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PROGRAM INFORMATION DOCUMENT (PID) CONCEPT STAGE Report No.: AB6046 Operation Name Region Sector Project ID Borrower(s) Implementing Agency Date PID Prepared Estimated Date of Appraisal Authorization Estimated Date of Board Approval Public Resource Management and Governance Reform (PRMG) Development Policy Operation AFRICA General public administration sector (100%). P123374 DEMOCRATIC REPUBLIC OF SÃO TOMÉ AND PRÍNCIPE MINISTRY OF FINANCE AND INTERNATIONAL COOPERATION Ministry of Finance and International Cooperation Largo das Alfandegas São Tomé October 13, 2010 December 09, 2010 March 31, 2011 1. Key development issues and rationale for Bank involvement The Democratic Republic of São Tomé and Príncipe (STP) is a small and fragile state and one of the smallest economies in Africa. The country faces many development challenges due to its small size and insularity, limited institutional capacity, and aid dependency. STP’s development shortcomings translate into low productivity and low export levels as well as vulnerability to external shocks. As in other small island states, STP cannot exploit economies of scale in the provision of infrastructure, services, and economic activities. All these features translate into: (i) high costs per unit of government and utility provision services; (ii) limited flexibility of the economy to adapt to shocks due to a non-diversified export base and a dependence on external financing; and (iii) few opportunities for risk diversification within the domestic market. The incidence of poverty remains high and, as of 2001, 54 percent of the population lived in poverty. To face large poverty, the authorities have been implementing a Poverty Reduction Strategy, as outlined in the Poverty Reduction Strategy Paper (PRSP), since 2003, with a PRSP Unit made operational in 2005 to supervise PRSP implementation. A Committee was appointed in 2008 to develop a new Development Strategy to replace the PRSP, and this strategy is expected to be finalized in 2011, after the poverty profile is updated. The new Development Strategy will be based on a domestic-led pro-poor growth strategy, and, given the increased uncertainty in petroleum production revenues at this time the petroleum economy will not be considered in the new Development Strategy. For the last five years, the government has pursued prudent macroeconomic policies and implemented important structural reforms in line with the objectives set out in the IMF’s 2006-2008 Poverty Reduction and Growth Facility (PRGF) and 2009-2011 Extended Credit Facility (ECF) programs. Between 2001 and 1 2009, real GDP growth averaged 6 percent a year and the primary fiscal deficit was steadily reduced from 14.7 of GDP in 2004 to 7.5 percent of GDP in 2008, financed thanks to oil signature bonuses and privatization receipts. Considerable progress has been made in public governance and specially in public financial management, with support of previous Bank operations such as the US$8 million Public and Natural Resource Management and Development (PNRMD) development policy operation (DPO), approved in 2008, and the US$5 million Capacity Building Technical Assistance (CBTA) project approved in 2004. This macroeconomic and governance efforts have paid off, allowing the country to reach the Completion Point under the Enhanced HIPC Initiative in 2007 and receive debt relief in the amount of US$314 million. Notwithstanding these achievements, STP remains vulnerable to a variety of shocks. For example, the sharp rise in international fuel and food prices in 2008 impacted adversely on STP’s economy through inflationary pressures (costly imports) that affected the poor and vulnerable. The World Food Program (WFP) estimated an increase in the number of vulnerable people (those for whom food is inadequate or at the limit) that need its support by 10-15 percent. In addition, the on-going international economic and financial slowdown has limited the capacity of the Government to consolidate fiscal sustainability through reduced external financing. Following the international slowdown, a sharp decline in FDI, tourism-related investment, foreign assistance, and oil signature bonuses that did not materialize slowed down GDP growth to 4 percent in 2009. This has translated into lower public revenues that the new corporate and personal income tax laws introduced in 2009, aimed at enhancing compliance, have not been able to compensate with additional public resources. Despite efforts to contain discretionary current expenditure the domestic non-oil primary deficit has increased to an estimated 8.2 percent of GDP in 2009. To cushion the impact of the global slowdown on the poor and vulnerable groups, the government seeks additional fiscal resources to protect and increase priority spending, which is intended to address the basic needs of the population and foster productivity. To ensure that fiscal resources are used most effectively to support long-term growth and achieve policy objectives as defined in the PSRP and the Millennium Development Goals, the authorities have committed to accelerate reforms in public finance management and improve the quality of public governance to raise the effectiveness of public expenditure at a time progressive fiscal consolidation is required. The proposed Public Resource Management and Governance Reform (PRMG) Grant in the amount of US$4.3 million (about 2.3 percent of GDP) to STP. The proposed single tranche operation supports the objectives set out in the Government’s Program that are in line with STP’s poverty reduction strategy, as set out in the Poverty Reduction Strategy Paper (PRSP), which is in line with the Bank’s Interim Strategy Note under preparation and the ECF IMF program. The PRMG grant supports the continued progress and consolidation of reforms supported by the preceding PNRMD DPO and the CBTA project, and helps to consolidate macroeconomic stability. 