is the following: The goal for universal primary education by 2015, also reflected inthe PRSP goals relatedto literacy and net school enrolment rate, should be achievable, givenmore effective provision o f sufficient institutional and financial support from donors. Theredoes not appear to be serious gender gaps inaccess to education. Enrollment rates for boys and girls are equal at the primary and secondary levels but a larger proportiono f girls than boys drops out. While the PRSP suggests that gender equality shouldbe sought, no specific indicator or milestone i s included to capture the MDG goal o f eliminating the slight gender disparity inprimary and secondary education-which should be achieved preferably by 2005 and, inall levels o f education, no later than 2015. The educational systemwill needto establish partnerships with civil society and communities to achieve this goal. - 11- 37. Education. The education sector is characterized by a weak structure and organization which negatively impacts on the quality and efficiency of education. Almost one third o f primary schools operate under a triple shift system which means that average class time i s severely curtailed. The sector employs the largest group inthe civil service but the ability o f the Ministry of Education to use these human resources cost- effectively i s hampered by its weak capacity for personnel planning and management, supervision o f teachers and monitoring resource use. Teachers are de-motivated and untrained with their salaries corresponding to a mere 1.5 times the GDP per capita, and no career development path inplace. 38. The Ten Year Education Strategy (2003-2013) covers the entire sector and emphasizes four broad areas for action: (i) the foundation for a better managed and laying integrated six-years primary education system and for the promotion o f adult literacy programs; (ii) improving access to education irrespective o f gender or income level; (iii)improving learning and reducingrepetitionby strengtheningthe quality o f inputs and management o f the system; and (iv) improving service delivery through policy and institutional reforms and capacity building. To address these goals, the PRSP proposes to increase the share of education in the budget and the relative budgetary allocation for primary education. This inturnwill help increase and equip classrooms inorder to phase out two and three-shift teaching, reduce regional and income disparities, retain more teachers through better training and higher salaries and decentralize the education system. 39. Health. As previously mentioned, health indicators have worsened in the 1990s with increasesin child and adult mortality and child morbidity. Poor sanitary conditions, malnutrition, weak sector management and inadequate attention to primary healthcare are the major factors contributing to the worsening health outcomes. At around 80 percent, general vaccination coverage is good compared to other countries in the region but the national average hides inequities among districts. Malaria i s the main public health problem inthe country, i s responsible for 65 percent o f all hospitalizations of children under 5 and i s the major cause o f death, especially among children under 5 years o f age. STP's populationhas one o f the highest rates o fbednet use inSub-Saharan Africa but only about 45 percent o f babies less than 6 months o f age sleep under a mosquito net and only 53 percent o f the nets are impregnated. 40. The health systemis characterizedby inequities in availability and access to health services, the lack o f qualified staff and weak supervision and monitoring o f the system. The Ministry o f Health has limited management capacity in terms o f planning, implementation, monitoring and evaluation. Staff capacity i s extremely low due to lack of training and career structures, as well as an overall shortage o f staff. Low salaries, scarce data availability and poor utilization o f financial resources complete the dire picture, To achieve the health goals, the PRSP envisages an increase in the budgetary allocation for the health sector. The strategy focuses on restructuring o f basic health services, refocusing care on preventive approaches and on the diseases with the highest morbidity, guaranteeing access to specialized (tertiary) care and improving national nutritional levels. - 12- 41. The Ministry of Health developed a National Health Development Plan for 2001-2010 which aims at (i) improving access to, and develop the quality of, primary care services; (ii) raising access to drinkingwater and sanitation for the poor and improve their nutritional status; (iii) improving public information, education and communication; (iv) strengthening reproductive health services; and (v) combating major endemic diseases (malaria, TB and others). The Government also developed the National Strategic Planto Roll-Back Malaria 2001-2010 which has the following goals: (i) reduce mortality in children under 5 years attributed to malaria by 100 percent; and (ii) reduce by 90 percent the morbidity caused by malaria in the general population. The anti- malaria campaign was launched inthe first halfo f 2003 which emphasizes preventionvia education, use o f mosquito nets and spraying. The program requires substantial technical assistance given the weak local capacity as well as significant financial resources to complement the Government's contribution (Taiwan,. Portugal and the U S are already supporting the program). 42. The HIV/AIDS prevalence in STP is still relatively low, but recent data shows that this is quickly changing; prevalence rates among pregnant women rose from 1percent in 1993 to 5.4 percent in 1996". There i s a high rate o f sexually transmitted diseases, awareness about HIV transmittal methods i s very low, condom use i s less than one percent and cultural traditions mean that sexual activity begins early and involves multiple partners. These conditions create an environment that allows HIV prevalence rates to increase rapidly. A strategy o f HIV/AIDSwas developed, costed and adopted in 2003 which aims to (i)reduce the risk for HIV infection; (ii) the vulnerability to reduce infection; and (iii)reduce the impact o f the epidemic. However, implementation arrangements for many specific actions still have to be designed. I. Infrastructure 43, Access to basic infrastructure services remains low, particularly among the poor. Road andtransport infrastructure i s ina state o f decline and rural infrastructurehas suffered from a prolonged absence o f investment (although the EC i s emphasizing this sector in its aid program). Most rural roads have been badly neglected since the demise o f the cocoa plantations. The low frequency and high prices o f air services and poor airport infrastructure are significant barriers to the development o f tourism. The limited port structure also hampers the integration o f STP into the regional and global markets: improvements to the port structure and services are essential to promote private sector development. Unsuccessful attempts have been made in the past to privatize the water and electricity company - EMAE; given the difficult international energy environment, privatization i s no longer being considered in the short-run. Cost recovery o f EMAE i s an issue as the company has suffered from chronic deficits inthe past. The Government i s the biggest consumer o f electricity and does not pay its bills on time which creates serious financial problems for EMAE. lo Data scarcity makes it difficult to provide a more recent estimate of prevalencerates. - 1 3 - 44. Notwithstanding these constraints, the picture on infrastructure is not all negative. Telecommunications are better than the Sub-Saharan Afiica (SSA) average with 41 telephone lines per 1,000 people in 2003, compared to the SSA average o f 21. Sixty percent o f households have access to electricity although transmission problems and irregular power supply constrain the system. Regular rainfall and the mountainous nature o f Sao Tome island suggest that fresh water i s abundantly available inthe form o f rivers and streams although actual data on access to potable water i s scarce. 45. The PRSP comprehensively covers infrastructure issues: (i) for telecommunications, the Government intends to liberalize the market by end-2005 to foster investment; (ii) in water and sanitation, it foresees more connections, improved quality and proper maintenance; (iii)for the transport sector, the strategy sets an ambitious agenda for repair and maintenance o f roads, reform o f air traffic and development o f airports and seaports; and (iv) in the energy sector, it envisages increasing electricity supply and service through enhanced private sector participation and reform o fthe finances andmanagement o fEMAE. Box 3: Environment STP has an equatorial climate with heavy rainfall, hightemperatures and highhumidity. Sao Tome island is mountainous with cocoa plantations carved out o f dense jungle, intersected by numerous streams. Principe occupies just 15 percent o f the total area o f the archipelago and i s extremely jagged and indented with numerous bays. There is abundant bio-diversity o n the islands, particularly flora and birds. STP's forest resources have been indiscriminately developed, with deforestation one o f the main environmental problems. Despite the support o f the European Commission, the Government has yet to implement a plan to protect areas. STP has benefited from Bank support in the past to develop its National Environmental Action Plan (NEAP) and the UNEP is also active inthe country inassisting them address environmental issues. The Government i s aware o f the importance o f the country's biodiversity, notjust for the potential o f developing eco-tourism but as a world heritage in its own right. The Ministry o f Natural Resources and Environment has committed to implementing a series o f environmental and biodiversity conservation programs. N o oil production or refining is anticipated on the islands so fiture environmental risks arising from the oil era are judged to be relatively low. The private sector oil companies have expressed willingness to observe international standards o f environmental practices and intend to carry out the necessary environmental assessment associated with their activities. Inlate-2004, STP received a GEF grant for $200,000 which assists the Government to draft a plan prioritizing the actions needed to prepare the country for projected climate change impacts in key sectors, e.g. declining capacity for hydropower, increased coastal flooding, impacts on agriculture, etc. It i s expected that this initial grant will pave the way for STP's climate change program to benefit from further GEF support for the implementation o f the priority actions. The Bank's rural and environmental team is working closely with the Government o n the initial GEF grant to ensure a successful action plan i s prepared and that fiu-ther grant resources are made available for its implementation. - 14- J. Governance and Capacity 46. The key constraints facing STP in implementing its reform program stem from weak institutional capacity, governance issues, and lack of skilled human resources. While successive Governments have expressed their commitment to reform in general, effective and timely implementation o f measures has suffered from insufficient technical and financial assistance and lack o f political will in specific reform areas such as civil service and land reform. Governance issues are a source o f concern with the arrival o f oil signature bonuses and the future oil era. As a consequence, improving governance must be at the forefront o f the poverty reduction agenda and concerted efforts are neededto buildstrong institutions to prepare for the oil era. 47. The PRSP recognizes that good governance has a significant impact on poverty reduction. It stresses the need to consolidate the rule o f law, including constitutional reforms to remove potential sources o f conflict among the branches o f the government. Other measures considered include basing the National Assembly on proportional representation, reforming and reinforcing the judiciary by training judges and civil servants in modern law, updating the legal framework and empowering law enforcement. The PRSP envisages a reorganized public sector to increase its efficiency and transparency through: (i) eliminating overlapping functions between agencies; (ii)decentralizing and strengthening local government structures; (iii) with-drawing from productive activities; and (iv) reforming the civil service to enhance the provision o f public services. 48. On budgetaryprocedures,capacityis beingstrengthenedin order to improve public expenditure management,with more a priori and posteriori checks. With the support o f the IMF, World Bank and others, the Government is moving ahead with reforms to improve procurement, inventory and accounting practices o f government assets, receipts and expenses. In this regard, the Government will shortly begin the implementation of an integrated budgetary andtreasury information system. Another key action i s the strengthening o f the internal and external audit o f government agencies by empowering the Auditor General's Office. The accounting tribunal started its activities inJuly 2003. Intax administration and collection, better cooperation and an information sharing system among different directorates and authorities have led to improvements in taxpayer registration and tax collections. Efforts continue to reorient public expenditure toward the education and health sectors in the context o f the PRSP, and the authorities continue to ensure that all government financial operations, including PRSP-related spending, are within a single budget framework. The Government i s reforming the programming and implementation process o f the PRSP by creating a PRSP unit within the Ministryo f Planningand Finance. Notwithstanding this progress, the overall budget framework needs to be further strengthened, and the capacity o f key ministries to formulate programs and their associated budgets needs to be improved. Budget execution i s not well coordinated, with numerous steps involved inexpenditure approval, while control remains weak. - 15- 49. InApril 2004, an updateofthe HIPC-AAP revealedthatwhilesome progress hasbeen made, much morework remainsto be done. Onthe positive side, the budget formulation is exhaustive; unified under one budgetary system, with little reliance to extra-budgetary processes; and captures approximately 90 percent o f external support. Internal arrears are usually cleared within a few weeks. Regular internal reporting o f budget execution and debt follow up is adequate and the yearly books are closed within two months o f the end o f the fiscal year. As regards work to be done, the HPC-AAP suggests that the budget needs to be updated to the modern nomenclature system and adapt a multi-year approach. Also budget execution is weak: in2002, it was 23.2 percent of budget programmed. Execution i s not well coordinated among ministries, with numerous steps involved in expenditure approval, weak accounting practices (no double entry accounting), andweak a priori and posteriori controls. External reporting o fbudget execution to the National Assembly is still unavailable and poverty reduction expenditures are not yet identifiable. 50. Overall, despite some progress, the implementationof the reform program has been slow pacedin some areas while unevenin others due to political instability, lack o f political will and low institutional capacity. Reforms in all areas were slowed by the drawn-out political in-fighting, six reshuffles or changes in governments between September 2001 and September 2004 and the consequent general uncertainty. K. Productive Sectors 51. Agriculture represented19 percentof GDP in 2003 with cocoa productionas the main economic activity. Production o f cocoa has been increasing since 2000 as international cocoa prices have risen. The positive price trend has reversed somewhat the decline in the cocoa sector which hampered the economy in the 1990s. The Government's program in rural development concentrates on diversifying agriculture towards other crops and promoting export linkages. Reduction o f the food import bill i s also a priority for the Government, since most food needs, except cereals, could be supplied locally. A major land reform program has been underway since 1993, with support in the early years from the World Bank. Its objective i s to distribute land from former state plantations to small-scale farmers in an attempt to increase and diversify agricultural production and increase equity. However, smallholder farmers have been constrained by a lack o f credit, extension services and training and by poor access to markets as a result o f inadequate road transport. Fishing licenses have become the country's largest source o f foreign exchange after cocoa. A three-year fishing agreement was signed with the EUinJanuary 2002 for about US$2.5 million. 52. Increasing labor productivity and diversifying income-generatingactivities, especially in rural areas, is criticalfor reducingpoverty. The Government's strategy emphasizes needed improvements in basic roads and marketing infrastructure for agricultural products and extension services, the development o f downstream agro- industrial activities as well as tourism and fishing networks in the archipelago. These actions are not well costed or prioritized inthe PRSP so that their impact on growth and poverty could be assessed. - 16- 53. Industry accounts for 18 percent of GDP but the manufacturing sector is limited to some small factories involved in the agro-industrial sector and other light industrial activities. Privatization o f state companies has slowly proceeded with the telecoms company, the state airline and the national fuel company having private capital investment. There is still a lot to do to create the financial, administrative, institutional and infrastructure conditions necessary to support growth inprivate sector production. 