Document of

The World Bank

FOR OPICUAL USE ONLY

Report No. 13303

PEOJECT COMPLETION REPORT

SAO TOME AND PRINCIPE

FIRST STRUCTURAL ADJUSTMENT CREDIT (CREDIT 1825-STP)

AND AFRICAN FACILITY CREDIT (A-29-STP)

JULY 1, 1994

Country Operations DivisionWestern Africa DepartmentAfrica Regional Office

This document has a restricted distribution and may be used by recipients only in the performance of

their ofticial duties. Its contents may not otherwise be disclosed without World Bank authorization.

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

CURRENCY EQUIVALENTS

Current Unit = Dobra (Db)

Period Average Exchange Rates

US$1.00 =

1987 1988 1989 1990 1991 1992 199355 87 124 140 280 375 380

ABBREVIATIONS AND ACRONYMS

AfDB African Development BankAfDF African Development FundBNSTP Banco Nacional de Sao Tome e Principe

(National Bank of Sao Tome and Principe)ECOMEX Empresa de Comercio ExternoGDP Gross Domestic ProductIDA International Development AssociationIMF International Monetary FundPCR Project Completion ReportSAC Structural Adjustment CreditSAP Structural Adjustment ProgramSDR Special Drawing RightSTP Sao Tome and PrincipeWFP World Food ProgramUNDP United Nations Development Program

FISCAL YEAR

Government: January 1 - December 31

FOR OFFICIAL USETHE WORLD BANK

Washington, D.C. 20433U. S. A.

OMce of Director-GeneralOperations EvalusUon

July 1, 1994

MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT

SUBJECT: Project Completion Report on Sao Tome and PrincipeFirst Structural Adjustment Credit (Credit 1825-STP)and African Facility Credit (A-29-STP)

Attached is the Project Completion Report on Sao Tome and Principe First Structural AdjustmentCredit (Credit 1825-STP) and African Facility Credit (A-29-STP) prepared by the Africa Regional Office,with Part II contributed by the Borrower.

The SAC I and the African Facility Credit supported the Government's economic recovery programthrough (i) exchange rate devaluation; (ii) monetary and fiscal reforms; (iii) price liberalization; and (iv)incentives to promote private sector development. The fiscal reforms included major measures designed torestructure the public investment program and the public enterprise sector.

Overall, the performance of the reform program under SAC I is rated satisfactory and its institutionaldevelopment impact negligible. The major policy measures were implemented, but with delays. The seriousovervaluation of the currency was overcome through the adoption of a more flexible exchange rate. Tradeliberalization improved domestic incentives for production. The import and export administrative procedureswere simplified. To facilitate implementation of reform measures, IDA allowed the split of the secondtranche, by introducing a third tranche. Sustainability, however, is uncertain. To continue support of furtherreforms, IDA subsequently extended a second adjustment credit, SAC II.

The PCR provides an account of the objectives, accomplishments, and shortcomings of the programimplementation. Political problems apparently contributed to the weakening of resolve on programimplementation. This was aggravated by a weak institutional and administrative capacity in government.

OED intends to carry out an audit of this adjustment operation together with the EconomicRehabilitation and Modernization Project and with SAC II, when the latter is completed.

Robert Picciotto

by H. Eberhard K6pp

Attachment

This document has a restricted distribution and may be used by recipients only in the performance of theirofficial duties. Its contents may not otherwise be disdosed without World Bank authorization.

FOR OFFICIAL USE ONLY

PROJECT COMPLETION REPORTSAO TOME AND PRINCIPE

FIRST STRUCTURAL ADJUSTMENT CREDIT (CREDIT 1825-STP)AND AFRICAN FACILITY CREDIT (A-29-STP)

TABLE OF CONTENTS

Page No.

PREFACE .................... i

EVALUATION SUMMARY .................... ii

PART I: PROGRAM REVIEW FROM IDA'S PERSPECTIVE .1

1. Project Identity .1

1. INTRODUCTION .1A. Country Context .1B. Economic Performance: 1980-1986. 2C. Structural Adjustment Program. 2

2. CREDIT BACKGROUND. 3A. Preparation of the Credit. 3B. Role of the IMF. 4

3. CREDIT DESIGN AND IMPLEMENTATION. 4A. Credit Design. 4

1. Credit Objectives. 42. Conditions of Second Tranche Release .5

B. Implementation of SAC I. 61. Correcting Macroeconomic Distortions. 6

a. Exchange Rate Policy. 6b. Fiscal Policy. 7c. Monetary Policy. 7

2. Restoring the Profitability of Agriculture. 73. Administrative Reforms. 8

a. Civil Service Reform. 8b. Public Enterprises. 8c. Cocoa Export Taxes. 9

4. ECONOMIC AND SOCIAL IMPACT. 9A. Economic Impact. 9B. Social Impact .10

This document has a restricted distribution and may be used by recipients only in the performance of theirofficial duties. Its contents may not otherwise be disclosed without World Bank authorization.

TABLE OF CONTENTS (CONT.)

Page No.