2. Proposed objective(s) The PRMG operation supports critical public finance management reforms to raise public sector effectiveness at a time that fiscal consolidation limits available resources in line with reforms launched under previous operations. Uncertainties surrounding the outlook for oil production and the recent adoption of the peg against the Euro underscore the importance of reversing the recent fiscal deterioration and STP will accelerate fiscal consolidation to maintain macroeconomic stability and support growth. Improved public finance management will be critical to raise public sector effectiveness at a time that fiscal consolidation limits available resources. Specific government objectives supported include: (i) raising the 2 transparency and accountability of budget preparation, improving the execution and control of public financial management, and strengthening the alignment of public expenditures with poverty reduction activities; and (ii) promoting sustainable economic policies by strengthening the fiscal policy framework and improving coordination with donors. In addition, this operation will support the Government’s plan to initiate preparation of a new PRSP. These two areas are expected to have a positive direct impact on STP’s overall governance and poverty reduction. In particular, the DPO will help raise the level of transparency in public resource management and reinforce the fiduciary framework through the production of public accounts and its review by external oversight bodies. The PRMG objectives broadly coincide with key recommendations of the Public Expenditure Management and Financial Accountability Review (PEMFAR), the European Union’s Public Expenditure and Financial Accountability Review (PEFA), the Debt Management Performance Assessment (DeMPA), and the ongoing Country Economic Memorandum (CEM). 3. Preliminary Description Building upon the achievements and lessons of previous and current projects, the recommendations of the PEMFAR and the recently completed CEM, and the results achieved under the IMF-ECF, the proposed operation supports policy reforms identified in the Bank’s ISN (currently under preparation). The ISN will cover the period between 2011 and 2013 and continues to support areas of previous engagement (i.e. deepening reforms in social sectors and public sector governance, and supporting macroeconomic stability and pro-poor growth). The proposed PRMG operation supports the Government’s Program that is in line with STP’s poverty reduction strategy, as set out in the Poverty Reduction Strategy Paper (PRSP). Considerable progress has been made in improving public financial management over the last five years, with substantial support from two predecessor operations (CBTA and PNRMD). Accelerating reforms in the two areas of focus of this operation is expected to have large positive impacts not only on growth and poverty but also on governance across the country. Funds from this operation will help sustain economic growth without undue pressure on the country’s balance of payments—a critical issue for small states facing large volatilities in revenues and world prices. The proposed PRMG DPO is expected to improve the public sector’s capacity to better deliver key services and support growth. This operation will also support the preparation of a new results-oriented poverty strategy that incorporates lessons learnt from the previous PRSP implementation, updates the poverty profile, and provides growth diversification prospects. The focus of a DPO would be on public finance management (PFM), with the aim to enhance public sector and economic governance, thereby strengthening the links between public expenditure, fiscal sustainability, and sector strategies. The activities that would be supported by this operation can also enhance the capacity of the country to better design and implement medium term strategies by introducing a formal consultative mechanism to coordinate donor assistance. The PRMG operation would also support the preparation of a new results-oriented poverty strategy that incorporates lessons learnt from the previous PRSP implementation, updates the poverty profile, and provides growth diversification prospects. The PRMG operation will be coordinated closely with the IMF ECF program, and with other donors. 4. Rationale for Bank’s Involvement The rationale for Bank’s involvement rests on (i) its ability to provide significant resources (US$4.3 million or 2.3 percent of GDP) to allow the implementation of the 2011 budget in line with the Government’s 3 reform program; (ii) its technical contribution to the policy dialogue and the PFM reform in the country based on the PEMFAR, the DeMPA and the recently completed CEM; (iii) the success of the previous budget support operation, the PNRMD Policy Grant (which closed in June 2010), and the CBTA project (which closed in September 2010) that supported PFM reform, PRSP implementation, and governance in the oil sector; and (iv) the leadership of IDA among the donor community in the country. 5. Environment Aspects Policy actions supported by the proposed PRMG Grant are not expected to have significant impacts on the environment, forests, or other natural resources. The specific policies supported under this Grant address primarily institutional reforms. The focus of the reforms is on transparency and accountability or public resources, on the efficiency of public expenditures, and on promoting good governance. 6. Tentative Financing Source: BORROWER/RECIPIENT International Development Association (IDA) Total ($m.) 0 4 4 7. Contact Point Contact: Mr. Marco Antonio Hernández Oré Title: Country Economist Tel: (202) 473-6802 Fax: (202) 473-8466 Email: [email protected] 4