54. Services - predominantly public administration, tourism and commerce - contributethe remaining63 percentof GDP. The tourism potential lies inthe islands' great natural beauty, unspoiled beaches, endemic bird species and old plantation houses. However, tourists are deterred by the islands' isolation, high malaria rates and poor air access with high air fares. The Government i s trying to promote eco-tourism and some investment has flowed in. Foreign exchange earnings from tourism have increased from US$4.1 million in 1998to an estimated US$15.8 million in2004. Box 4: Gender Issues in Sao Tome and Principe In June 2004, the Government and the Bank finalized a Country Gender Assessment for STP (Report No. 29300- STP). This report highlighted that STP has a distinctive gender profile characterized by a dichotomy between the officially-accepted gender equality laws and policies and the actual gender-associated socio-economic status. While gender equality is emphasized inthe constitution and inthe legal framework, actual practice i s often contradictory. A highproportion of households are headedby women who are mostly either single or living in"free union". These women are four times more likely as men to be illiterate. On the whole, female-headed households tend to be larger, poorer and with lower per capita consumption than male-headed households. Women's participation in decision making at the local levels is marginal and cultural attitudes relegate women to more traditional roles. Women are confined to a limited set o f economic activities - usually a form o f self-employment in the informal sector - and they have limited access to productive resources. Women constitute the largest segment o f the economically inactive population. Among those who are economically active, women are twice as likely as men to be unemployed; specifically a quarter o f women in the labor force are unemployed compared to ten percent for men. Employed women tend to be concentrated in the informal sector, mainly in commerce and services, while men are likely to be employed as public or private sector salaried workers. There i s increasing evidence to indicate that domestic violence rates against women and children are high. On the positive side, however, several women occupy high-level decision-making positions at the national level, there does not appear to be any gender gaps in access to education and health and there is an official discourse that espouses gender equality. Enrollment rates for boys and girls are equal at the primary and secondary levels but a larger proportion of girls than boys drops out. While there are gaps inliteracy rates between men and women in older age groups, the gap is rapidly closing inyounger generations. Interms of power and decision making, women had, or continue to have, a significant share at the highest levels o f Government. The previous Prime Ministerwas a woman, the current Govemor of the Central Bank is a woman, women have headed the Ministries o f Planning and Finance, Health, Foreign Affairs, Education, Culture and Justice, and women hold some senior presidential advisory positions. Despite this good representation at the highest political level, the share o f women in the political process and decision-making is very limited at the lower levels. Hence, while there i s a clear commitment towards gender equality at the higher levels o f Government, more effort i s needed to expand opportunities for women's participation at other levels. As part o f the preparation o f the Country Gender Assessment, a national workshop was held in January 2004 in STP to discuss gender issues. The main recommendations were to: (i) an integrated national approach to gender adopt issues by developing a body o f gender-sensitive policies that would provide for access to information, awareness- raising and legislative reform; (ii)strengthen institutional capacity to integrate gender issues into development programs and policies; (iii)establish advocacy, social mobilization, information, education and communication programs on gender and development issues; and (iv) update existing legislation and adopt new legislation that is more gender-equitable. The Bank i s supporting some o f these recommendations through the IDF for Justice Capacity Building as well as the Governance Capacity Building TA Project. The UNDP, ADB and the Portuguese and Taiwanese bilateral aid programs also support gender issues. - 17- 111. BANK GROUPASSISTANCE STRATEGY A. Implementation of the last CAS 55. The previous CAS for STP was discussed by the Board in November 2000 and covered the FYO1-05 period. The CAS followed the finalization o f the Interim PRSP (April 2000) and was closely aligned to the priorities outlined therein. The main objectives o f the CAS were aimed at: (i)sustaining strong economic growth to raise incomes and reduce poverty; and (ii) broadening access to social services and improving their quality. Given the small IDA envelope available to STP, the CAS placed emphasis on a multi-sectoral approach within new lending. While no additional, formal economic and sector work (ESW) was envisaged during the CAS, inactuality several studies were undertaken to complement the Bank's lending interventians, support the finalization of the PRSP, and assist the Government in qualifying for the Enhanced HIPC Initiative, as shown inBox 5 below. Box 5: Non-Lending Activities CarriedOut Duringthe PreviousCAS Policv dialogue and AAA: 0 Assistance for qualifying for the Enhanced HIPC Decision Point and moving towards achieving the Completion Point. 0 Support infinalizing the PRSP 0 On-going dialogue, incollaboration with the IMF, on macroeconomic management 0 Support to the development o f the petroleum revenue management law. 0 Dialogue and TA on policy reforminthe telecommunications sector. ESW: 0 Country Economic Memorandum (FY04) 0 Country Gender Assessment (FY04) 0 Poverty Diagnostic (FY05) 0 Diagnostic Trade Integration Study (DTIS) (on-going) Other: 0 IDFfor Capacity Building inthe Justice Sector 0 PHRD financing for specific social sector studies (Study on the Situation o f Orphans and Vulnerable Children, Institutional Assessment o f the Social Sectors, Analysis o f M&E in the Social Sectors) 0 GEF grant for analyzing the vulnerability o f STP to the effects o f global wanning (the $200,000 grant was recently approved inDecember 2004 and activities are being launched) 0 BelgianTrust Fundfor poverty analytical work. 56. As the CAS CompletionReportin Annex 11describes, the Bank rebuilt both its knowledge base of STP and its relationship with the Government and other development actors during the CAS period. The Bank actively pursued the policy dialogue in the context o f PRSP preparation and HIPC relief, implemented and prepared new operations, and focused ESW to support areas o f engagement. The Bank hadlimited - 1 8 - engagementwith the country inthe periodimmediatelypreceding the CAS and thus the CAS suffered from a poor analytical and knowledge base and could be considered as a relatively "light" strategy. Nevertheless, the actual implementation o f the CAS was robust and the Bank's program was increasingly broadened as the dialogue deepened with Government. 57. As regards lendingoperations,the CAS outlinedthat activitieswould remain limited to the existing portfolio of two projects and two new projects - the Public Resource Management Credit (PRMC) and a supporting Public Resource Management Technical Assistance Project (PRM-TA), which were both approved at the time o f the CAS discussion. However, the CAS did make provision for possible further lending in the context o f the future PRSP and indicated that such lending would be targetedto the social sectors and capacity building for petroleum policy and management. Performance by STP during the CAS period was considered sufficiently satisfactory to allow for approval o f two hrther projects - the Social Sector Support Project and the Governance Capacity BuildingTechnical Assistance Project. I Box 6: BankLendingProgramFor the FY01-05 CAS Period I Projects already active at time Projectsapprovedat same time Projectsapproved during CAS of CAS discussion as CAS period Agricultural Privatization and Public Resource Management Social Sector Support Project Smallholder Development Project Credit (US$6.5 million, FY04) (US$9.8 million, FY92) (US$7.5 million, FYO1) Public Resource Management Governance Capacity Building (US$l 1.4 million, FY92) Technical Assistance Project Technical Assistance Project (US$2.5 million, FYO1) (US$5 million, FY05) 58. The two projectswhich were active at the time of the CAS - the Agricultural Privatization and Smallholder Development Project (US$9.8 million, FY92) and the Health and Education Project (US$11.4 million, FY92) - were both closed in 2001. In the case o f the Agricultural project, the ICR and OED rated the project's outcome, Bank performance and Borrower performance as Unsatisfactory. This investment project had been approved in FY92 and was not appropriately tailored for the country context. As acknowledged in the ICR, the project's design was unrealistic, the reform program was overly complex for local institutional capacity to handle, the planned implementation timeframe was too ambitious, and the supporting activities were too dependent on parallel financing o f other donors that had not yet been negotiated. The project also failed to incorporate lessons learned from earlier projects, particularly regarding the need to clarify and focus training activities appropriately. Project supervision did not take a holistic approach, suffered from inadequate composition and timing, and was undermined byhighturnover o ftask managers (five ineight years). - 19- 59. In the case of the Health and EducationProject, the ICR rated the project's outcome, Bank performance and Borrower performance as Satisfactory but OED ratedeach of these as Unsatisfactory. The analysis o fthe project was that it was poorly ' designed, overly complex, and did not take capacity constraints sufficiently into account. Similar to the Agriculture Project, the Health and Education Project was approved in FY92. The project suffered from the frequent changes in government and reliance on thirdparty funding for implementation. Inaddition, supervisionwas deemed inadequate, with missions lackingthe specialists neededto cover the range o f activities included. 60. Duringthe period covered by the CAS, the Bank implemented fully the PRMC (which closed inJune 2004) andthe PRM-TA (which closed inDecember 2004). 61. The PRMCwas designedas a quick-disbursingoperationto fillthe financing gap for the period 2000-01, and also provided support to the implementation of economic reforms. The project supported economic reforms with the following objectives: (i)improve domestic resource mobilization; (ii) strengthen public expenditure management; and (iii) continue implementation o f the public enterprise reform program. The PRMC was implementedinline with the IMF's Staff Monitored Program and aimed to help protect social sector expenditures. The ICR for the PRMC reflects a mixedrecord o f success. The project's outcome was rated unsatisfactory, its sustainability likely, its institutional development modest, and Bank and borrower performance unsatisfactory (OED agreed with these ratings). The ICR highlightsthat the PRMC was wide ranging and overly ambitious. The fast-disbursing nature o f the operation over only two years was too quick for the scope o f reforms proposed. While the Government progressed on tranche release conditions, other reform measures fell by the wayside (e.g., rural landtitle registration and some private sector development activities were never launched, extension services and the micro-credit system were weak or inconsistent). Successes under the PRMC included progress on domestic resource mobilization and management, with the implementation o f tax and tariff reform measures and the protection o f health and education expenditures; the Government also made efforts at privatizing public enterprises and introducing more transparency and govemance into its activities. Some o f the weaknesses inthe project's performance can be ascribed to elections and political instability. 62. The PRM-TA was designedin part to support measures implementedunder the Government's reform program supported by the PRMC. However, it also supported the elaboration o f some o f the sectoral strategies and the preparation o f the PRSP. It helped build institutional capacity in financial and budgetary management, judiciary, oil and statistics. It focused part o f its support to some nascent oil sector activities through: (i)successfully financing intemational experts to help the Government negotiate four oil contracts and launch and analyze the first round of bids for the Joint Development Zone; (ii)supporting the creation o f the National Petroleum Agency ("PA); and (iii)providing technical assistance to the Government in finalizing the petroleum revenue management law. The PRM-TA benefited from strong government ownership and active Bank supervision. The ICR for the PRM-TA is not yet finalized, however it i s expected to reflect the generally positive experience inimplementation. - 20 - 63. The GovernanceCapacityBuildingTechnicalAssistance Project($5 million) was approved in October 2004 andbuilds on the experience and lessons learnt o f the PRMC and PRM-TA. I s main objectives are to: (i) facilitate the implementation of help the PRSP through capacity building and management support; (ii)strengthen public expenditure management and the implementation o f reforms; and (iii) provide critical technical assistance and capacity buildinginthe oil sector. More specifically, the project aims to improve the impact of better budget and economic management on economic growth, development and poverty reduction through modernizing and building up capacity in economic (financial and budgetary) management and supervision, and through strengthening basic institutional and legal infrastructure in the Ministries o f Planning and Finance and o f Natural Resources and Environment (which includes petroleum). The project i s in line with objectives outlined in the country's PRSP and responds to the more complex economic and social environment arising from the onset o f the oil era. It targets the following oil sector interventions: (i) strengthening o f the NPA; (ii)strengtheningofthelegalframeworkincludingsector-related environmentalissues; (iii) theGovernmentprepareasoundpetroleumsectorstrategyandpromotethe helping Exclusive Economic Zone (EEZ) o f the country; (iv) establishing a functional information system that is transparent; and (v) undertaking studies and seminars for sector development andjob creation. The project includes a detailed results framework, with concrete indicatordtargets to track the Government's progress in implementation. While it remains to be seen to what extent the project achieves its development objectives, it i s o f f to a strong start under intense supervision and strong government ownership. 64. The Social Sector Support Project($6.5 million, of which $1.5 millionis IDA grant) was approved in May 2004. Its development objective is to contribute to improving the delivery o f basic health and education services with a focus on greater and more equitable access, betterquality and improved local governance. The project focuses on supportin the country inachieving the MDGs (it contributes directly to six out o f the eight MDGs ), and supports the implementation o f the PRSP and the national social 7, sector strategies. The project was a key element o f the Bank's 2000 FYO1-05 CAS as it contributes to the CAS goal o f broadening access to social services and improving their quality. The project deals to some extent with a re-definition o f the role o f Government as it involves NGOs and civil society in project implementation. Three social sector studies, financed by a PHRD grant, and the 2004 Gender Assessment, were used to inform the design o f the Social Sector Support Project, which incorporated the studies' recommendations. The project's specific HIV/AIDS component will aim to improve the statistical information base on HIV prevalence rates and ensure greater knowledge about prevention techniques among the population. 65. In FY05, the Bank approved an IDF for Capacity Building in the Justice Sector (US$314,958) which is an important element o f the Bank's program, although it was not plannedat the time o f the CAS. This IDFwas developed inresponse to a request from the Minister o f Justice andthe Prosecutor General's Office for the Bank's support to Namely: Goal #2 Achieve universalprimaryeducation; Goal #3 Promote gender equality and empower women; Goal #4 Reduce child mortality; Goal #5 Improve matemalhealth; Goal #7 Combat HIV/AIDS, malaria and other diseases; and Goal #8 Develop globalpartnershipsfor development. - 2 1 - pursue a strategic program o f reform and capacity building for the justice sector. The PRSP identifies judicial and institutional reform as a key determinant for economic development andpoverty reduction. Thejustice sector faces many constraints: (i) it lacks the resources and tools to ensure the full rule o f law; (ii) judges and prosecutors are poorly equipped to ensure a stable legal andjudicial framework; and (iii) with only 80 staff total, the judiciary is severely short o f capacity. As part o f IDF preparation, a variety o f stakeholders in the sector prepared their own proposals for urgently needed judicial and institutional reforms and capacity building activities. The IDF responds to the critical issues in each o f these proposals, focusing in particular on: (i) building capacity for strategic planning; (ii) coordinating reforms; and (iii) better leveraging the country's resources to create a consensus for those reforms. B. Other WorldBank GroupActivities 66. STP is not a member of IFC or MIGA. The Government has been encouraged to join both institutions in order to benefit from their investment services, but it has been unable to come up with the required capital subscription amount. A MIGA representation visited the country in the spring o f 2004 to discuss possible membership with the Government. FIAS has helped the country review the fiscal and investment codes. It is expected that the future oil era will usher ina new relationship between STP andthe IFC. 67. Representativesfrom STP benefitedfrom WBI trainingsinPRSPpreparation and implementation, social sector capacity buildingand other areas o f WE31trainings and knowledge services. More recently, STP is becoming more active in attending Lusophone training events (such as infrastructure regulationtraining inCape Verde). C. LessonsLearnt 68. OED evaluated all 8 of the Bank's projects since 1980 and concluded that halfof themhadUnsatisfactoryratings. The conclusions reachedwere that the Bank's projects were typically too complex to implement and did not address capacity issues sufficiently. In particular, there was weak capacity in project management and in key fiduciary control areas such as procurement. 