5. CREDIT IMPLEMENTATION AND SUPERVISION .... ..... 11A. Role of IDA .1................................. 1B. Credit Monitoring and Administration ..... ............ 11

1. Credit Disbursements and Procurement ..... .......... 122. Reporting and Auditing ........ ................. 123. Tranche Release and Closing ....... ............... 12

C. IDA Performance ............................... 13D. Borrower Performance .......... ................. 13

6. ASSESSMENT AND LESSONS LEARNED ..... .......... 14A. Administrative Capacity ......... ................. 14B. Consistency in Implementation ....... ............... 15C. Risks ..................................... 15D. Flexibility in Tranching ......... ................. 15

PART II: PROGRAM REVIEW FROM THE BORROWER'S PERSPECTIVE ... 17

PART III: STATISTICAL INFORMATION ......................... 18

Table 1 Basic Credit Data .18Table 2 Matrix of Policy Actions .20Table 3 Key Economic Indicators .22

- i -

PROJECT COMPLETION REPORT

FIRST STIRUCTJRAL ADJUSTMlENT CREDrT (CREDT 1825-STP)AND AFRICAN FACILITY CREDIT (A-29-SP)

PREFACE

This is the Project Completion Report (PCR) for the Structural Adjustment Credit(SAC) (IDA Credit 1825-STP and African Facility Credit A029-STP). SAC was approvedon June 23, 1987 for SDR 5.4 million (US$4.0 million), and the Closing Date was extendedto March 31, 1992, three years beyond the original Closing Date. The final disbursementswere made on June 25, 1992. 99.9 percent of the approved amount was disbursed; theremainder was canceled.

The PCR was prepared by the Country Operations Division (AF4CO) of theAfrica Regional Office (Preface, Evaluation Summary, Parts I and III). Preparation of thePCR was based on, inter alia, the President's Report, the Staff Appraisal Report, theDevelopment Credit Agreements, Supervision Reports, correspondence between the Bankand the Borrower, and internal Bank memoranda. AF4CO requested the Borrower toprovide its program review perspective and these comments are provided Part II of the PCR.

In the absence of the Government's adjustment effort and the associated foreignfinancing, GDP and living standards would have continued to decline and the shift in incomesin favor of the rural sector would have been delayed. While the overall impact of theprogram on GDP and living standards was positive in 1987-89, during 1990, the Governmentencountered serious difficulties in implementing the adjustment program. Many of themacroeconomic targets and objectives were not met and most other key structural reformsfell behind schedule.

- ii -

PROJECT COMPLETION REPORT

FIRST STRUCTURAL ADJUSTMENT CREDIT (CREDIT 1825-STP)AND AFRICAN FACILITY CREDIT (A-29-STP)

EVALUATION SUMMARY

Objectives

1. The purpose of the First Structural Adjustment Credit and the African Facility Creditwas to "support the Government's economic recovery program and allow economic activity toexpand while the reform program is implemented." This objective was expected to be achievedthrough a major exchange rate devaluation, monetary and fiscal policy reforms including therestructuring of the public investment program and loss-making public enterprises, priceliberalization, and an incentive package to facilitate private initiative. The anticipated benefitsof the project were aimed at improving the growth prospects of the economy through betterincentives, an adequate supply of producer and consumer goods, more efficient allocation offoreign exchange, and the creation of an environment conducive to private initiative andinvestment.

Implementation of SAC I

2. SAC I was broadly successful. During the Credit period, the country moved froma centrally planned to a more open economy with a more market orientation. During this period,the Government focussed mainly on stabilization measures to correct macroeconomic distortions,and there was movement from a centrally planned to an open economy with a market orientation.Notwithstanding key changes in the Government's economic team in early 1988 and again inJanuary 1989 that delayed implementation of the macroeconomic program, a series of measuresintroduced in mid-1988 and reinforced in 1989 kept the overall program on track. This occurreddespite a sharp decline in the international cocoa price and a deterioration in the country's termsof trade.

3. The Government successfully reduced the overvaluation of the domestic currencythrough a more flexible exchange rate policy. It also achieved some progress in controlling thefiscal deficit which contributed to slowing down credit expansion and improving price stabilityin the economy. Trade liberalization has improved the incentives for production and export.Import and export administrative procedures have been simplified. The dismantling of pricecontrols and the elimination of all subsidies on imported foodstuffs and petroleum products isnotable. Most noteworthy is the greater role allocated to the private sector in domestic andexternal trade and in the management of cocoa estates leading to their eventual privatization.Some modest progress was made in institution-building.

4. In 1990, however, the program was not consistently pursued in part because ofupcoming elections. By end-1990 at the completion of the program, most of the macroeconomictargets and objectives remained largely unmet. Also, structural reforms began to fall behindschedule. In 1991, the economic and financial situation showed further signs of deterioration,as the adjustment policies that were to have been implemented in the latter part of 1990 and 1991were postponed because of national elections held in early 1991. Subsequently, with the peaceful

- iii -

transition to a multi-party democracy in early 1991, more concerted implementation of theprogram has resumed and the macroeconomic situation has stabilized.

Results of SAC I

5. The adjustment program and the accompanying foreign financing was instrumental incurtailing the decline in GDP growth and living standards observed in mid-1980s which wouldhave likely continued on a downward trajectory in the absence of reform. The overall impactof the program on GDP was positive in 1988 and 1989. But GDP fell in 1990, reflectingprogram implementation problems and a sharp decline in the terms of trade. As is frequently thecase in structural adjustment programs, the social impact has been mixed. Preliminary evidencesuggests that civil servants and urban residents have been adversely affected because of priceincreases in fuel and utilities. Meanwhile, the impact on the rural population has been positivebecause the terms of trade have favored agriculture.

Assesment and Lessons Learned

A. Administrative Capacity

6. The objectives of the program were very ambitious in relation to the Government'sadministrative capacity. Outstanding measures associated with institutional reforms, namely inthe civil service, public enterprises and the tax system suffered from a lack of adequate andtimely technical assistance and studies. In retrospect, the relatively weak administrative capacitysuggests that the timetable for the institutional reforms was too short and the program was tooambitious.

7. Lessons Learned. The program's primary risk which was articulated at the outset,pertaining to the limited administrative capacity in the public sector to make decisions andimplement the proposed reforms therefore, proved important. Further, the limited experienceof the Government which has been dealing with a very complex and ambitious agenda in adifficult economic environment, coupled with limited political support, has rendered the tasks tobe quite challenging. Structural reforms require not only the analytical capacity to propose majorchanges, but also the capacity to implement them. Implementation plans need to developed inrelation to the capacity of the agencies undertaking reform.

B. Consistency in Implementation

8. The experience of Sao Tome and Principe illustrates the importance of consistency inimplementation. The adjustment process initially proceeded well, but implementation wassidetracked. Much less time was devoted to the program than was necessary and hence,administrative capacity was exacerbated by the need to attend to the political transition. Thesituation was further exacerbated by foreign exchange constraints, precipitated by sharply fallingworld market prices for cocoa, growing debt service obligations, and additional spending onhousing that was not included in the approved public investment program.

9. Lessons Learned. The appropriate timing of implementation of a complex set ofreforms is an essential ingredient of success. If adjustment proceeds from the outset but isdeterred because of external and internal circumstances, important gains may be diminished. It

- iv -

should not be unexpected that implementation would be delayed by transitions in the politicalorder. To the extent that such transitions are known during the course of program design, it isimportant to build these considerations into implementation establishing timetables and conditionsof effectiveness. In such cases, priorities on several strategic interventions would recognize theimpact of such events as well as the scarcity of implementation capacity.

C. Risks

10. One of the main vulnerabilities of the project was its linkage with cocoa prices.Certainly the structure of agriculture production in which cocoa was and continues to be the mainarea of comparative advantage suggests that the cocoa sector be bolstered as part of an adjustmentprogram. The extensive reliance on cocoa export revenues as a means of financing the publicsector indicates the precariousness of the economy generally, as well as the tenuousness of effortsthat build on an uncertain and vulnerable foundation.

11. Lessons Learned. Adjustment programs need to build on a country's strengths andgiven that cocoa is a product for which Sao Tome and Principe is well-known suggests that it wasappropriate to focus on this subsector in an adjustment program. Simultaneously, however, itis also well-known that reliance on a single commodity for the sustenance of the economy canjeopardize adjustment efforts. Hence, to the extent that agricultural diversification strategies canbe built in to reform programs, it would ameliorate -- admittedly over time -- the precariousnessof the economy.

D. Flexibility in Tranching

12. The experience of Sao Tome and Principe illustrates the need for flexibility inmodifying initial tranching conditions and thereby accommodating local circumstances. Twofactors were important in the Government's performance in the adjustment program. First, theinternational price of cocoa, the main source of export revenues, dropped by 25 percent frommid-1987 to mid-1988. This decline led to a critical shortage for foreign exchange which wouldpreclude the ability to finance a minimum level of imports. Without the minimal level ofimports, the Government's ability to maintain its commitment to the reform program would havebeen severely constrained.

13. Given the progress that was demonstrated in terms of the macroeconomic measuresthat had been implemented, the credit's original tranching specifications were modified. But also,there was some concern about delays in the implementation of the institutional reforms as wellas the strength of macroeconomic performance that suggested the need to split the second tranche.The third tranche release was conditioned on the implementation of the outstandingadministrative measures and continued satisfactory progress on the macroeconomic side.

14. Lessons Learned. The Bank's strategy for supervising progress needs to be adaptiveand flexible in the context of changes in internal and external circumstances. In this case, thethird tranche was created to acknowledge the progress made and to permit additional progressin those areas that lagged behind at the time of the release of the second tranche.

SAO TOME AND PRINCIPEFIRST STRUCTURAL ADJUSTMENT CREDIT (CREDIT 1825-STP)

AND AFRICAN FACILITY CREDIT (A-29-STP)

PROJECT COMPLETION REPORT

PART I: PROGRAM REVIEW FROM IDA'S PERSPECTIVE

1. Project Identity

Project Name First Structural Adjustment CreditCredit Number Credit 1825-STP and

African Facility Credit A-29-STPCredit Amount . US$18.0 millionRegional Unit . Africa Regional OfficeCountry : Sao Tome & Principe

1. INTRODUCTION

1. The First Structural Adjustment Credit and the African Facility Credit supported the SaoTome and Principe Government's Structural Adjustment Program (SAP). The credit providedthe vehicle for the dialogue between IDA and Sao Tome and Principe on macroeconomic andinstitutional issues. This dialogue was instrumental in achieving major policy breakthroughs inan economy traditionally characterized by strong government control. The credit also served asa vehicle for IDA's dialogue with other donors.