69. The lessonslearnedfromthe CAS implementationare the following12; (i) national ownership o f the reforms and related capacity buildingprocess i s necessary for successful implementation and sustainable impact o f projects/programs; l2The CAS Completion Report in Annex 11 provides more details on the implementation of the last CAS and the lessons leamt. - 22 - operations should take into account STP's limited, weak institutional and human resources capacity. Therefore, there is a need to keep the project simple, clear and focused in design, implementation (components and indicators) and follow-up (supervision); with respect to capacity buildingsupport, activities should be delivered in conjunction with project/programs, and should be part of a detailed action plan attached to the Government's policy agenda; implementation arrangements and monitoring and evaluation activities should be simple but robust, including appropriate capacity building (e.g., training, technical assistance) as necessary; a multi-sector approach to project lending is more efficient in a small country setting, but progrdproject objectives should be focused on a limited number o f priorities in each sector, within the capacity o f properly trained implementers; flexibility should be built into project/program design, to allow for adaptation to evolving needs on the ground during implementation non-governmental stakeholder participation should be more systematically incorporatedinthe planningand implementationo f activities; the collaboration o f the Bank with the IMF had a positive impact on the outcome o f the PRMC and PRM-TA projects; and enhanced donor collaboration and coordination i s critical to improving the efficiency, efficacy, andimpact o f external assistance. 70. A key conclusion from the experience in STP under the CAS and previous operations is that project support may not be the most effective instrument to deliver Bank financing to assist the country in meeting its development challenges. Development policy operations (Le,, budget support) - coupled with appropriate capacity building activities, technical assistance, analysis, and policy dialogue - should be considered as a potentially more effective and efficient way o f delivering the Bank's assistance. The critical issue i s to ensure that there is appropriate design and timing o f such operations and that they build on the lessons learnt from the quick-disbursing experience o f the PRMC. Development policy operations also provide more leverage to the small amount o fIDAresources availableto STP. D. Assistance Strategy 71. The CAS builds on the experience and lessons learned from the implementation of the mol-05 CAS and sets out a strategy that consolidates and deepens those activities already undertaken. The two principal objectives o f the Bank's strategy are: (i) to support the implementation of the PRSP and strengthen the areas where the PRSP needs to be improved, as highlighted inthe JSAN. - 23 - (ii) to provide assistance to STP to ensure that it i s sufficiently prepared to maximize the benefits o f fbture oil revenues. 72. The strategy draws from the wider base o f ESW and AAA that has been conducted since the last CAS (the CEM, Poverty Diagnostic, Gender Assessment and draft DTIS). It focuses on just a few selected areas o f intervention to maximize the Bank's impact and to ensure complementarity with other development partner^'^. This selectivity is dictated by the limited IDA financial envelope which i s available for STP and by the Bank's internal administrative constraints which allow for only a relatively small number o f non-lending activities to be conducted ina country o f STP's size14. Box 7: ParticipatoryCAS Process As noted previously, the CAS is specificallylinked to the PRSP and is "the Bank's implementationarm" o f the PRSP: in this regard, it benefits from the participatory process of the PRSP. The CAS team conducted preliminarydiscussionswith the GovernmentinDecember2004 about the possiblestrategicdirectionof the CAS and the overall lendingenvelopethat couldbe expected. The CAS team visited Sao Tome in early April 2005 to carry out consultations with Government officials, their advisors and staff, as well as with representatives of labor unions, members of the National Assembly, the Federation ofNGOs (FONG), representativesfrom the Chamber of Commerce andrepresentatives of donors and international agencies (UNDP, WHO, UNICEF, European Commission, Embassies of Portugaland Brazil). The team coordinatedvery closely with a mission from the African DevelopmentBank (AfDB) which was in Sao Tome at the same time to discuss their organization's draft assistance strategy for 2005-2009. The team held fruitful and frank exchanges with all these actors which allowed for a better understanding of the development challengesfacing Sao Tome andPrincipeas well as the role of the World Bank inthe country. There was general agreementthat the World Bank's focus on building institutional and humanresource capacity is critically important. Stakeholders also agreed that the Bank shouldcontinue to focus on the sectors where it is already active although there were demands for broadening the Bank's financial assistance to cover non-oil productive sectors. The CAS team emphasized that the proposed budget support operations could assist in carrying out neededreforms and interventionsinproductivesectorsbut that traditional investment projectsinthis regardwould not bepossibledue to the limitedfinancingenvelopeavailable. Moreover, the Bankwould continue to target its analytical support and policy dialogue on addressing the constraints facing the productive sector through identifying necessary reforms for trade facilitation, private sector development and economic diversification. Implementationof the recommendationscontained in the Country Economic Memorandum, as well as follow-up on the analysis ofthe on-goingDiagnosticTrade IntegrationStudy, will be especially critical in this regard. Inparticular, there was a strongdemandfor the Bank and other donorsto helpwith moretraining and more capacitybuilding specifically targeted at income-generating activitiesto permit awider set of employment options for the population. The CAS team emphasizedthe goal of the Bankto enhance its cooperationwith other donorswhich are active inthese sectors. As the Bank programdoes not bring significant IDA resourcesto the country, the CAS consultationsresultedina greater degree of understandingand ownership of both the lending and non-lendingsupport which the Bank can provide to STP. Even after oil revenues come on stream, the Government has indicatedthat it is interested in havingthe Bankplay an advisoryrole in regardto helpingthe country successfullymanageits oil revenue. 73. Above all, the strategy remains tightly focused, building upon on-going activities and enhancing and deepening the strategy laid out inthe previous CAS. Inthis regard, the Bank's support will betwo-fold: l3Annex 10providesdetails of the sectoral focus of donors' programs inSTF'. l4The ResultsFramework inAnnex 1outlines a few keyresultsto whichthe Bank'sprogrami s aimingto contribute. - 24 - (9 continue the implementation o f on-going activities, especially with respect to social sector service delivery, capacity-building in public finance management, institutional support to managing the oil sector, and follow- up on recommendations o fthe Bank's ESW and AAA. InFY06, possible additional financing could be considered for the two on-going operations for specific capacity building activities not originally covered by the projects but focused on related aspects o fPRSP implementation; and (ii) movegraduallytoprovidingaseriesofDevelopmentPolicyOperations (budget support) starting in FY07, with the objective o f strengthening implementation o f the PRSP and maximizing IDA'S impact. Such operations would be undertaken in close collaboration with other donors interested in providing budget support. In the period leading up to this, the Bank would work closely with the Government to prepare the country's fiduciary framework and institutional capacity for the management and implementation o fbudget support. Box 8: SPECIFIC ACTIVITIES OF THE BANK'S PROGRAM On-GoingActivities ProposedNew Activities On-going policy dialogue on macroeconomic issues, Development Policy Operations incollaboration with the IMF Sustained support to the implementation o f the Additional financing to the Social Sector Support Social Sector Support Project and the Governance Project and/or the Governance Capacity Building Capacity Building Technical Assistance Project Technical Assistance Project Continued assistance to STP to achieve the HIPC Enhanced AAA support for preparing the Completion Point groundwork for the move to budgetary support Support to the implementation o f the Petroleum Launch an Integrated Fiduciary Assessment in Revenue Management Law FY06, to be completed in FY07, which will cover aspects o f a PER, CFAA and CPAR" Finalization o f on-going ESW work (DTIS) and Further analysis o f poverty and support to the follow-up on recommendations o f other ESW government to conduct two surveys aimed at reports (CEM, Poverty Diagnostic and Country improving the present household and expenditure Gender Assessment) data Implementation o f the IDF grant for Capacity New IDFandor Trust Fundfinancing for support to Building inthe Justice Sector critical aspectso f PRSP implementation GEF grant for developing Global Warming and Pursuit o f further GEF financing for implementation Climate Change program o fpriority actions o f the climate change program The Bank and IMF will continue to work together Consideration o f other ESW and AAA with othex with the Government on the HIPC-AAP16. development partners, i.e. support to census IsThe Bankbudget for the country is insufficient to cover individualcore diagnostic reports ineach of these areas. l6The analysis and recommendations of the HIPC-AAP for STP have fed into the design of the Governance Capacity Buildingproject as the projecthas aspecific indicator linkedto improvementsinthe HIPC-AAP scores. - 25 - 74. An over-riding theme of the strategy is that the Bank will assist the Governmentto "scale-up" for the future era when it will have highlevels of its own resourcesfrom oil (as previously mentionedinfootnote 3, STP is expected to remain an IDA borrower for the CAS period). As part o f this transition, the strategy proposes to provide financial support through Development Policy operations in support o f PRSP implementation, with a view to preparing the ground for managing future oil revenues into the budget. This Development Policy Lending (DPL) would deliver a form of annually-negotiated budget support to the implementation o f the PRSP, starting inFY07. This would not be a multi-year rolling commitment that is usually associated with the Bank's PRSCs since the macro track record isn't yet sufficient to justify a medium-term commitment. Rather, it would be a form o f annually-reviewed financing that i s delivered to support the PRSP program. This would represent a true new strategic direction for the Bank program which would be triggered by sound macroeconomic management and progress inpublic finance and oil management. 75. DPLs are justified as an effective way to deliver necessary financial support to the PRSP. Given the small export base of STP with a concentrationon cocoa receipts and the uncertainty related to oil prospects, the economy i s highly vulnerable to exogenous shocks. Even after STP reaches HIPC Completion Point, the country will likely face a significant financing gap untiloil revenues become available, duringwhich time the Bank will continue to be an important partner. Although the share o f STP inthe signature bonus for the first block i s in the order o f US$49 million, the actual amount available to the 2005 budget i s only $13 million (see footnote 8). Moreover, the amount o f funds available from other oil bonus signatures i s still uncertain, as well as the timing o f the availability o f the funds. It is, therefore, important that the Bank consider providing some form o f quick disbursing fimding that will allow for timely support to the implementation o f the PRSP and will strengthen the overall budgetary framework as preparation for the arrival o f oil revenues. 76. The DPLs would likely be delivered in FY07 as the current framework in STP is not conducivefor providingimmediate budgetary support for the following main reasons: (i) there i s a need to strengthen the overall strategy outlined in the PRSP, particularly to prepare annual priority action programs; (ii) a medium-term program for strengthening the fiduciary framework i s not yet elaborated to ensure transparency and financial safeguards required for this form o f financing; and (iii) there is a need to identify a clear set of monitorable indicators around which future budgetary support operations could be aligned. Therefore, a core element o f the Bank's work for the coming 12-18 months will be to help STP prepare the necessary framework for receiving budget support from the Bank and other donors. In the immediate future, it will be necessary to work closely with the Government and other development actors in STP to outline an annual priority action program for the PRSP and identify a set o f monitorable indicators against which budgetary support could be aligned. This work would be carried out as part o f the overall support to strengthening the PRSP and progress made on this front could be assessed as part o f preparing the Annual PRSP Progress Report (expected inApril 2006). - 26 - 77. In addition to support for PRSP strengthening, the Bank will provide analytic support and technical assistance to the Government for outlining a medium-term program for strengtheningthe fiduciary framework. An Integrated Fiduciary Assessment will be launched in FY06 for delivery in early FY07. Areas o f concem for this assessment will be the following: (i)the budget elaboration process, specifically using hlly implemented budget nomenclature and functional classification based on intemational standards; (ii) the public accounting system based on a simple but efficient computerized network; (iii)budget execution reporting produced on a regular basis; and (iv) intemal and external controls, particularly for ex-post control o f the Supreme Audit Court. The Bank will work closely with Governrnent on implementing the recommendations o f this assessment in parallel with on-going work on the HIPC- AAP and other relevant analyses. The timing o f delivery o f financing in the form o f DPLswill be linked to progress on this front. 78. While it is too early to confirmwhat exact reformmeasures the DPLs would support, it is likely that they will be linked to the sequential implementation o f the underlying reforms for managing the hture oil inflows and to other critical issues such as the investment climate and growth-relatedissues, drawing on the recommendations o fthe C E M and the DTIS. The DPLs will draw from the lessons leamt o f the PRMC, be designed to complement the Govemance Capacity Buildingproject, will be closely linked to the PRSP Annual Progress Reports and will be prepared in close collaboration with other donors (notably the African Development Bank and the EC). It i s hoped that the DPLswould contribute to meeting the expectations o fthe populationduringthe transition period to an oil economy. 79. In the nearer-term,i.e. in FY06, the Bankwill consider deliveringadditional financing to the on-going Social Sectors andor Govemance Capacity Buildingprojects. This financing would be relatively small - no more than US$1.5 million - and would support a broader range o f capacity building and institutional support interventions, linked to critical aspects o fPRSP implementation. 80. The IDA-14 framework indicatesan allocationof US$5.5 millionfor STP for FYO6-08 (Base Case). It also indicatesthat STP is eligible to receive all of its FY06 IDA allocation on grant terms". This allocation is indicative only and is subject to performance by the country'*. Should STP perform well on overall economic and public sector management as assessed in an improved CPIA rating, as well as achieve strong implementation of IDA-financed projects, then its IDA allocation for FY06-08 could be increased up to US$7.5 million (High Case). Thereafter, for FY09 (which is also covered in this CAS), hrther IDA resources would be available as part o f the following three-year IDA-15 envelope for FY09-11 andwould be calculated based on the assessment o f STP's progress during FY06-08. While it is not possible to determine what the IDA-15 allocation would be at this time, good progress should allow STP to benefit from an indicative IDA allocation o f $2 million per annum ina base case and $2.5 Grant eligibility will be reviewed annually. I*As per the IDA-14 framework, actual amounts will depend on the following: (i) IDA performance rating; (ii) STF"s STP's performance relative to the performance o f other IDA recipients; (iii) amount o f overall resources available to IDA; and the (iv) the terms o f financial assistance provided (i.e. grants versus loans). - 27 - million in the high case if performance improves significantly. Therefore, the CAS outlines a notional lending program in the range o f $5.5 million to $10 million over 4 years. The financial amounts o f the DPLs would be increased in line with the overall increase o f the IDA envelope (see Box 9). A CAS Progress Report will be undertakenat the mid-point of the CAS implementation period (late FY07/early FY08) which will review the financing scenarios and assess overall progress on PRSP implementation, CPIA assessments and project performance. Box 9: FY06-09IDAFinancialAssistanceProgram(inthe formofIDA Grants) I IDA-14 IDA-15 FY06 FY07 FYO8 FY09 Base Case Additional Financingto Development Development Development On-GoingProjects Policy Lending-1 Policy Lending-2 Policy Lending-3 $1.5 million $2million $2 million $2 million HighCase Additional Financingto Development Development Development On-GoingProjects Policy Lending-1 Policy Lending-2 Policy Lending-3 $1.5million $3 million $3 million $2.5 million 81, The low-casescenario. Inthe event that the macro-economic framework would not be sufficient to support the move to DPLs, the Bank's strategy would move to a low- case one whereby the Bank would only provide additional financing to the two on-going IDA-financed projects. The actual amounts to be provided would be determined by the IDAallocationwhichnaturallywould be lower reflecting the weaker performance. 82. As part of the Bank's non-lendingwork, on-goingactivitieswill be continued and further ESW, IDF and/or Trust Fund financing for support to critical aspects of PRSP implementationwill be explored. The DTIS is expected to be completed by the end of FY05 so the Bank will focus on following-up on its recommendations, as well as following-up on the recommendations o f the CEM. The Bank also plans to stay engaged with Technical Assistance in the telecommunications sector. The Bank i s also considering, together with the UNDP and UNFPA, support to a national census for analyzing the impact o f uncontrolled immigration and the rapidly growing population. Initial analysis o f immigration dynamics in STP shows that it is increasingly quickly, particularly from neighboring Nigeria. Population statistics for STP are sketchy with some extrapolations concluding that the population i s closer to 180,000 than 150,000. A census would moreover be important and timely to determine who i s Sao Tomean and thus who is entitledto social services, particularly for the future once oil revenues arrive and are channeled into improving social service delivery. E. Country Financing Parameters 83. The country financing parameters for STP have been prepared and agreed upon with the Government (see Annex 10). As previously mentioned in this CAS, - 28 - domestic resources are currently limited and the Government's budget is highly dependent on foreign fbnds. Nevertheless, with respect to cost sharing agreements, as a sign o f the Government's commitment to its development program (as set out in its PRSP), the Government and Bank agreed that a minimum Borrower cost sharing o f 10 percent-which has been the norm for past Bank projects in STP-would be maintained. Decisions regarding the actual cost-sharing percentage under individual projects would be made on a case-by-case basis. These cost sharing parameters will also apply to IDF grants and recipient-executed trust funds. Box 10: DonorCoordination and InternationalAssistance STP has traditionally benefited from one of the largest amounts of aid per capita in the world - equivalent to US166 per capitain 2002. Accordingto the OECD, net official developmentassistance to STP reachedapeak of US$84 million in 1995 but fell to about US25 million in 2002 due to the poor quality o f macroeconomic management inthe 1990s. The 2000 RoundTablemeetingledto pledgesof assistance of US$49million, of which US$35 million was disbursed. Giventhe prospects for increases inrevenuesfrom oil, the currentlyhigh levels of grants from donors (compared to other low income countries), amounting to about 37 percent of GDP in 2001 and 27 percent of GDP is 2002, may not be available in the future to the same extent. Nevertheless, it is critical for STP to maintaindonor support until the start of oil production. Donors' programsin STP are poorly coordinatedby Government. This situationis exacerbatedby weak absorptive and management capacityin the country. The Government aims to improve donor coordinationthrough ensuring that activities are all aligned to the PRSP and are harmonized to the extent possible (the Governance Capacity Building projectprovidesspecific financial support to this aim). The Govemment has requestedthe Bank to play a role in leveragingthe assistance of other donors and provide policy and programmatic leadership in some areas, notablythe socialsectors andthe oil sector. In order to mobilize better the donor community, the UNDP and the Bank have agreedto work closely together with Govemment on organizinga RoundTable meetingaround the PRSP (the meetingis tentatively scheduledfor Fall 2005). The PRSPprovidesan excellent opportunity for more donors to becomeactivein STP and for existing donors to increase their support around the comprehensive PRSP framework. Greater donor dialogue and coordinationwill benecessarybetweennow andthe HIPC CompletionPoint(expectedinApril 2006). The recognitionby STP of Taiwan inMay 1997has resultedin significantaid flows andthe Taiwan aidprogrami s very visible in the country, financing road rehabilitation, hospitals and other infrastructure and supporting the social sectors, particularlymalariacontrol. The impending oil era has greatly increasedwestern strategic interest in STP - particularly from the US. The U S military is consideringsettingup amilitary base inSao Tom6 andthe US govemment is funding feasibility studies on the constructionof a deep water port and the extension of the internationalairport's only runway. USAID is preparinga proposal to address issues of governance and efficient use of the petroleumrevenues: this assistance will likely comprisetechnical advisors, specifically for the implementationof amoreefficient, performancedriven budgetaryprocess. NigerianandAngolan interest in STP has also increased. Nigeria is strongly positioning itself to be the main actor inthe country. The Columbia University Advisory Project, led by Professor Jeffrey Sachs and funded by the Open Society Institute,has an active programin support of STP andplayedakey role inthe preparationofthe petroleumrevenue management law. The objective of its work is to support STP to develop a new Consensus Plan of Action for sustainable economic development, covering the period 2005-2010. The work has focused on informing and facilitating discussionby suggestinganumber of specific public investments and policy changes on the part of the Govemment, aiming to lay the foundation of public services that are needed for a wide range of private sector activity. The University of Columbia intends to concentrate its support on the development of the required secondary laws and regulations for the Oversight Committee and the Public Registry and Information Office considered in the petroleumrevenue managementLaw. To this end the University of Columbia will be working with the recentlyappointedPetroleumCommitteeofthe NationalAssembly. 84. Recurrent cost financing associated with Bank projects has traditionally been extremely limited, makingup only a small percentage o fproject expenditures. For instance, recurrent costs accounted for zero percent o f project expenditures in FYO1, 5.4 percent inFY04, and about eight percent during the first half o f FY05. This low level is expected to be maintained in the near to medium term as a limited number o f on-going investment projects, DPLs, technical assistance, and analytic and advisory activities remain the mainstay of the Bank's program in STP. In such an environment, recurrent cost financing will continue to be determined mainly by project specific considerations. Inall cases, recurrent cost financing will be applied after consideration ofthe sector and project sustainability issues, including institutional arrangements to allow for greater emphasis on sustainability through result-based monitoring and evaluation systems and strengthening o f capacity at national and local level; and implied future budget outlays. Particularly when the Bank moves toward the provision o f financial assistance in the form o f DPLs, the Bank would closely monitor STP's fiscal and debt position and the implications o f recurrent cost financing, taking into account sustainability issues at the sector andmacroeconomic levels, including careful consideration o fbudgetary outlays. 85. Local costs, on average, were 60 percent of project expenditures over FY99- 04 and 78 percent over FYO2-04. The Government's own revenues are not sufficient to meet total local cost financing needs, and the financing o f foreign expenditures alone by the Bank would not enable the Bank to assist in the financing o f individual projects. Government tax revenue in 2003 constituted approximately 20.5 percent o f GDP (or 41 percent o f total revenues and grants), non-tax revenues constituted an estimated 4.5 percent o f GDP (9 percent o f total revenues and grants), and grants constitute 49 percent o f revenues (highlighting STP's dependence on foreign assistance). The percentages o f local and foreign expenditures financed by the Bank as set out in the Governance Capacity Building Technical Assistance Project-i.e., 100 percent financing o f foreign and 95 percent financing o f local costs for goods and works; 98 percent financing of consultant services and audits; and 100 percent financing o f training and workshops-are expected to represent the status quo o f Bank fundingunder individual projects. 86. STP's taxes and duties are not considered unreasonable or discriminatory. As is typical o f small island economies, trade taxes figure prominently in the economy, constituting 5.6 percent o f GDP in 2003; consumption and other taxes constituted 8.8 percent o f GDP; and direct taxes (profits and income taxes) were 6 percent o f GDP. The corporate tax structure i s 30 percent on taxable profits, with an additional 15 percent on taxable profits above 12 billion dobras; in the context o f the fiscal law under consideration by the National Assembly, this is to be brought down to 25 percent. Personal income tax i s a flat rate of 13 percent. There are three tariff bands (ie., 3, 10, and lo), with some products, such as alcohol, cars, and gasoline, subject to surcharges. Bank projects have to date been granted waivers from import taxes under the intemationaWnited Nations rule. The consumption tax on imported and domestic goods covers only a few major products (including some products that do not appear in Bank- financed projects) and i s product specific: the tax rate on petroleum products ranges from 42 to149 percent; and on motor vehicles from 10 to 35 percent. The consumption tax on services i s 5 percent. The Bank may finance taxes and duties associated with project - 3 0 - expenditures, determining on a case-by-case basis whether they constitute an excessively highshare ofproject costs. IV. MANAGINGRISKS 87. The main risk in the short-run comes from the potentialmis-managementof the influx of large amounts of money fromthe signaturebonusesof the oil contracts. As with many other countries which have experienced a huge windfall o f revenues from oil, the risk is that these revenues will either be poorly spent or will be misdirected to expenditures outside the budgetary framework. In this context, governance i s key andthe requisite "checks and balances" need to be in place to ensure that the population can benefit. The successful preparation, adoption and implementation o f the Petroleum Revenue Management Law mitigates this risk and presents a real opportunity for STP to show that it can use its windfall wisely. The Bank's Governance Capacity Building Project has the objective o f strengthening governance to off-set this risk. Moreover, while the bonus is substantial compared to GDP, the Government i s aware that the amount and timing o f future bonuses cannot be dictated or reliedupon and that it will still need to show commitment to the petroleum revenue management law inorder to continue to benefit from donor resources. 88. The revenues from the oil signature bonuses potentially add to the political instability and increase social expectations. In other countries, oil revenues have generated social and distributional risks - such as increased conflict, exclusion o f rural areas, elite capture - which could also occur in STP and could be exacerbated by the country's weak institutions. The Bank plans to assist the Government in mitigating this risk through ensuring that the revenue management framework is respected, that the signature bonuses are translated into transparent budgetary allocations and by continued and concerted efforts to build institutional capacity and engage in dialogue/consultation with Government and civil society. The Bank will assist the Government in being transparent and open about its management of the oil economy through ensuring that consultation and information dissemination are broadened and deepened at both the central and local government levels. The PRSP consultations were a positive experience and have created momentum within the country; the Government will be encouraged to build on this in the future. The Bank is also working closely with the Government and other donors on the efficient implementation o f the IDA-financed Social Sectors Support project to enhance the focus on the actual service delivery on the ground, thereby reducingthe potential for social instability. 89. With respectto the implementationof the CAS, the main risks posed are the Government'swillingness to pursue reformsin a sustainable and consistent manner and its ability to maintain a stable macroeconomic environment and focus expenditures on the priority sectors. The Bank will work closely with the IMF and other development partners inoff-setting this risk through concerted financial and advisory support to ensure that there i s follow-through on the reform program. The HIPC framework will also - 31 - facilitate dialogue and adherence to the reforms laid out therein. Inthe event that there are set-backs to the reform efforts, the Bank's program would drop to a low case one. The Bank will continue to pursue a frank and open dialogue with the Government about the importance o f reforms in order to increase investment and foreign aid. The CAS Progress Report (planned for FY07) would provide the opportunity to re-orient the strategy inresponse to such a situation. 90. Even when Government commitment is present, weak capacity poses a significantriskto the successfulimplementationof the CAS. The Bank's Governance Capacity Building Project focuses on a set o f key reforms and measures that can influence the performance o f the public sector and that can strengthen the implementation o f the PRSP and o f the Bank's support program. In the same way, the Social Sectors Support project focuses on strengthening capacity both within Government and among non-Government actors which are playing a role in service delivery. Furthermore, the Bank's Integrated Fiduciary Assessment i s focused on identifying the necessary reforms and capacity building activities for managing fiduciary risks. The Bank also i s coordinating with other donors who are providing institutional development and capacity building support inthis area. 91. There is also a risk posedby the Government's willingnessto work with the Bank giventhat the Bank is only ableto bringlow levels of financialassistance. Itis possible that the Government may not consider that the financial support under the CAS i s sufficient for them to invest inpursuing a long-term dialogue and relationship with the Bank. The Bank plans to offset this risk through ensuring greater understanding and engagement with the Government and stakeholders on the CAS to ensure that the Bank's role i s widely seen as bringingto bear a variety o f other instruments o f assistance which are non-financial - such as policy advice, ESW, AAA, support to PRSP implementation, IDF and GEF grants, etc. - and that the Bank has the ability to leverage other donors' assistance. Finally, STP has not yet reached Completion Point in the Enhanced HIPC Initiative so there i s still an important window o f opportunity in the short-run for the Bank to play a keyrole. 