A. Country Context

2. Upon independence in 1975, Sao Tome and Principe (STP) emerged from five centuriesas a Portuguese colony with an economy oriented toward the production of a single crop, cocoa.Under colonial rule, cocoa was produced on estates covering virtually all the country's arableland, leaving no room for smallholders and forcing dependence on imported goods. Followingindependence, the new Government was faced with an aging production base and a critical lackof skilled manpower. It responded with an economic policy based on central planning andpriority programs in health and education. An ambitious public investment program was initiatedin 1976 and carried through to 1983 which involved substantial investments in construction,poultry, beverages, fishing, transport, and tourism. The nationalized cocoa estates wereregrouped into 15 state enterprises which performed poorly. Cocoa production, which had stoodat about 10,000 tons in 1975, dropped to 4,500 tons in 1987. Poor management, aging cocoatrees, volatile international cocoa prices, and inappropriate exchange and credit policies were themajor factors that accounted for the sharp decline in production. However, the soil is well-suitedto cocoa production as well as a broad range of crops owing to the variety of microclimates thatexist.

- 2-

B. Economic Performance: 1980-1986

3. Ten years after independence, the STP economy was precarious. Under the fixedexchange rate policy, the real exchange rate appreciated by an estimated 80 percent between 1977and 1985. Meanwhile, the initial decreases in cocoa production led to large operating deficitsfor the agricultural state enterprises, which the Government financed through expansionary creditpolicies that fueled inflation. Expansionary monetary and credit policies to finance domesticdeficits, coupled with official price controls, led to the appearance of parallel markets fordomestic and imported goods. The purchasing power of workers in state-owned farms fellsubstantially. Government policies that set prices and wages provided little if any incentive toincrease productivity. GDP per capita declined by an estimated 30 percent in real terms duringthe period. A large public sector investment program (an average of 40 percent of GDP) focusedon capital-intensive projects and was financed mainly through external borrowings and did notcontribute significantly to value added. Instead, heavy recurrent costs ensued.

4. From 1980 to 1986, the goods and services account balance deficits averaged 50 percentof GDP. Corresponding deficits in the current account balance were financed through a draw-down on external reserves, short-term borrowings in 1982 and 1984, reschedulings in 1984 and1985, and a build up of external arrears from 1983 to 1986 totaling more than US$ 24 millionat the end of 1986. Outstanding external debt at the end of 1986 reached US$65 million,excluding arrears which were equivalent to 141 percent of GDP. Export receipts increased fromUS$7 million to only US$10 million per annum. Meanwhile, scheduled external debt servicepayments amounting to US$7 million in 1986 represented over two-thirds of the country's exportsof goods and non-factor services. At the end of 1986, external reserves represented only 6 weeksof imports.

5. In 1984, the Government moved to liberalize the economy. Initial steps were taken towithdraw the public sector from commercial activities and a new Investment Code was adoptedto encourage foreign private investment. A land distribution program also was initiated.Meanwhile, the Government's priority objective was (and still is) to rehabilitate the cocoa sector.An increase in cocoa production was expected to be achieved though more efficient managementof state enterprises and better crop husbandry. A sustainable recovery of cocoa production andthe agricultural sector generally would depend on the successful implementation of an incentives-based reform. Given the severe distortions which characterized the STP economy, these reformswere not expected to succeed if a parallel effort was not undertaken to introduce fundamentalchanges in the macroeconomic policies that were identified as the root cause of the decline of thesector. Considering the size of the imbalances and the external debt contracted prior to 1986,substantial balance of payments support was required to bridge the external gaps until the cocoarehabilitation projects could start yielding increases in exports. Notwithstanding the adoption ofreforms beginning in 1984 aimed at reorienting the incentive system, internal and externalimbalances remained at critical levels.

C. Structural Adjustment Program

6. To resolve the economic and financial crisis and avoid a further deterioration of theeconomy, the Government decided to systematically pursue an outward-oriented developmentstrategy. This strategy was expected to take advantage of the country's extensive naturalresources for the expansion of agriculture, even as it took into account the country'ssocioeconomic structure resulting from five centuries of monocultivation of cash crops and the

- 3 -

very small numbers of independent farmers. The Government's strategy was based on fouressential objectives to be carried out in two phases:

(i) create the enabling environment for a strong expansion of agricultural output andexports and progressive diversification toward other foreign exchange earners,particularly tourism-related activities;

(ii) reduce the public sector deficit while shifting available resources toward theproductive sectors, particularly agriculture;

(iii) stimulate growth by reforming the incentive system including pricing and wagepolicies in favor of the rural sector and greater private sector participation; and

(iv) implement a financial strategy to mobilize the concessional external resourcesneeded to achieve stabilization and balanced growth.

2. CREDIT BACKGROUND

A. Preparation of the Credit

7. It was originally envisaged that a credit operation would be undertaken to rehabilitate thecocoa sector. But it was concluded that investment in the sector alone would not lead to thehoped-for increases in production and exports without a concurrent operation to addressmacroeconomic imbalances. Indeed in May 1986, an IMF Article IV Consultation mission withBank participation concluded that macroeconomic distortions constituted a major obstacle togrowth and cocoa production.

8. In November 1986, a Bank mission with IMF and AfDB staff participation agreed withthe Government on a 'Program of Macroeconomic Adjustment' which articulated acomprehensive set of reforms that would be implemented in phases. The first phase of theprogram was designed to remove the most critical macroeconomic distortions, namely anovervalued exchange rate and excessive fiscal deficits and monetary expansion, and restore theprofitability of the agriculture sector, cocoa in particular. During this phase, long-term technicalassistance coordinated by UNDP and financed by UNDP, AfDB, IDA and IMF was selected toassist the Government in managing the structural adjustment process.