92. Although STP has made some efforts to diversify its exports, it remains extremely vulnerable to exogenous shocks, especially to fluctuations in its terms o f trade and dependence on the availability o f foreign aid. Inparticular, the impact o f the current high oil prices and a possible hrther decrease in the price o f cocoa present significant risks. As with any economy that i s heavily concentrated inthe production and export o f a few goods and services, there will always be an element o f vulnerability to negative world commodity price changes. To mitigate this risk it is vital to continue the course o f prudent public sector finance management, strengthening capacity and investing in human and institutional capital. Good govemance and an attractive investment climate can help indiversifyingthe economy over the long run. The Bank's program as laid out inthis CAS concentrates on these areas. - 32 - V. CONCLUSION 93. The World Bank remains committed to supportingthe economic and social development of STP. The key areas o f focus are to assist the country inimplementing its PRSP and achieving the HIPC Completion Point, ensure strong implementation o f the on-going IDA-financed projects and follow-up on the recommendations o f the Bank's analytical work. As regards future Bank activities, the focus is on; (i)laying the groundwork over the next 12-18 months for, thereafter, delivering the Bank's financial assistance inthe form o f budgetary support; and (v) supporting the country to prepare for the arrival o f oil revenues and to strengthenthe overall macroeconomic andpublic sector context to ensure that it i s conducive for the proper and sustainable use o f future oil revenues. While this strategy i s challenging, it i s ultimately feasible so long as the Bank and other development actors can sustain their involvement in STP and bring to bear concerted financial and advisory support. 94. Beyond this CAS period, it is expected that STP could have sufficient resources in-coming from oil revenues and may not require financial assistance from IDA. The Bank is preparingfor this era by strengthening its client orientation and the role o f the Knowledge Bank with the goal o f remaining active in the country as partners on fightingpoverty. - 33 - + 0 I In m I d I M E 0 Y 3$ CAS Annex A24 Sao Tome and Principe at a Glance 4/27/05 1 SBo Tom6 Sub- POVERTYand SOCIAL and Saharan LOW. Principe Africa income hvelopmentdiamond' 2003 Population,mid-year(millions) 0.16 703 2,310 Lifeexpectancy GNI per capita (Atlasmethod, US$) 330 490 450 GNI (Aflasmethod, US$ billions) 0.05 347 1,036 Average annual growth, 199743 Population 1%) 2.0 2.3 1.9 Laborforce (56) 2.4 2.3 5NI Gross ier w a r y Mostrecent estlmate (latest year available, 1997-03) XPlta enrollment Poverty (% ofpopulation belownationalpovertyline)-2000 e 54 Urbanpopulation (% of totalpopulation) 56 36 30 Lifeexpectancyat birth(years) 66 46 56 Infant mortality(per 1,000 live births) 75 103 62 Child malnutrition(% ofchildren under5) 13 44 Access to improvedwater source Access to an improvedwater source (% ofpopulation) 56 75 IlliteracyI%ofpopulation age 75+) 35 39 Gross primaryenrollment (% of schwl-age population) 126 67 92 - Sao Tome andPrincipe Male 130 94 99 Low-incomegroup Female 122 60 65 KEY ECONOMIC RATIOS and LONG-TERMTRENDS 1983 1993 2002 2003 GDP (US$ billions) Economlc ratios* 0.05 0.05 0.05 0.06 Gross domesticinvestmentlGDP 16.6 35.3 32.5 36.1 Exportsof goods and serviceslGDP 20.6 22.1 43.7 42.1 Trade Gross domesticsavings/GDP -16.7 -17.5 -16.7 Gross nationalsavingsIGDP 6.0 15.9 Currentaccount baiancelGDP -27.5 -54.4 -53.9 -54.4 Domestic InterestpaymentsIGDP 1.o 2.1 5.0 Investment Total debffGDP 63.9 440.6 savings Total debt servicepaid/exports beforedebt relief 60.6 56.0 Present valueof debffGDP 1,154.0 1,301.6 Present value of debtlexports 575.4 Indebtedness 1983-93 1993-03 2002 2003 200347 (averageannualgrowth) GDP 1 7 2.6 4.1 4.0 5.0 Sao Tome andPrincipe GDP percapita -1.1 0.3 2.1 2.0 2.7 Exportsof goods and services 6.9 6.9 7.0 7.0 7.0 ',I1 ~ STRUCTUREof the ECONOMY 1983 1993 2002 2003 Growth of Investmentand GDP ('A) (% of GDP) Agriculture 27.617.9 28.919.7 18.015.5 17.014.6 I Industry Manufacturing .. 6.5 4.6 Services 54.5 51.4 66.5 6::; 1 0 Private consumption 77.1 97.1 112.5 109.4 - 5 0 1 Generalgovernmentconsumption 36.3 34.5 37.2 39.6 Importsof goods and services -GDI -GDP 198343 2o02 2003 Growthof exportsand Imports('A) (averageannualgrowth) Agriculture 5.1 3.1 3.1 3.2 4o Industry 0.9 2.5 4.3 4.3 20 ManufaCtUnng 0.6 2.0 3.0 3.0 Services 0.2 2.3 4.7 5.4 O Private consumption 23.3 -10.6 -20 Generalgovernmentconsumption -14.5 6.2 .. -40 Gross domestic investment 0.4 3.7 -7.4 22.6 -Exports +Imports - 38 - CAS Annex A2-2 Sa0 Tome and Principe PRICESand GOVERNMENTFINANCE 1983 1993 2002 2003 Domesticprices I%change) Consumerprices 25.5 9.2 9.6 ImplicitGDP deflator 39.0 10.8 9.5 Government tinance (% of GDP, includescurrentgrants) Current revenue 18.0 29.7 33.4 08 88 W 01 02 03 Domesticprimarybalance -4.3 -11.8 Overallsurplus/deflcit -17.8 -17.2 -GDP deflator -CPI TRADE I 1983 1993 2002 2003 (US5 millions) Exportand Import levels (US$mill.) Totalexports (fob1 5 5 6 Cocoa 4 5 6 30 T n.a. Manufactures 20 Total imports (cifl 32 24 25 Food 7 6 5 10 Fueland energy 2 3 4 I CapitalQOOdS 11 14 14 0 Exportpriceindex (7995=700) 81 55 57 07 88 00 00 01 02 Importpriceindex (1995=100) 90 87 88 EExports EImports O3 Terms of trade (7995=100) 89 63 64 BALANCE of PAYMENTS 1983 1993 2002 2003 (US5 millions) Currentaccount balanceto GDP (%) Exportsof goods and services 10 11 20 22 0 Importsof goodsand services 25 42 42 42 Resourcebalance -15 -32 -22 -20 -15 Net income -1 -5 -4 -4 Net current transfers 1 4 2 4 -30 Currentaccountbalance -14 -33 -24 -20 4 5 Financingitems (net) 12 33 26 19 Changesin net reserves 2 0 -2 1 -00 Memo: Reservesincludinggoid (US5 millions) 20 25 Conversionrate (DEC, locaNUS5) 42.3 429.9 9,088.3 9,347.6 EXTERNALDEBT and RESOURCE FLOWS 1983 1993 2002 2003 (US$ millions) I Composition of 2002 debt (US$mlll.) Total debt outstandingand disbursed 44 210 333 IBRD 0 0 0 IDA 0 38 66 I G 23 Total debt service 3 3 5 IBRD 0 0 0 IDA 0 0 0 Compositionof net resourceflows Officialgrants 8 20 10 Officialcreditors 7 14 1 Privatecreditors 0 0 0 Foreign directinvestment 0 -1 3 Portfolioequity 0 0 0 World Bank program Commitments 0 0 0 A - IBRD E Bilateral Disbursements 0 5 1 ~ 6 . IDA D Other multilateral . F. Private Principalrepayments 0 0 0 C. IMF G -Short-term Netflows 0 5 1 Interestpayments 0 0 0 Nettransfers 0 4 I Note: This tablewas producedfrom the DevelopmentEconomicscentral database. 4/27/05 - 39 - CAS Annex B2 Sao Tome and Principe - Selected Indicators"of Bank PortfolioPerformanceand Management As of Date 04/27/2005 Indicator 2002 2003 2004 2005 Portfolio Assessment Number of Projects Under Implementationa 2 2 2 2 Average Implementation Period (years) 1.7 2.7 1.9 0.5 Percent of Problem Projectsby Numbera , c 0.0 0.0 0.0 0.0 Percent of Problem Projectsby Amount 0.0 0.0 0.0 0.0 Percent of Projects at Risk by Number a , d 0.0 0.0 50.0 0.0 Percent of Projectsat Risk by Amount a , d 0.0 0.0 27.8 0.0 Disbursement Ratio (%) e 29.2 54.3 47.5 8.5 Portfolio Management CPPR during the year (yeslno) No No No No Supervision Resources (total US$) 112 73 70 293 Average Supervision(US$/project) 5612 3713 3512 7314 Memorandum Item Since FY 80 Last Five FYs Proj Eva1by OED by Number 8 2 Proj Eva1by OED by Amt (US$ millions) 65.5 21.1 % of OED Projects Rated U or HU by Number 50.0 100.0 % of OED Projects Rated U or HU by Amt 56.6 100.0 a. As shown in the Annual Report on Portfolio Performance(except for current FY). b. Average age of projects in the Bank's country portfolio. c. Percentof projects rated U or HU on developmentobjectives (DO) and/or implementationprogress (IP). d. As defined underthe Portfolio ImprovementProgram. e. Ratioof disbursementsduring the year to the undisbursedbalance of the Bank's portfolioat the beginningof the year: Investmentprojects only. * All indicatorsare for projects active in the Portfolio,with the exception of DisbursementRatio,which includes all active projects as well as projectswhich exited during the fiscal year. - 40 - CAS Annex 83 IBRDADA Program Summary - Sao Tome and Principe As of Date 04/27/2005 Proposed IBRDIIDA Base-Case Lending Program a Fiscal year Proj ID US$(M) Strategic Rewards b (H/M/L) Implementation b Risks (H/M/L) 2006 Additional Financing to On- 1.5 H M Going Operations 2007 Development Policy Lending 1 2.0 H M 2008 Development Policy Lending 2 2.0 H M 2009 Development Policy Lending 3 2.0 H M Overall Result 7.5 - 41 - CAS Annex B4 Summary of Non-Lending Services - Sao Tome and Principe As Of Date 04/27/2005 Product Completion FY Cost (US$OOO) Audiencea Objective' Recent completions CEM 2003 148.5 KG Telecom Reform 2003 71.5 KG Supportto PRlS 2003 61.5 KG Gender Assessment 2004 29.1 KG, PB Poverty Diagnostic 2005 Trust Funds KG, PB Underway Climate Change GEF 2006 240.0 KG, PB, PS DiagnosticTrade Integration 2005 106.7 KG Study (DTIS) IDF Justice Capacity Building 2006 14.0 PS Telecom Reform 2006 40.0 KG Planned IntegratedFiduciaryAssessment 2007 148 K, PS a. Government,Donor, Bank, Public dissemination. b. KnowledgeGeneration, Public Debate, Problem-Solving - 42 - CAS Annex B5-PovertyandSocial DevelopmentIndicators ,Sa0Tome and Principe Social Indicators Latestsingle year Same regionlincome group Sub- Saharan Low- 1975-80 1985-90 1997-2003 Africa income POPULATION Total population,mid-year (millions) 0.09 0.1 0.2 704.5 2,311.9 Growth rate (% annual average for period) 2.8 2.1 2.3 1.9 Urban population(% of population) 30.8 39.1 55.6 36.5 30.4 Total fertility rate (births per woman) 5.1 4.3 5.2 3.7 POVERTY (% of population) Nationalheadcount index 54 Urban headcount index Rural headcountindex 65 INCOME GNI per capita (US$) 430 330 500 440 Consumer price index (1995=100) Food price index (1995400) INCOMElCONSUMPTlON DISTRIBUTION Gini index Lowest quintile (% of income or consumption) Highestquintile (% of income or consumption) SOCIAL INDICATORS Public expenditure Health(% of GDP) 10.3 2.6 1.5 Education(% of GDP) 6.2 3.3 3.2 Net primaryschool enrollment rate (% of age group) Total 97.1 77 Male 100 82 Female 94 72 Access to an improvedwater source (% ofpopulation) Total 79 58 75 Urban 89 82 89 Rural 73 46 70 Immunization rate (% of children ages 12-23 months) Measles 71 87 61 65 DPT 92 94 59 67 Child malnutrition(% under 5 years) 17 13 44 Life expectancy at birth (Years) Total 62 66 46 58 Male 60 63 45 57 Female 64 69 46 59 Mortality Infant (per 1,000 live births) 75 75 101 80 Under 5 (per 1,000 live births) 118 118 171 123 Adult (15-59) Male (per 1,000 population) 269 519 319 Female (per 1,000 population) 226 461 268 Maternal(modeled, per 100,000 live births) 916 689 Birthsattended by skilled healthstaff (%) 79 39 38 Note: 0 or 0.0 means zero or less than half the unit shown. Net enrollment rate: break in series between 1997 and 1998 due to change from ISCED76to ISCED97. Immunization:refersto children ages 12-23 monthswho received vaccinationsbeforeone year of age. 2005 World DevelopmentIndicatorsCD-ROM, World Bank - 43 - CAS Annex B6 Key Economic Indicators Sao Tome and Principe - - As of Date 0412712005 National accounts (as YOof GDP) Gross domestic producta 100 100 100 100 100 100 100 100 Agriculture 20 20 18.0 17.0 Industry 17 17 15.5 14.6 Services 62 63 66.5 68.4 Total Consumption 106 127 112.5 109.4 122.1 122.0 121.5 120.0 Gross domestic fixed investment 43 30 32.8 36.1 34.4 37.8 41.2 46.8 Govemment investment 26 19 14.8 20.1 19.4 16.5 16.2 15.7 Private investment 17 11 18.0 16.0 15.0 21.3 25.1 31.2 E X P O ~ ~(GNFS)~ S 33 36 44 38 38 46 47 44 Imports (GNFS) 83 93 95 77.5 78 116 117 115 Gross domestic savings -6 -23 -17.5 -16.7 -22.1 -22 -21.5 -20 Grossnational savings' 3.7 10.6 8.3 15.90 7.10 5.30 7.70 9.60 Memorandum items Gross domestic product 46 47 50 60 62 (US$ million at current prices) GNIper capita (US$,Atlas method) 290 290 300 330 370 Real annual growth rates (%, calculatedfrom 1987 prices) Gross domestic product at market prices 3.0 4.0 4.1 4.5 4.5 3.0 4.5 5.5 Gross Domestic Income 0.0 7.8 9.4 7.3 4.6 7.9 Real annual per capita growth rates (%, calculated from 1987prices) Gross domestic product at market prices 0.8 1.8 1.9 2.3 2.3 0.8 2.3 3.2 Total consumption -16.3 43.8 -4.6 -7.3 17.5 1.6 17.6 15.5 Private consumption -30.5 Balance of Payments (US$ millions) EXPOI~S (GNFS)~ 16 17 20 23 24 27 28.8 31.2 MerchandiseFOB 4 4 5 6 7 8 8 8 Imports (GNFS)~ 38 43 45 45 59 68 74 79 MerchandiseFOB 21 24.4 28.5 33 36 37 40 45 Resourcebalance -22 -26 -25 -23 -35 -41 -44 -49 Net current transfers 6 4 2 4 4 4 4 4 Current accountbalance -20 -3 1 -27 -27 -34 -40 -43 -48 Net private foreign direct investment 3 4 5 8 9 16 22 27 Long-term loans (net) Official 11 11 Private Other capital (net, incl. errors & ommissions) Change inreservesd 1 -3 -2 -8 8 0 0 0 '' The CAS period extends to 2009but projections are not availablebeyond2007. - 44 - CASAnnex B6 Sao Tome andPrincipe Key EconomicIndicators - - (Continued) Memorandum items Resource balance (% of GDP) -47.6 -58.8 -45.3 -39.8 -56.4 -70.7 -69.5 -71.5 Real annual growth rates ( YR87 prices) Merchandise exports (FOB) 3.2 22.5 16.9 4.5 Primary 3.2 22.5 16.9 4.5 Manufactures Merchandise imports (CIF) 4.2 -12.8 8.6 -2.2 Public finance (as % of GDP at market prices)e Current revenues 25.6 25.2 23.4 25.8 29.4 27.6 27.0 27.0 Current expenditures 24.2 28.8 33.0 33.1 46.3 41.0 36.4 32.2 Current account surplus (+) or deficit (-) 1.4 -3.6 -9.6 -7.3 -16.9 -13.4 -9.4 -5.2 Capital expenditure 41.9 46.0 28.8 35.8 35.8 30.0 29.6 29.0 Foreign financing 80.0 84.9 91.2 80.8 77.6 87.0 87.0 88.0 Monetaryindicators M2/GDP 30.3 32.4 33.1 Growth o f M2 (%) 28.8 36.7 26.9 41.8 7.4 Private sector credit growth / 3.4 -2.0 11.6 20.4 31.8 total credit growth (%) Priceindices(YR87 =loo) Merchandise export price index 54.8 41.2 48.2 59.1 Merchandise import price index 79.0 99.1 95.4 105.2 Merchandise terms o f trade index 69.4 41.6 50.6 56.2 Real exchange rate (US$/LCU)' Real interest rates Consumer price index (% change) 11.0 9.5 9.2 9.6 12.8 14.5 12.4 10.0 GDP deflator (% change) 7.4 9.8 10.8 9.5 8.5 15.5 13.9 9.0 ~ ~~ a. GDP at market prices b. "GNFS" denotes "goods andnonfactor services." c. Includes net unrequited transfers excluding official capital grants. d. Includes use of IMF resources. e. Consolidated central government. f. "LCU" denotes "local currency units." An increase inUS$/LCUdenotes appreciation. Current expenditures - 45 - CAS Annex B8 (IFC) for Sao Tome andPrincipe SZio Tomb and Principe Statement o f IFC's Held and DisbursedPortfolio (InU SDollars Millions) Held Disbursed FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic Approvals PendingCommitment Loan Equity Quasi Partic - 46 - rz I d I r I 00 d I ANNEX 10: COUNTRY FINANCINGPARAMETERS The country financing parameters for Sao Tome and Principe set out below have been approved by the Regional vice president, Africa, and are being posted on the Bank's internal website. Item Parameter Remarks/ Explanation Cost sharing. Limit on the proportion 90% The Bank will continue to finance up to 90 3 f individual project costs that the percent o f project costs. This will also be the Bank may finance case for IDF grants and recipient-executed trust funds. Recurrent costfinancing. Any limits No Given STP's fragile financial situation, the Bank :hat would apply to the overall amount country- will continue to monitor the aggregate fiscal and 2 f recurrent expenditures that the Bank level limit debt situation and its implications for recurrent may finance cost financing. Inall cases, recurrent cost financing will be applied after consideration o f the sector and project sustainability issues, including institutional arrangements to allow for greater emphasis on sustainability through result- basedM&E systems and strengthening o f capacity at national and local level; and implied future budget outlays. Local costfinancing. Are the Yes The two criteria are met. The Bank may requirements for Bank financing o f therefore finance local costs inthe proportions local expenditures met, namely that: needed inindividual projects. (i) financing requirements for the country's development programwould exceed the public sector's own resources (e.g., from taxation and other revenues) and expected domestic borrowing; and (ii) the financing of foreign expenditures alone would not enable the Bank to assist inthe financing o f individual projects. Taxesand duties. Are there any taxes None The Bank may finance the costs o f taxes and and duties that the Bank would not duties associated withproject expenditures, since finance? these have beenjudged to be reasonable and non- discriminatory. At the project-level, the Bank would consider whether taxes and duties constitute an excessively highshare o f project - 49 - ANNEX 11: CAS COMPLETION REPORT NB: Recognizing IDA'Slimited role in Sa0 Tome and Principe and the needfor flexibility in applying the results-based CAS approach in small states, including the CAS Completion Report (CASCR), this CASCR briefly reviews the Bank's experience in the country, with a focus on lessons learned and implicationsfor the Bank's engagement under the next CAS. Country: Democratic Republic o f Sao Tome and Principe Dateof CAS: October 10,2000 (no Progress Reports) PeriodCovered by the CASCR: October 10,2000 to June 30,2005 CASCRCompletedby: Allison Berg, Operations Officer Eavan O'Halloran, Senior Country Officer Dorsati Madani, Country Economist Date: April 15,2005 I.BackgroundandSaoTomeandPrincipe'sLongerTermStrategicGoals 1. The Democratic Republic o f Sao Tome and Principe (STP) is a small archipelago o f two islands located inthe Gulf o f Guinea, with an estimatedpopulation o f about 150,000, and a land area o f just over 1,000 square kilometers. Its economic and social indicators are negatively affected by basic challenges that afflict many small island states: remoteness, insularity, weak institutional and human resource capacity, a narrow resource base, limited economic diversification, vulnerability to exogenous shocks, constrained access to external capital, and entrenchedpoverty. 2. According to a 2000/01 household survey, 54 percent o f the population i s poor and 15 percent live in extreme poverty. There i s a strong likelihood that most MDGs will not be reached. STP i s Africa's smallest economy, with an estimated GDP o f US$60 million and a per capita income o f US$320 in 2003, making it also one o f the poorest. The economy i s characterized by a large public sector suffering from weak institutional capacity, a high reliance on foreign aid, a low savings rate, and a dependency on cocoa production and tourism. The majority o f the population i s involved in smallholder farming, though agricultural productivity remains low and agricultural services are lacking. Public enterprise reform and privatization has progressed, but with delays. STP's debt burden i s among the highest in the world (external debt accounted for more than 600 percent o f GDP in nominal terms in 1999). STP reached the Decision Point o f the Enhanced HIPC Initiative in early 2001 and i s expected to reach its Completion Pointby mid-2006. 3. Since 1991, STP has transformed from a Marxist, one-party state into a pluralist democracy. Civil society organizations have formed gradually, but political institutions remain fragile with periods o f instability, and institutional capacity i s weak. President - 5 0 - Fradique de Menezes was elected for a five-year term inJuly 2001 in STP's third multi-party election, which was deemed fair and was conducted peacefully. However, the anticipated arrival o f oil production has increased social expectations and created political tension and disturbances, which came to a head in July 2003 in an attempted coup. While the president and prime minister were restored to power within a week following a negotiated settlement, the event underscored the country's delicate political situation. 4. Following a profound economic and social crisis from 1987-1997, STP launched an ambitious recovery and economic development program. The results were poor mainly due to weak institutional capacity, lack o f adequately skilled human resources, and adverse external shocks (especially the decline in world cocoa prices since the economy i s heavily dependent on the production o f aging cocoa plantations). Real GDP growth rates remained low, macroeconomic imbalances worsened, unemployment increased, and living conditians deteriorated. In 1998-99, within the framework o f an IMF staff monitored program, the Government launched in earnest a series o f macroeconomic reforms that helped stabilize the economy and, in parallel, implemented several structural policy reform measures supported by a Bank-financed Public Resource Management Credit (PRMC). As a result o f these reforms, improved cocoa prices, and growth inthe tourism and construction sub-sectors, real GDP per capita rose from 3.3 percent to 4 percent between 1999 and 2003. The CPI dropped from 12.6 percent in 1999 to 9.2 percent in 2002, though in 2003 the increase in energy prices, post-coup social expenditures, and civil service salaries contributed to a rise in the inflation rate to 9.6 percent. Real GDP growth in2004 was 3.8 percent, slightly lower than in 2003 as the expected increase in petroleum-related economic activity did not materialize. Economic growth was sustained through a relaxation o f fiscal and monetary policies, leading to a rise in inflation (15.2 percent at end-2004) and deterioration o f the fiscal and monetary balances. 5. Though STP became a member o f IDA in 1977, IDA'Sassistance to STP only began in 1985 and has been limited, both as an overall share of the Government's budget and relative to several other donors (e.g., the African Development Bank, European Union, Portugal, and Taiwan, China have larger commitment than the Bank). As o f April 2005, World Bank assistance consisted o f 12 IDA creditdgrants (10 closed, 2 active) totaling US$83.4 million; nine IDFs; a PHRD grant for several social sector studies22; a GEF grant o f US$200,000 for analysis o f vulnerability to global climate change; a Belgian Trust Fund for poverty analytic work; a commercial debt buy back operation totaling US$l.8 million; and a PPIAF grant o f US$175,000. The IDA credits approved before the 2000 CAS included a modernization line o f credit (FY85), two adjustment operations (SAL I,FY87 and SAC II/TA, FY90), two agricultural projects (cocoa, FY87 and agriculture, FY92), two multi- sector projects (FY89 and FY91), and a health and education project (FY92). Due to declines ineconomic management, no new lending operations were approved between 1992- 2000. In conjunction with the 2000 CAS, the PRMC (an adjustment operation o f US$7.5 million, FYO1) and PRM-TA (US$2.5 million, FYO1) were approved, and during CAS implementation a Social Sector Support Project (US$6.5 million, o f which US$1.5 million i s an IDA grant, FY04) and a Governance Capacity Building Technical Assistance Project (US$5 million, FY05) were approved. STP i s not a member o f IFC or MIGA. 22Study on the Situation of Orphans and Vulnerable Children, Institutional Assessment of the Social Sectors, Analysis of Monitoring and Evaluation inthe Social Sectors. - 51 - 6. STP finalized its Interim Poverty Reduction Strategy Paper (I-PRSP) in April 2000. Itidentifiedtwo broadobjectives (a) sustaining strong economic growth to raise incomes and reduce poverty; and (b) broadening accessto social services and improvingtheir quality. The I-PRSP outlined further details o f the objectives and a "roadmap" for preparation o f the country's full Poverty Reduction Strategy Paper (PRSP). The country finalized its PRSP in January 2003, though it was not submitted to the Bank and Fund Boards until April 2005 because the country's macroeconomic framework was insufficiently developed.23 The five main PRSP pillars-(i) reform o f public institutions, capacity reinforcement, and the promotion o f a good governance policy; (ii)accelerated and redistributive growth; (iii)creation o f opportunities for growth and diversification o f income for the poor; (iv) human resource development and access to basic social services; and (v) adoption o f mechanisms for follow-up, evaluation, and strategies for updating-built upon the I-PRSP's objectives. 11. CAS Objectives andOutcomes,BankPerformance, andQualityof Services 7. Following the I-PRSP, the Board discussed the CAS on November 2, 2000. The CAS states, "IDA'S strategy for the period 2000-05 i s to support the Government in the pursuit of its objectives as set forth inthe I-PRSP: (a) sustaining strong economic growth to raise incomes and reduce poverty; and (b) broadening access to social services and improving their quality." The CAS assumed that, given the likelihood that IDA resources and administrative budget allocated to STP would remain limited, support to the country would be delivered through the existing portfolio (at the time, the Agriculture Privatization and Smallholder Development Project and the Health and Education Project) and a multisector approachwithin selected new lending. 8. The CAS envisaged one new project every two to three years duringthe CAS period. The two ongoing projects at the time o f the Board discussion o f the CAS closed soon after, but the PRMC and PRM-TA were approved with the CAS. The latter two operations were the Bank's main lending interventions during the first half o f the CAS period, closing near the end o f the CAS period (inlate FY04 and the second halfof FY05, respectively). During the second halfo f the CAS period, the Social Sector Support Project (envisaged for FY03 in the CAS) and the Governance Capacity Building TA Project (the Petroleum Support envisaged for FY05 in the CAS) were approved in FY04 and FY05, respectively. Though the Social Sector Support Project has experienced some delays ingettingactivities underway, the two projects currently comprise the Bank's active lendingportfolio inthe country. Table 1 summarizes the lending operations delivered over the CAS period and, although not mutually exclusive, the mainlonger term goals supported. 23The PRSP was submittedwith a supplementupdatingthe period2003-2005. - 52 - Table 1. BankLendingOperations during STP CAS, 2000-05 9. There were several pieces o f analysis ongoing at the time o f the Board discussion o f the CAS, mainly supported by Institutional Development Fund (IDF) grants. While no additional, formal economic and sector work (ESW) was envisaged in the CAS, in actuality several studies were undertaken to complement the Bank's lendinginterventions, support the Government infinalizing its PRSP, and assist the Government inqualifylng for the Enhanced HIPC Initiative. A Country Economic Memorandum (CEM), Gender Assessment, and Poverty Diagnostic were undertaken, and a Diagnostic Trade Integrated Study (DTIS) i s soon to be finalized. Policy dialogue with the Government deepened during implementation o f the PRMC and PRM-TA and during preparation o f the Social Sector Support and Governance Capacity Building Projects. Table 2 summarizes the ESW and analytic and advisory activities (AAA) undertaken duringthe CAS period and, although not mutually exclusive, the main longer terms goals supported. - 53 - Table 2. BankM A and ESW duringSTP CAS, 2000-05 Ongoing Activity New ESWIAAA IICompleted 1I atTime ofCAS I1 CAS Over 10. Overall, the CAS can be characterized as weak, and Bank (and borrower) performance in implementing lending and non-lending activities as mixed. Because Bank involvement with the country was limited for an extended period before CAS development, the Bank started from a very low knowledge base in developing its strategy (a 1997 Public Finance Review was the only ESW carried out by IDA within a decade and there was limited analytic work available from other partners). Given this and the limited engagement with the country in the period immediately preceding the CAS, the CAS was extremely "light." The main text o f the CAS was limitedto 12 pages, and the CAS didnot include a programmatrix with progress indicators. Clearly, monitoring and evaluation, including evaluability o f the CAS, are major weaknesses. 11. In spite of these weaknesses, the CAS does a relatively good job of elucidating the major development challenges facing STP, but it fails to make a strong link between them and the Bank's proposed assistance strategy/program. Institutional capacity and economic management i s among the first challenges described in the CAS-in retrospect, the Bank strategy/program should have placed much greater emphasis on capacity and institution building, including delivery o f targeted, long-term training and technical assistance, to address STP's institutions' low implementation capacity and shortage o f trained staff, to help the country develop the skills and know how to better manage its development process. While Bank projects had acknowledged these weaknesses and attempted to incorporate technical assistance measures to address them, few were successfd in implementing such measures untilthe PRMC-TA and Governance Capacity BuildingTA Project. - 54 - 12. To its credit, the Bank rebuilt its relationship with and knowledge o f STP during the CAS period. The Bank team actively pursued the policy dialogue in the context o f PRSP preparation and HIPC relief; vigorously implemented and prepared new operations; and focused ESW to support areas o f engagement. Recognizing the lack o f monitoring indicators in the CAS, both the Social Sector Support Project and the Governance Capacity Building Project include detailed results frameworks. (The PRMC/PRM-TA also included an ambitious matrix o f policy actions, performance benchmarks, and expected outcomes, on which more below.) Given the Bank's necessarily selective program in STP, the most important factors indetermining CAS outcomes were the level o f Bank follow-up on lending and non-lending activities (achievements were most tangible when adequate and timely Bank supervision was carried out); the borrower's weak institutional and human resource capacity; and the government's instability during the CAS period (STP experienced five changes o f government and multiple ministerial shuffles between 2001-2004). Further details on Bank (and borrower) performance and quality o f services along the country's two broad, longer term strategic goals/CAS objectives are described below. a. Sustaining StrongEconomic Growth to Raise Incomes and Reduce Poverty 13. Overall, some progress on this objective was made during the CAS period- economic growth over 1999-2003 led to a slight improvement in income, with per capita GDP increasing from US$290 in 2000 to US$320 in 2003. Projects active during the CAS period in line with this objective included the Agricultural Privatization and Smallholder Development Project, the PRMC and PRM-TA, and the Governance Capacity Building Technical Assistance Project. AAA/ESW included Agriculture Policy ESW, Civil Service Reform ESW, Budget Planning ESW, Energy ESW, Telecom Reform supported by the Public-Private Infrastructure Advisory Facility (PPIAF), support for PRSP finalization, support for development o f the petroleum revenue management law, dialogue on macroeconomic management (with the IMF), a CEM, support for HIPC Decision Point qualification, a Poverty Diagnostic, a Diagnostic Trade Integration Study, a Justice Sector Capacity BuildingIDF, and a GEF for a diagnostic o f impacts o f global warming. 14. The Implementation Completion Report (ICR) and OED rated the Agricultural Privatization and Smallholder Development Project's outcome, Bank performance, and borrower performance unsatisfactory. This investment project had been approved in FY92 and reflected the "old style" approach to projects. As acknowledged inthe ICR, the project's design was unrealistic: the reform program was overly complex for (untested) local institutional capacity to handle; the planned implementation timeframe was too ambitious; and the supporting activities were too dependent on parallel financing o f other donors that had not yet been negotiated. The project also failed to incorporate lessons learned from earlier projects, particularly regarding the need to clarify and focus training activities appropriately. Project supervision did not take a holistic approach, suffered from inadequate composition and timing, and was undermined by high turnover o f task managers (five in eight years). 15. Incontrast, the PRMC was designed as a quick disbursingoperation that coveredthe financing gap for 2000/01 and aimed to support the Government in implementing economic reforms. Such reforms included: (a) improving domestic resource mobilization; (b) strengthening public expenditure management; and (c) continuing implementation o f the - 55 - public enterprise reform program. The PRMC was implemented in line with the IMF staff monitored program and aimed to help protect social sector @.e., education and health) expenditures. The PRMC was accompaniedby the PRM-TA, which was originally designed to support measures implemented under the Government's reform program supported by the PRMC; a study fund to carry out analysis for PRSP preparation; and development o f the agenda for macroeconomic reforms. However, in response to the Government's request for assistance in dealing with petroleum revenue management, the PRM-TA was refocused during the CAS period to help build institutional capacity in financial and budgetary management, in the judiciary and petroleum sectors, and in statistics. The PRM-TA successfblly financed international experts to help the Government negotiate four oil contracts and launch and analyze the first round o f bids for the Joint Development Zone (between STP and Nigeria); supportedthe creation o f the National Petroleum Agency (NPA); and provided technical assistance to the Government in finalizing the petroleum revenue management law. The PRM-TA benefited from strong government ownership and active Bank supervision. 16. The ICR for the PRM-TA is not yet finalized, however it i s expected to reflect the generally positive experience in implementation, benefiting from strong Government ownership and Bank supervision. The ICR for the PRMC, however, reflects a mixedrecord o f success. The PRMC's outcome was rated unsatisfactory, its sustainability likely, its institutional development modest, and Bank and borrower performance unsatisfactory. The ICR highlights that the PRMC was wide ranging and overly ambitious. The fast-disbursing nature o f the operation over only two years was too quick for the scope o f reforms proposed. While the Government progressed on tranche release conditions, other reform measures fell by the wayside (e.g., rural land title registration and some private sector development activities were never launched, extension services and the micro-credit system are weak or inconsistent). Successes under the PRMC included progress on domestic resource mobilizationand management, with the implementation o f tax and tariff reform measures and the protection o f health and education expenditures; the Government also made efforts in privatizing public enterprises and introducing more transparency and governance into its activities. 17. According to the ICR, Bank supervision o f the PRMC was satisfactory given fbnds available. The team defined concrete steps and a timetable to put the project on track when needed. However, the operation's matrix o f policy actions/outcomes consisted o f two tables that in some instances were inconsistent and vague on timing, which led them to become outdated. Though the matrix o f policy actions fit within I-PRSP/CAS objectives and was well intended, as mentioned above, actions not related to tranche release conditions were not given priority by the Government thus, as an implementable logical framework, the matrix was unrealistic. To provide a better basis for judging progress under the PRMC, the supervision team retroactively introduced some outcome/output measures. Table 3 summarizes key outcome indicators. Lack o f data in some areas points to the need for statistical capacity buildingin STP, an area not well addressed inthe CAS. - 56 - Table 3. Key PerformanceIndicators andAchievements under the PRMC Are tive Increase government revenue to 22% o f GDP in2002. Domestic Increase revenue collection in Tax revenue increased from 16.2% in 1999 to Resource the medium-termleadingto a 18.3% in2001 and an estimated 23.4% in2004. Mobilization more sustainable fiscal position. Free floating exchange rate established. GDP per Greater transparency andbetter capita increased from 3.3 to 4% over 1999-2003. management o f government's financial resources. Limitprimary spending (excluding foreign financed Pro-poor expenditures constituted around 23% o f Public investment) to 18% o f GDP by the budget on average from 2001-2004. Share o f Expenditure 2002. health and education expenditures has vaned: Management Increase the share o f total 2001 2002 2003 2004(est.) primary spending allocated to Educ. share ofGDP 11.4 9.0 10.3 7.8 educationand health as Healthshare ofGDP 8.6 2.7 6.2 6.1 recommended by the PERs. Civil Service Reduce the number o f civil 308 dismissed after long delays and higher cost Reform servants from4708 to 4176. than envisaged. General evidence suggests public sector still dominates economy, though construction, non- traditional agriculture, andtourism are engines o f Increase private investment growth. 