9. A staff appraisal mission, with the IMF and AfDB staff participation, visited STP in April1987 to work with the Government on the detailed design of the lending operation that wouldsupport the first phase of the SAP. Negotiations were held in Washington in May 1987. SACI was approved by the Executive Directors in June 1987 and became effective in January 1988.The second phase of the SAP was planned to assist in consolidating progress made under the firstphase. It is supported by SAC II, which was approved by Executive Directors in June 1990.

10. In parallel to the macroeconomic adjustments, the Government sought to remove someof the physical constraints affecting not only the cocoa sub-sector, but other economic sectorswhich could block the efforts undertaken to improve cocoa production. A series of small priorityinvestments were identified in agriculture, transport and energy as well as technical assistance to

- 4 -

undertake institutional reforms. This effort was supported by IDA through the EconomicRehabilitation and Modernization Line of Credit, which was approved by Executive Directors inMay 1985.

B. Role of the IMF

11. IDA coordinated closely with the IMF in the preparation of the Credit; Fund staffparticipated in both the preparation and appraisal missions in particular to provide support to thediscussion with the authorities on monetary and fiscal policies. Based on the result of the SACappraisal mission, IDA and Fund staff prepared a draft Policy Framework Paper (PFP) as a basisfor the Structural Adjustment Facility (SAF) requested by the authorities in February 1987 andthe Government reached broad agreement with the IMF on its content. The IMF assessment atthe time was that the measures described in the SAC would produce a major improvement i thecountry's overall economic and financial situation and would represent a very important first steptoward the achievement of external viability.

12. Use of the IMF's ordinary resources was not envisaged by STP, as it seemed likely thatthe Government would be in a position to service borrowings from the Fund over the mediumterm. The Fund was, however, to provide vital assistance to the authorities in formulating theirmacroeconomic policies, and in setting specific annual performance targets for monetary andfiscal policies. These targets were agreed with the Fund in the context of the SAF. It wasexpected at the time that a first year program would be in place by the end of 1987.

3. CREDIT DESIGN AND IMPLEMENTATION

A. Credit Design

1. Credit Objectives

13. The objective of SAC I was to improve the growth prospects of the economy throughbetter incentives to encourage private investment and initiative, an adequate supply of producerand consumer goods, more efficient reallocation of foreign exchange, and concentration ofinvestment in the productive sectors. In quantitative terms, it was projected that economic growthwould be sustained at about 3 percent over the 1987-1990 period. Investment was predicted toincrease from 25 percent of GDP in 1986 to 70 percent of GDP in 1990.

14. Pursuant to these objectives, the policy package included a major exchange ratedevaluation, monetary and fiscal policies including the restructuring of the public investmentprogram and loss-making public enterprises, price liberalization and an incentive package tofacilitate private initiative. Technical assistance, financed under separate arrangements, was tobe provided to strengthen economic management in the areas of exchange rate, fiscal monetaryand investment policies as well as economic data collection. Parallel financing was provided byAfrican Development Fund FUAs 7.0 million (US$8.5 million equivalent), and IMF SAF of SDR1.9 million $2.4 million equivalent). The financing package totaled about US$ 18.0 millionequivalent.

15. The major risk identified during appraisal was that inadequate administrative capacity inthe country could delay the implementation of the adjustment program. This risk was expectedto be minimized by the progressive withdrawal of the Government from productive andcommercial activities and by the technical assistance (provided by several multilateral andbilateral institutions and coordinated by UNDP) to assist the Government in managing theprogram. To counter sociopolitical risks caused by the removal of distortions in the monthsfollowing the devaluation, the Government introduced a program to alleviate the impact of theprice increases on vulnerable groups, including a redeployment fund to facilitate the relocationof redundant public sector employees. Other risks identified were (a) the risk of a sharpdownturn in the international economic environment (particularly a drop in cocoa prices); and (b)lower supply response from both private farmers and public estates. While there was nothing thatcould be done to avoid the first risk, given the long-term nature of the agricultural diversificationprocess, the second risk was expected to be largely mitigated through the Cocoa RehabilitationProject and through the greater availability of imported producer and consumer goods financedthrough the Credits.

2. Conditions of Second Tranche Release

16. The Credits were originally to be disbursed in two tranches. The disbursement of thefirst tranche of SDR 1.5 million (US$ 2.0 million equivalent), including retroactive financing foran aggregate amount of SDR 0.7 million, (US$1.0 million equivalent) was to be available uponeffectiveness of the Credits and the second tranche of about US$5.0 million equivalent followinga performance review in mid-1988. The estimated period of disbursements was September 1987to March 1989. The specific conditions for release of the second tranche were grouped into twomain areas:

(a) macroeconomic and pricing policies emphasizing:

(i) satisfactory progress in the implementation of an exchange rate reform;

(ii) approval of a satisfactory fiscal program and credit target including apublic investment program;

(iii) approval of a satisfactory action plan for the gradual price increase of sixbasic commodities.

(b) administrative reforms emphasizing:

(i) satisfactory progress in reducing the size of the civil service;

(ii) approval of a satisfactory action plan for the reform of the cocoa exporttax system;

(iii) settlement of the debt owed by public sector enterprises to BNSTP andthe Treasury;

(iv) approval of a satisfactory action plan to restructure, privatize or closepublic enterprises;

(v) approval of a satisfactory action plan to restructure the public exporttrade company accounts to settle past debts;

(vi) approval of satisfactory action plan for setting up new tariff structure forfuels, electricity, and water to achieve full cost recovery.

B. Implementation of SAC I

17. SAC I was broadly successful. During the Credit period, the country moved from acentrally planned to a more open economy with a more market orientation. As described in moredetail below, even though many of the targets in the program were not met, the Governmentadopted and sustained a broad range of stabilization and adjustment measures including successiveexchange rate devaluations and liberalization of most domestic prices. Some modest progress wasmade in institution-building.

1. Correcting Macroeconomic Distortions

a. Exchange Rate Policy

18. A central element in the program was the establishment of a realistic market value forthe dobra. 1/ In July 1987 an exchange rate adjustment of 101 percent was designed to secureprofitability of cocoa production. Excess demand for foreign exchange continued, however.Consequently, in January 1988, the Government introduced a 30 percent across-the-board importsurcharge which was replaced by a 33 percent exchange rate devaluation in July 1988. Yetanother devaluation of 20 percent occurred in February 1989. By this time, the gap between theparallel and official exchange rates was reduced from an estimated 120 percent to about 20percent. Further, although world cocoa prices had declined, the reforms helped make thereformed cocoa estates more profitable. In addition, the Government lent its commitment tomaintain a flexible exchange rate regime whose purpose was to minimize the gap with the parallelmarket and pursue higher profitability for cocoa.

19. The Government continued to adjust the official exchange rate to changes in the parallelmarket rate, devaluing by 8 percent in October 1989, 9 percent in November 1989 and a further7 percent in May 1990. These steps reduced the gap between the official and parallel exchangerates from about 85 percent in July 1987 to about 25 percent in May 1990; at the end of 1992,the gap had been virtually eliminated. They also led to a 75 percent devaluation of the dobra inreal terms vis a vis the U.S. dollar since the inception of the program. Unfortunately, theseexchange rate adjustments were taken only after long delays which resulted in an exchange ratepolicy which helped to reduce price distortions but did not go far enough to improvecompetitiveness or reduce the trade gap significantly. Z/ The country continued to rely heavilyon external assistance. Thus, between mid-1987 and end-1990, the real effective exchange ratedepreciated by 20 percent, indicating a modest enhancement of the country's competitivenessduring the period.

1/ The dobra was pegged to the SDR until 1987 when it was linked to a basket of currencies of nine majortrading partners of the country.

21 During the 1986-1990 period, the tcrms of trade of STP continued to detcriorate (30 percent in the period)as did that of most other Sub-Saharan countries.

- 7 -

b. Fiscal Policy

20. In early 1988, fiscal performance deteriorated but mid-year corrections includingdevaluation, fiscal discipline, and higher sales taxes and fees sought to reverse this trend.Overall, for 1987 and 1988, the fiscal deficit on a commitment basis declined to about 8 percentof GDP as compared to 10 percent in 1986. To pursue continued reductions of the deficit to 3.7percent of GDP in 1989 and to keep the fiscal program on track, the Government initiatedadditional fiscal measures in February 1989. They included price increases for six strategic foodimports as well as petroleum products, electricity and telecommunications, and a 50 percent taxincrease on alcoholic beverages and tobacco. In mid-1989, the Government eliminated pricesubsidies on beans, cooking oil and rice. These steps reduced subsidy expenditures. At the endof 1989, the Government eliminated subsidies on the remaining essential foodstuffs -- sugar andwheat flour. But maximum profit margins were still applied and were maintained until early1992. The 1989 fiscal deficit (on a commitments basis) was estimated at 8 percent of GDP whichis above the 5 percent of GDP target. During 1990, the fiscal deficit continued its upward trendincreasing to 11.9 percent of GDP. However, if interest payments on external debt are excluded,the deficit (on a commitment basis) narrowed to 3.0 percent of GDP by 1990.

21. The inability to meet program targets was the result of several factors: (a) lower thanprojected cocoa earnings due to the sharp fall in cocoa prices; (b) lower than expected importsdue to poor management of external resources; (c) serious weaknesses in tax administrationcompounded by the failure to adjust fully specific import taxes as well as some administeredprices in line with exchange rate adjustment; and (d) lower-than-programmed profit transfers frompublic enterprises.

C. Monetary Policy

22. During the program period, the Government substantially reduced its need for deficit-financing through domestic credit expansion. Although it did not achieve the credit benchmarksagreed in the context of the Structural Adjustment Facility, the Government followed a fairlystringent credit policy in 1988 and 1989. While domestic credit grew by 19 percent in 1989 andby 56 percent in 1990, reflecting substantial increases in credit needs of the Government, theseborrowings were offset during 1988-1990 by a buildup of sterilized counterpart funds generatedby external balance of payments financing on concessional terms.

23. While there is no reliable price index for STP, it is estimated that prices, as measuredby the official consumer price index, increased by an average of 25 percent in 1987, 40 percentin 1988, 36 percent in 1989, and 30 percent in 1990; based on movements in market prices,rather than changes in official prices, the rates of inflation for 1988, 1989 and 1990 were muchlower. In early 1987 interest rates were adjusted sharply and became positive in real terms fora period. In a reverse of the policy in 1987, nominal rates were reduced in 1988 and deposit andlending rates became negative in real terms and remained negative through 1990.