5 o f 7 public enterprises liquidated, sold, Public through a reduced role of the or being privatized at project end. Government Enterprise state and the implementation o f introduced competition inair travel leading to Reform institutionall administrative sharp price decreases. EMAE(public electricity reforms. and water company) being restructured, but financially weak-privatization strategy yet to be developed. Telecoms to be liberalized by end- 2005. 18. Building on lessons learned under previous projects, particularly the PRMC and PRM-TA, the Governance Capacity Building Technical Assistance Project aims to: (a) help facilitate the implementation o f the PRSP through capacity building and management support; (b) strengthen public expenditure management; and (c) provide critical technical assistance and capacity building in the oil sector. More specifically, the project aims to improve the impact o f better budget and economic management on economic growth, development, and poverty reduction by modemizing and building capacity in economic (financial and budgetary) management and supervision, and by strengthening STP's basic institutional and legal infrastructure in the finance and natural resources/environment ministries. The project i s in line with objectives outlined in the country's PRSP (finalized duringthe second halfo f the CAS implementation period) and responds to the more complex economic and social environment arising from the onset o f the oil era. Following on actions under the PRM-TA, the project targets the following oil sector interventions (a) strengthening the NPA; (b) strengthening the legal framework, including sector-related environmental issues; (c) helping the Government prepare and promote the country's Exclusive Economic Zone; (d) establishing a functional information system that i s transparent; and (e) undertaking studies and seminars for sector development andjob creation. The project includes a detailed results framework, with concrete indicatodtargets to track the Government's progress in - 57 - implementation. While it remains to be seen to what extent the project achieves its development objectives, it i s off to a strong start under intense supervision and strong government ownership. 19. Sectoral ESW and studies conducted to support this longer term strategic goal/CAS objective targeted appropriate topics (ie., agriculture policy, budget planning, civil service reform, energy, telecom reform) but, in several areas, the combined lack o f follow-up on the part o f the Bank and/or lack o f ownership and capacity on the part o f the borrower resulted in negligible impacts. In the case o f telecom reform, however, the team actively followed through on the recommendations in the analysis, helping the Government to put in place a supervisory and regulatory framework to prepare the way for privatization (the telecoms sector i s to be liberalized by end-2005, with the Government aiming to end the telecom monopoly). The recently completed C E M i s also providing the Bank and current government policy makers and other stakeholders with useful information on the state o f STP's economy. The team is planning to follow-up more closely with government officials on the recommendations in the CEM, in conjunction with the recently completed Poverty Diagnostic, and soon to be completed DTIS. b. Broadening Access to Social Services and Improving their Quality 20. Overall, some progress on this goal/objective was made during the CAS period, however Bank (and borrower) performance was again mixed.Projects active duringthe CAS period in line with this objective included the Health and Education Project and the Social Sector Support Project. AAA/ESW included public expenditure reviews (PERs) in health and education, several social sector studies, and a Gender Assessment. Similar to the agriculture project under the first goal/objective, the Health and Education Project was approved in FY92. The ICR rated the project's outcome and Bank and borrower performance as satisfactory, but OED rated each o f these as unsatisfactory, again due to overly complex design and lack o f attention to capacity constraints. The project suffered from the frequent changes in government and reliance on third party funding for implementation. In addition, supervision was deemed inadequate, with missions lacking the specialists needed to cover the range o f activities included. 21. The more recent Social Sector Support Project is key to this goal/objective going forward. Its development objective i s to contribute to improving the delivery o f basic health and education services with a focus on greater and more equitable access, better quality, and improved local governance. The project focuses on supporting the country's efforts to achieve the MDGs, contributing directly to six o f the eight MDGs, and supports the Government in implementing its PRSP and associated social sector strategies. The project deals with a re-definition o f the role o f Government as it involves NGOs and civil society in project implementation. The team is cognizant that this project will require intense supervision ifit i s to meet its development objectives. 22. ESW undertaken to support this goal/objective was also well targeted but, again, in some cases lacked follow-up and ownership. Inparticular, the PERs in education and health were o f poor quality and never finalized. However, the more recent studies have underpinned the Bank's lendingactivities. The three social sector studies financed by a PHRD grant were used to inform the design o f the Social Sector Support Project, which incorporated the studies' recommendations. The recent Gender Assessment i s o f high quality, and the team - 58 - plans to follow-up with government authorities on its recommendations, also in conjunction with the recent Poverty Diagnostic. 111. PortfolioPerformance,CountryDialogue, andAid Coordination 23. While operations and analytic work undertaken during the second half o f the CAS period had greater impact and success-due to more intense engagement by the Bank team and increased stability and ownership by the Government-the Bank still struggled to make the most of limited human and financial resources allocated to the STP program. In particular, early inthe CAS period, the Bank's performance was affected by overly ambitious operations that were not designed in tune with STP's institutional and human resource capacity; inadequate supervision o f operations; and lack o f follow-up odownership o f ESW policy recommendations. Government instability during this period was also a factor in undermining the Bank's impact, negatively affecting portfolio performance. In addition, onerous procedures for project restructuring at the time made it difficult to modify inappropriate or poorly designed operations even once deficiencies had been identified. These factors are evident inportfolio indicators for STP, which are shown inTable 4. (Note that indicators are expected to improve once the ICR for the PRM-TA i s completed, and as newer projects, which better incorporate past lessons, are completed.) ProjectsEvaluatedby OEDby Amount 65.5 21.1 (US$m) Percentof OEDProjectsRatedUor HUby 50.0 100.0 Number Percentof OEDProjectsRatedUor HUby 56.6 100.0 Amount 24. Country dialogue for the CAS was fed by PRMC/PRM-TA preparation, which began almost one year before presentation o f the CAS and these projects to the Board. A team o f eight staff visited STP inNovember 1999 and worked over the year to prepare the projects; members o f the team simultaneously developed the CAS. Just before the CAS was discussed by the Board, the Bank worked closely with UNDP in organizing a donor Round Table meeting (October 5-6, 2000) for STP in Geneva. The CAS describes the Bank's interaction - 59 - with other donors in the design and implementation o f assistance programs, including the European Union, African Development Bank, IFAD, France, Norway, Portugal, Taiwan, and the IMF. However, the level o f collaboration and coordination among donors on the ground was limited over the CAS period, and the Government's role in aid coordination was nonexistent. This i s clearly an area o fweakness. 25. Donor coordination, collaboration, and harmonization in STP i s starting from a very shallow base. However, due to the necessarily limitednature o f the Bank's program in the country, it will be key to leveraging the impact o f Bank interventions. While the Bank liaises with the other development partners active in the country, aid coordination remains nascent. Helping the Government to realize that enhanced donor coordination i s in its interest, and taking advantage o f the window o f opportunity that exists under the period o f the next CAS (until petroleum revenue comes on stream) to enhance donor coordination so that the Government and people o f STP can realize their long-term development vision o f a productive society that benefits from-rather than relies on-petroleum revenue, will be critical, Donor partners, civil society, members o f the private sector, and other stakeholders have a large agenda to tackle on this front, but one that i s crucial to ensuring that STP achieves its objective o f diversifying its economy to avoid mistakes made by other petroleum producing countries. IV. LessonsLearnedandImplicationsfor the Future 26. Of the 10 closed Bank operations in STP, OED has evaluated eight, with half rated unsatisfactory. OED's evaluations and the operations' ICRs deliver a consistent set o f messaged lessons learned from this high failure rate, which the CAS acknowledges. However, it was not untilrecently that such lessons have been successfully incorporated into the design o f operations, such as the PRM-TA and the Governance Capacity Building TA Project, Principal lessons learned include: Operations should take into account STP's limited, weak institutional and human resources capacity; All aspectso fprojectlprogram design should be simple, clear, and focused; Government ownership o f reforms i s necessary for successful implementation and sustainable impact o fprojectdprograms; Capacity building activities should be delivered in conjunction with projectlprograms, and should be part o f a detailed action plan attachedto the Government's policy agenda; A multi-sector approach to lending is more efficient in such a small country, but projectlprogram objectives should be focused on a limited number o f priorities in each sector, within the capacity o f properlytrained implementers; Flexibility should be built into projectlprogram design, to allow for adaptation to evolving needs on the ground duringimplementation; Implementation arrangements and monitoring and evaluation activities should be simple but robust, includingappropriate capacity building(e.g., training, technical assistance) as necessary; Non-governmental stakeholder participation should be more systematically incorporated inthe planningandimplementation ofdevelopment activities; Enhanced donor collaboration and coordination i s critical to improving the efficiency, efficacy, and impact o f external assistance. - 60 - 27. A keyconclusion from the experience inSTP underthe CAS andprevious operations i s that project support may not be the most effective instrument to deliver Bank financing to assist the country in meeting its development challenges. Development policy operations (i,e,, budget support)--coupled with appropriate capacity building activities, technical assistance, analysis, and policy dialogue-is seen as a more effective and efficient way o f delivering the Bank's assistance. Development policy operations provide more leverage to the small amount o f IDA resources available to STP and allow for a more efficient use o f the limited Bank administrative budget allocated to the country. Overall, budget support is seen as a more appropriate and effective way to help the country implement its PRSP. Ensuring that the country has an adequate fiduciary framework and elaborates relevant sector strategiedpriority action plans based on PRSP objectives so that IDA can move toward budget support will be a focus over the period o f the next CAS. 28. Conclusions can also be extrapolated from the Bank's experience in STP to apply to the way inwhich the Bank engages with small state borrowing member counties in general. While small states receive, on average, a higher share o f IDA and Bank administrative resources per capita, staff time allocated to small states i s oftennot commensurate to meeting the high transaction costs o f delivering this aid, and incentives for staff to work on small states are weak. The Bank gains some economies o f scale by taking a regional approach when feasible (e.g., inthe Caribbean and Pacific), but traditional Bank instruments applied to all borrowers alike, such as STP, may not be appropriate. Since the 2000 Joint Task Force report on small states24, the Bank has recognized that small states' development challenges are as complex as those o f large states. However, other than the introduction o f horizontal adaptable program loans in the Caribbean and regional ESW, the Bank has not adapted its approach to more effectively and efficiently help small states like STP meet their development challenges. The Bank needs to think creatively about how it can improve the delivery o f lending and non-lending services to such counties, while respecting the institution's operational policies and due diligence responsibilities. OED's review o f the Bank's programs in small states, the five-year review o f the Small States Task Force report agenda, and the simplification proposal under development by Bank staff working in small states will hopefully help to galvanize efforts to make the Bank more responsive-and effective-in responding to small state clients' needs. 24 See Small States: Meeting Challenges in the Global Economy,report ofthe Commonwealth Secretariatiworld Bank Joint Task Force on small states, April 2000, available at www.worldbank.ordsmallstates. - 61 - Appendix I:DebtSustainability 1. This appendix presents an update o f the debt sustainability analysis (DSA) presented in Sa0 Tome and Principe's Decision Point document. The purpose o f this exercise i s to compare the evolution o f the external debt burdenprojected at the time o f the decision point with current projections, and to asses the impact o f the HIPC debt relief that will be provided at completionpoint on the country's debt burden. Inaddition, debt burden indicators are analyzed under the low income countries framework (LIC framework), which provides a forward-looking analysis o f Sao Tome and Principe's external debt profile and its future financing needs. 25 As it will be shown in this appendix, both debt sustainability and future financing needs are highlydependent on the prospects o f large revenues from the oil sector. Background 2. Sao Tome and Principe (STP) i s one o f the most heavily indebted countries participating in the Enhanced HIPC Initiative. STP's outstanding debt amounted to US$294 million as o f end-1999, equivalent to 624 percent o f GDP. At that time, the net present value (NPV) o f the stock o f debt amounted to US$190 million, equivalent to 1,395 percent o f exports o f goods and services, well above the HIPC threshold o f 150 percent. 3. STP reached the decision point under the Enhanced HIPC Initiative inDecember 2000. A total assistance o f US$97 million inW V terms 26 was committed for STP to reach the targeted NPV o f debt-to-export ratio o f 150 percent. Since that date some creditors including IDA, the African Development Barik and the OPEC Fundhave been providing interim relief and a number o f additional creditors have committedto providing their share o f HIPC assistance at the completion point.27 The Paris Club has provided traditional relief inthe form of a reschedule o f all arrears on eligible outstanding debt at end-March 2000 and current maturities from April 2000-April 2001.28 25 The LIC framework differs from the HIPC DSA framework, both conceptually (the indicative debt burdenindicators are based on the quality of countries' policies and institutions) and methodologically (using different definitions for debt ratio denominators and discount and interest rates). Thus, results obtained under each framework should be interpreted carefully, considering the underlying methodological differences. For further information on the L I C DSA framework see: "Debt Sustainability in Low-Income Countries: Proposal for an Operational Framework and Policy Implications", SMl04127 and IDAEecM2004-0035 and "Debt Sustainability in Low-Income Countries--Further Consideration on an Operational Framework and Policy Implications," SM/04/3 18 and IDA/SecM2004-0629/1. 26 Equivalent to a reduction o f 83 percent on the debt due and outstanding as o f December 31, 1999. 27 IDA'Sshare o f debt relief i s US$45 million in nominal terms, and is being provided through the reduction on debt service over a period o f 23 years. 