2. Restoring the Profitability of Agriculture

24. The underlying thrust of the first phase of the Government's adjustment program was torestore agricultural output. The strategy has been to improve efficiency and productivity of thecocoa producing sector, diversify into other export crops (e.g. fish, coffee, and pepper), increase

- 8 -

food self-sufficiency, and explore prospects for agro-allied investments (e.g. cocoa processing)and tourism. This thrust was to be achieved by appropriate trade liberalization and producerpricing policy framework, improved production and management technology, increased workerincentives, and more timely imported inputs, thereby avoiding disruption in the agriculturalproduction and marketing process. The sustained fall in cocoa prices since the adjustmentprogram began, however, increased the magnitude of the adjustment required. Thus,Government has taken longer than originally planned to complete the stabilization and adjustmentprocess. The Government is currently studying the feasibility of leasing some public landsdirectly to local and foreign investors.

3. Administrative Reforms

25. To increase the efficiency of the public sector, the Government embarked on acomprehensive series of institutional reforms in 1987 addressing the civil service, publicenterprises, and the cocoa export tax system.

a. Civil Service Reform

26. As part of its civil service reform, the Government: (i) introduced a freeze on new hires;(ii) completed a census to identify numbers, positions, and qualifications of civil servants andeliminate ghost workers; (iii) enacted legislation to implement administrative reform and earlyretirement; (iv) appointed an administration expert funded by UNDP to help with implementationof the reform program; and (v) adopted an action plan for the next stages of reforms to beimplemented during phase two of the adjustment program. In February 1989, the Governmentagreed to adopt a timetable for reduction in force beginning end-1989 following review ofexisting staff members. The Government also agreed to establish a fund for civil servants whowould be retrenched. More recently, although targets for retrenchment have been discussed, aswell as incentive schemes for retaining qualified staff, civil service reform has been more difficultto implement than had been anticipated since political support is weak.

b. Public Enterprises

27. The Government initiated a phased action program to restructure, privatize, or closepublic enterprises, to settle cross debts, and to establish a new tariff structure for fuels,electricity, and water. During the first phase, the Government created a full-time unit forimplementation of public enterprise reform within the Ministry of Economy and Finance andappointed a senior civil servant to lead it. It agreed to privatize ROSEMA (beer), restructureEMAG (publishing) and ATELIER CENTRAL (mechanic), and liquidate EMAVE (poultry).Recently, progress has been achieved in the latter three public enterprises during the course ofthe second structural adjustment credit, but the ROSEMA progress is lagging considerablybehind. Meanwhile, the brick factory (EMCERA II) and the telecommunications company(ENATEL) were transformed into joint venture companies with majority foreign privateparticipation. Currently, financial data are being gathered for other public enterprises and auditsof selected public enterprises are being conducted.

28. Other noteworthy achievements concern the electricity and water supply company,EMAE, which made an operating profit in 1988 which was transferred to the Treasury. Further,EMAE increased its electricity tariffs by 200 percent in February 1989. This increase more thancovered its increased costs to result in larger real transfers to the Treasury.

- 9 -

c. Cocoa E:xport Taxes

29. The Government sought to implement an action program to reform the cocoa export taxsystem and to reduce the level and number of cocoa export taxes. In this context it consolidateda number of taxes and reduced the level from 20 to 17 percent in 1989. To promote cocoaproduction further, the Government planned to reduce export taxes to an ad valorem rate of notmore than 10 percent of the f.o.b. value. The cocoa export tax has been 10 percent since thebeginning of 1992. The tax remains because of the limited economic tax base. Most taxrevenues have come from the taxation of international trade and petroleum products. As taxreform progresses and more revenues are obtained from income taxes, the cocoa export tax couldbe gradually reduced.

4. ECONOMIC AND SOCIAL IMPACT

30. In the absence of the Government's adjustment effort and the associated foreign financing,GDP and living standards would have continued to decline and the shift in incomes in favor ofthe rural sector would have been delayed. While the overall impact of the program on GDP andliving standards was positive in 1987-89, during 1990, the Government encountered seriousdifficulties in implementing the adjustment program. Many of the macroeconomic targets andobjectives were not met and most other key structural reforms fell behind schedule.

A. Economic Impact

31. Compared with a decline in GDP by 4 percent in 1987, GDP is estimated to have grownby 2 and 2.5 percent during 1988 and 1989, respectively, but declined by 2.2 percent in 1990.This initial growth was due mainly to the impact on agricultural production and improvedmanagement and incentives during the early years of the program. Cocoa production expandedfrom about 3,900 tons in 1987 to about 4,300 tons in 1988 and to 5,000 tons in 1989. A supplyresponse was also observed in coffee, copra, oil palm, vegetables, fish, chicken, pork, and goatproduction. Construction, mainly housing, and services, and tourism grew during the period.

32. On the demand side, consumption grew by an estimated 6 percent in 1989 followingdeclines of 4 percent in 1987 and 1988. Consumption declined again in 1990 by 4 percent.Total investment grew by an average of 15 percent during 1988 and by more than 70 percent in1989. This compared to 6 percent in 1987. The increase in investment reflected mainlysubstantial investments in agriculture, infrastructure, and health and education sectors.