28 The Paris Club had agreed to reschedule all arrears on eligible outstanding debt at end-march 2000 and current maturities from April 2000-April 2003 inthree phases. While phase one took place (2000-Ol), phases2 and 3 were inoperative. - 62 - 4. At the time o fthe decision point, STP was expected to reach the completion point under the Enhanced HIPC Initiative in 2003, but difficulties in implementing a stable macroeconomic program have set back the implementation of the poverty reduction strategy and, thus, delayed the completion point. It is currently expected that STP could reachthe completion point in September 2006.29 UpdatedDSA underthe HIPC Framework 5. This section updates the DSA conducted at the decision point with revised projections for exports and debt data, and using exchange and interest rate parameters prevailing at end-2004. The update took into account the observed performance o f exports for the period 2000-04 and revised exports projections for 2005 -25. The debt data was updated with information provided by the authorities on actual disbursements from STP's creditors for the period 2000-04.30 In addition, new borrowing assumptions from 2005 onwards were updated. 6. Compared to the decision point projections, export performance has not been as strong as expected, inparticular during the period 2006-10. This i s mainly explained by the fact that commercialization o f oil i s not expected to begin in2006, as assumed inthe decision point document. At the time o f the decision point, the oil prospects were highly uncertain as progress in reaching an agreement in the delimitation o f maritime borders with Nigeria was Updated projections take into consideration the oil signature bonuses recently agreed for the first block o f e~ploration,~~ inthe order ofUS$49 million (equivalent to 90 percent o f GDP). In addition, the updated projections envisage a productionphase starting in2012.33 7. The main results from this exercise indicate that the NPV o f debt to exports ratio after the full delivery o f enhanced HIPC assistance would stand at 274 percent as o f end- 2004, as compared with 142 percent projected in the decision point document,34 and i s projected to stay above the decision point projections until 2013 (Figure 1). The main factors underlying the difference inthe ratios are: 29 Subject to receiving financial assurances from the Paris Club andprovidedthat an IMFPRGF is put in place, followed by at least a 6-month period o f good performanceunder the program. 30 A full loan-by-loan reconciliation will be conducted prior to the preparation o f the completion point DSA. 31 The border dispute was solved in2001, and the first round o f biddings for the oilblocks was conducted until2003. 32 The Joint Development Zone is divided into 9 blocks. 33 The projections assume the following timeline: exploration phase (2005-06), the development phase (2008-1 1) and the production phase (2012-31). See Article IV Consultation Staff Report. April, 2004. IMF04/108. 34 Ifthis ratio i s assessed conditional upon reaching the completion point (i,e., without considering the fbture reliefthat would be received after the completion point), it would stand at 741 percent. a) An unanticipated fall in the discount rates and the depreciation o f the dollar, which increase the dollar value o f the NPV o f debt. (About 45 percent o f STP's debt is denominated inUSD). b) Lowerthan estimated exports. c) New borrowing has been somewhat higher than anticipated at the time o f the decision point. 8. The updated DSA also indicates that the provision o f HIPC assistance will have an important effect inreducing STP's heavy debt burden. Assuming that no further debt relief i s provided beyond the interim relief already granted, the NPV o f debt-to-exports ratio i s projected to remain above 400 percent for the period 2004-11. The provision o f HIPC assistance at completion point will significantly reduce this ratio to levels slightly above 200 percent. In order to bring STP debt burden to levels below the HIPC thresholds, proceeds from oil commercialization would need to be realized. (Figure 1) Figure1:NPV of debt-to-exportsratio. 800 700 600 500 400 300 200 100 2004 2006 2008 2010 2012 2014 2016 2018 2020 ImpactofIDA Lendingon DebtSustainability 9. As presented infigure 1, STP's debt ratios are expected to fall to levels below the HIPC threshold once STP benefits from the large oil revenues expected in 2012. IDA lending, which i s provided inhighly concessional terms, would have a greater impact on STP's debt sustainability duringthe period of 2005-11, before the arrival o f oil revenues. 10. Under the base case scenario, the IDA-14 envelope for FY06-08 provides for an allocation o f US$5.5 million for STP. Provided that STP observes positive performance - 64 - throughout this period, IDA allocation could be increased up to US$7.5 million under the highcasescenario. 11. According to the current IDA-14 guidelines, STP i s eligible to receive 100 percent o f its FY06 IDA allocation inthe form o f grants (its eligibility for grants inFY07 and FY08 will be determined at a later point). Even under such scenario, and assuming that the IDA allocation for the following CAS period i s provided at least as 50 percent grants, the external debt burdeni s projectedto remain high.(Figure 2) 12. Given the small financial envelope available for STP, the impact on the debt burdeno fproviding the full IDA allocation as loans would be small, butnot insignificant. As presented in Figure 2 below, under the base case scenario for the CAS, the NPV to exports ratio i s estimated at 269 percent at end-2005, and i s projected to remain above 200 percent until 2012 when it i s expected to reduce significantly to 45 percent. Moving to the high case scenario, would result in a slight increase in the NPV ratio from 273 percent in2007 to 274 percent. 13. Despite the prospect o f largeoil revenues inthe future, debt sustainability remains a concern in the near term. Furthermore, in the event that oil commercialization i s delayed, IDA financing in concessional terms, would be essential to reduce STP's high debt burden.Nevertheless, the arrival o f oil revenues in2012 will represent an important structural change inSTP's economy, thus its financial needs will need to be reassessedto better reflect STP's position as an oil producing country. Figure 2: NPV of debt to exports ratio Grants vs Loans 275 270 265 260 255 250 245 240 2005 2006 2007 2008 2009 2010 2011 -+-Base Case 100%loans- - - -HighCase 100%loans- 100 %grant allocation - 65 - Debt Sustainability Analysisfor Low-IncomeCountriesFramework 14. This section presents an analysis o f the projected debt profile o f STP using the L I C framework methodology, which provides for a forward-looking analysis of the country's extemal debt sustainability. 15. As previously mentioned, one o f the differences with the HIPC methodology is that the debt burden indicators in the LIC framework are based on the quality o f each countries' policies and institutions, as measured by their CPIA rating. Inthis context, STP i s classified as a weak policy country, on the base o f its 2003 CPIA rate (2.7). Table 1 below shows the applicable indicative debt-burden thresholds and compares them with the STP's projected average ratios for the periods 2004-11and 2012-24: Table 1.IndicativeDebt-BurdenThresholdsfor a Weak PolicyCountry NPV of debt Threshold Average Average service in (2004-11) (2012-24) ercent of Revenue 200 342 I Debt service I I I I inpercent of Exports 15 11 1 Revenue 25 13 10 ~~ 16. As previously suggested by the results observed usingthe HIPC methodology, the LIC framework indicates that STP faces a highrisk o f distress, even after the full delivery o f HIPC assistance. Eventhough debt service ratios do not signal that a distress situation i s an immediate concem (debt service to exports ratio i s estimated at 14 percent as o f end-2005 and i s projected to remain below the debt-burden threshold throughout the period o f analysis), the high debt ratios signal an important risk o f debt distress (Table 2.a). Under the baseline scenario, the NPV of debt to exports as o f end-2005 i s estimated at 241 percent, increasingto 274 percent in2008 and sharply decreasing to 19 percent by 2012. Similarly, the GDP to exports ratio, estimated at 107 percent as o f end-2005, i s projected sharply decrease to 16 percent by 2012. 17. The dramatic reduction in the debt and debt service ratio in 2012 i s an indicative result that STP's debt sustainability i s highly dependent on the success o f the production and commercialization o f oil. Any delays inthe schedule foreseen will have a significant impact on the debt burden andwould require STP to rely heavily on extemal financing in highlyconcessional terms. - 66 - 18. Comparing the baseline assumptions with STP's historical performancereinforces these results. Assuming that the key macroeconomic variables that determine the debt dynamics grow at their historical levels resulted in a significant deterioration o f the debt anddebt service ratios compared to the baseline a~sumptions.~~presented inTable 2.b As and Figure 3, the NPV o f debt to exports is projected to be more than 100 percentage points higher than the baseline by 2010, remaining well above the indicative thresholds throughout the period of analysis. Similarly, the NPV of debt to GDP ratio i s projectedto reach 118 by 2011 and is expected to remain at levels above the debt-burden thresholds throughout the period o f analysis. Such scenario underscores the importance o f realizing the targets set out inthe baseline, inparticular interms o f oil-related exports. 19. Furthermore, stress tests performed under the LIC framework indicate the vulnerability o f debt distress to shocks in exports.36Under such scenario, STP's NPV o f debt to exports ratio i s significantly affected, reaching a peak of 404 percent by 2008, more than 100percent higher than the baseline projection. (Table 2.b and Figure 3) Conclusion 20. STP's NPV of debt-to-exports is estimated to have increased significantly since the decision point. The increase was mainly due to changes in exchange and discount rates, new borrowing and lower than anticipated exports. The updated D S A underscores the importance ofreaching the H P C completion point inorder to reduce STP's highdebt indicators, inparticular prior to the "oil era". It also highlights the needs to consider the structural change that the economy will face at the beginning ofthe oil commercialization phase to better assess STP's future financing needs. 21. Inaddition, the preceding scenarios suggest a highrisk o fdebt distress andahigh sensitivity to the arrival of oil revenues. Evenunder the baseline assumptions, debt ratios will not reach a sustainable level untilthe beginning o f the oil commercialization phase; any delays in the schedule would seriously compromise STP's extemal long-term debt sustainability. In this context, the government faces the challenge o f maintaining responsible fiscal policies and a credible strategy to sustain growth with a view to strengthen STP's repayment capacity and reduce vulnerability to shocks, in particular exports shocks. Equally important will be the authorities' efforts in diversifying its exports base (highly concentrated in services and cocoa exports) to further reduce its exposure to export shocks and minimize its impact inthe future. 35 The standard assumptions under this scenario are that real GDP growth, inflation, non-interest current account (in percent of GDP), and non-debt-creating inflows (inpercent of GDP) remain at their 10- year historical average. Given STP's high dependence on the exports growth in 2012, it i s further assumedthat the trade balance as percent of GDP will also remainat its historical average. 36 The stress test assumes that exports growth i s one standard deviation below its historical level during the period 2006-07. This scenario represents a 25 percent probability of occurrence. - 67 - ~ ~ m w - m m d m i d - i m v , I 00 \o I Table 2b. SPo Tome and Principe Sensitivity Analyses for Key Indicators of Public andPublicly Guaranteed Extemai Debt, 2004-2024 (Inpercent) Est. Projections 2004 2005 2006 2007 2008 2009 2010 2011 2012 2022 2023 2024 NPV oldebt-tc-GDP ratio 11 Baseline 105 107 107 106 I02 97 91 84 16 2 2 4 A. Alternatlve Scenarlos AI. Key variablesat their historicalaverages in2004-24 21 105 106 117 120 127 131 133 128 127 96 93 89 A2 Ncwpublic sector loam onlas favorabletemu in2004-24 31 105 107 106 102 98 92 85 79 14 2 2 3 8.BoundT e a BI. RealGDP growthat historicalaverageminusonestandarddeviationin 2005-06 IO5 109 112 110 106 101 94 88 1 6 2 3 4 82. Export value growth at historicalaverageminusonestandarddeviationin 2005-06 41 I O 5 107 107 109 108 I03 91 85 1 6 2 2 4 83. USdollar GDPdeflatorat historicalaverageminusonestandarddeviationin2005-06 IO5 118 131 127 125 118 111 103 1 9 2 3 5 84 Net nondebt creatingflows at historicalaverageminusonestandarddeviationin2005-06 51 105 107 107 109 108 97 91 84 1 6 2 2 4 85.Combinationof 81-84 wingone-halfstandarddeviationshocks 105 112 133 142 131 125 117 109 2 0 3 3 5 86. One-timc 30 percentnominaldepreciationrelativeto thebaselinein2005 61 105 145 151 149 144 137 128 119 2 2 3 4 6 NPV of debt-tc-exports ratio Bmrline 271 274 279 276 284 280 268 262 1 9 2 3 5 A. Alternwive Scenarios AI. Kcyvariablesat their historicalaverages in2004-23 U 271 336 370 380 401 415 422 405 402 304 295 282 A2. Nwpublic sector loam on Iso favorable term! 2004-23 31 271 274 274 267 272 265 252 243 1 7 2 2 3 B. BoundTests 81.RealGDPgmwthathistoricalaverageminusonestandarddeviationin2005-06 271 271 279 276 284 280 268 262 1 9 2 3 5 82. Export value gmwthat historicalaveragembus onestandarddeviationin2005-0641 271 318 376 383 405 400 362 353 2 5 3 4 6 B3. USdollar GDP deflator at historicalaverageminusone standarddeviationin2005-06 271 301 279 273 284 280 268 262 1 9 2 3 5 84. Net nondebt creatingflows at historicalaverageminusonestandarddeviationin2005-06 51 271 274 279 286 300 281 269 262 1 9 2 3 5 85. Combinationof 81-84 usingone-balfstandarddeviationshocks 271 285 336 354 348 343 328 320 2 3 3 3 6 86. me-time 30percentnominaldepreciationrelativeto thebaselinein2005 61 271 370 279 276 284 280 268 262 1 9 2 3 5 Debt service ratlo Basellne 9 11 9 I 1 II 11 II I1 5 0 0 0 A. Alternative Scenarios A1 Kcyvariablesat their historicalaveragesin 2004-23 2/ 9 14 10 14 14 16 19 19 75 25 27 31 A2. Nnv public Sectorloam onIKS favorabletemu in 2004-23 31 9 I 1 8 10 I O 10 I 1 11 4 0 0 0 B. BoundTests E1 RealGDP gmwthathistoricalaverageminusone standarddeviationin2005-06 9 II 8 10 10 II 12 12 4 0 0 0 82. Export value growth at historicalaverageminusonestandarddeviationin 2005-06 41 9 I3 II 14 I S 15 17 16 5 0 0 1 83 USdollar GDPdeflatorat historicalaverageminvsonestandarddeviationin2005-06 9 12 8 10 10 11 12 12 4 0 0 0 84. Net nondebt creatingflows at historicalaverageminusonestandarddeviationin2005-0651 9 11 8 II I 1 I 1 12 12 4 0 0 0 85.CombinationofB1-84 usingone-halfstandarddeviationshocks 9 I 2 10 13 13 13 15 I S 5 0 0 1 86 One-time30 percentnominaldepreciationrelativeto the baselinein2005 61 9 15 8 10 10 I 1 12 12 4 0 0 0 Memorandum ilem Grantelementa s d onraidual financing (:.e, hanchg requiredabovebaseline)7/ 33 31 30 28 27 25 23 23 22 13 12 I O Source. Staffprojectionsand sirmlations. 11By the year 2023 red GDP growth slows downsipifiuntly due to theprojecteddeclineinpeUOleumpmduction. U Variables includerealGDPgrowth, gmwthofGDP deflator (in U.S.dollar terms), noa-interstcurrent-ut inpercentofGDP, andnoa-debtcreatingflows. 31Assumes that the interst rateonncwbomuing isby 2percentagepoints higher than inthebaseline.,while grace andmaturityperiods arc the same as inthebaseline. 41Expom value are assmedto minQenMneatlyat the lowerINel, but the cuncnt smut as ashare of GDP is assumed to reblmto its baselinelevel aRer the shock (implicitly assuming an offsettingadjusmtent in import levels). 51 Inclvdesofficial andprivatenamfen and FDI 61Depreciationisdefinedas percentagedecline indollarllocal~ m c rat+ such that it never exceeds 100percent y 71&plies to all suessscenariosexcept for A2 (lasfavorablefinancing) inwhichthe termson all newhancingarc as specified infoomotc 2 - 69 - Figure 3: SsLo Tome and Principe: Indicators of Extemal Debt Under Altemative Scenarios, 2004-2024 (Inpercent) 200 NPV of debt-to-GDPratio 175 - Baseline 150 --- Historicalscenario 125 -----______ -Most extremeDSA stresstest 100 -----____ -- 75 50 25 0 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 450 500 1 NPV of debt-to-exportsratio - Baseline -Most extremeDSA stresstest - --. ---dj$@cal --- scenario --- 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 I 100 Debt service-to-exportsratio - 90 80 Baseline -Most extremeDSA stresstest --- Historicalscenario 30 - II -----____ ---- , _*----/ 20 - '-....I..I.I.I.s.I.......I....f.I.f...I.I.......I.. 15 I 2004 2005 2006 2007 ZOO8 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 Source:Staffprojectionsandsimulations. Underthe LIC bamework,Sa0 Tome andPrincipeis classifiedas a weak policy country. As such, its indicativedebt-burden thresholds areas follows: 100%for NPV ofdebt to exports, 30% for NPV ofdebtto GDPand 15%od debt service to exports. - 70 - I 3 l? I " O N ; ; " " " W O 5 4 4 5 5 5 6 6 6 6 6 6 """ Figure 2: Slo Tomb and Principe: Indicatorso fExternalDebt Under Alternative Scenarios, 2004-2024 (Inpercent) 120- NPV of debt-to-GDPratio ---_ - - - _ - - - - - - H - - .. 80 - \ \ \ \ \. 60 - 40 - -Baseline ---Historical 20 - scenario -Most extreme DSA stress test I 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 350 - NPV of debt-to-exportsratio - Baseline -Most extreme DSA stress test 200 - ---Historical scenario 150 - 100 - .------- ___------- 50 - I 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 i Debt service-to-exports ratio 6o 50 A 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 Source: Staffprojections and simulations. - 73 -