33. The current account deficit totaled US$26 million in 1989 which is about 44 percent ofGDP. This compared to US$ 15 million in 1987 and 1988. In 1989 and 1990, exports of goodsand services amounted to US$ 11 million compared to about US$ 15 million in 1988 and US$10million in 1987. Reflecting investments in housing, imports of goods and services increasedsubstantially to US$ 38 million in 1990 from US$ 27 million in 1989, US$ 20 million in 1988and US$ 17 million in 1987. The scheduled debt service to exports ratio was more than 100percent in 1987, 60 percent in 1988, and 80 percent in 1989 which reflects reschedulingagreements and changes in export earnings.

- 10-

34. Official transfers amounted to about US$16.1 million in 1990 and US$10 million in 1989,which includes US$ 6 million of food aid. These levels compare to US$7 million in 1988 andUS$ 9 million in 1987. The current account deficit was financed by rescheduling of debtservices, net foreign concessional inflows, short-term commercial inflows, and an accumulationof debt service arrears.

35. Despite many shortcomings, the overall program can be deemed to have some successesbecause it resulted in a more flexible, market-based approach to economic management thatincluded significant liberalization of the price, trade, and exchange systems, as well as areorientation of the public investment program toward rehabilitation of the cocoa sector and ofthe physical and social infrastructure. Most noteworthy is the greater role allocated to the privatesector in domestic and external trade and in the management of cocoa estates leading to theireventual privatization.

36. But in 1990, economic performance fell short in relation to what had been expectedlargely because of implementation problems and a sharp deterioration in the terms of trade. RealGDP declined and the primary fiscal deficit on a commitment basis widened significantly. Thiswas in large measure due to a revenue shortfall of about 40 percent as compared with the fiscalprogram target. Meanwhile, credit targets were exceeded and the external current account deficit(excluding official transfers) was higher than projected. Likewise, the overall balance ofpayments deficit was larger than anticipated and was financed mostly by accumulation of externalpayments arrears. In large part, the slippages were due to increased political activity in the run-up to the first multi-party elections which took place in early 1991.

37. It was in this context that SAC II was prepared - and presented to the Board in June1990 - in support of the second phase of the structural adjustment program (1990-1992). Thethrust of this phase was to: (a) consolidate progress in exchange rate, fiscal and monetary policy;(b) stimulate economic growth through appropriate trade and pricing policies, private investmentand diversification, cocoa sector development and land redistribution; (c) rationalize the publicinvestment program; (d) improve the administrative capacity of the public sector through publicenterprise and civil service reforms; (e) improve the functioning of the financial system; and (f)manage the external debt burden with the view to freeing up resources for economic growth.

38. The newly-elected Government reaffirmed its commitment to structural adjustment asreflected in key measures implemented in the second half of 1991: a substantial depreciation ofthe dobra, an intensive price liberalization program, more restrictive fiscal and monetary policies,and the resumption of structural reforms that had been subject to delay. These reforms led to areduction of the primary fiscal deficit to 4.5 percent of GDP in 1991, a slowing down of the rateof inflation, the achievement of positive real interest rates, and a narrowing of the gap betweenthe official and parallel exchange rates.

B. Social Impact

39. At the outset it was recognized that the reform program would shift the terms of tradein favor of the rural sector which would result in substantial increases in rural household income.Further, new wage and price liberalization policies were expected to benefit workers and smalllandholders. Meanwhile, adjustment policies would require a reduction in Government spendingand employment, especially in public enterprises. The shifts in resource allocation and incentivestoward the private sector would involve a transition period.

- 11 -

40. In recognition of the importance of ameliorating a negative social impact, the Governmentsought at the outset to pursue several avenues of reform:

(a) maintaining and increasing the distribution of food aid;

(b) improving the efficiency of public expenditures in the social sectors such ashealth and education;

(c) monitor the social dimension of the structural adjustment program through aUNDP-financed study managed by the World Bank;

(d) establish a redeployment fund to provide for a stable transition for publicemployees who are retrenched; and

(e) allow for land distribution to provide new opportunities for land holding amongthe poor.

41. But the Government still needs to address emerging social problems in the urban sectorcaused by unemployment and the removal of subsidies on basic foodstuffs, as urban public sectorwages have not kept pace with rising food prices. Preliminary findings indicate that adjustmenthas adversely affected civil servants and urban residents largely because of increases in fuel andutility prices. The impact on the rural population has been positive because the changes in theterms of trade have favored agriculture.

5. CREDIT IMPLEMENTATION AND SUPERVISION

A. Role of IDA

42. IDA played an important role in STP's adjustment program through project preparationand supervision. Indeed, given the size of the country and the absence of sufficient numbers ofqualified and experienced staff, IDA was well positioned to help the country steer its adjustmentprogram to allow it to respond more quickly and effectively to changes. During projectpreparation, a Bank mission assisted the authorities in preparing a draft Letter of DevelopmentPolicy and proposing a Timetable which defined the nature of the economic and financial crisis,set forth the medium and long-term objectives of Government economic policy, and proposed anaction plan to restore macroeconomic equilibria. IDA monitoring of the program was carried outthrough numerous missions specifically to review progress under the SAC. The IMF and AfDBassisted the Government in implementing the devaluations and related fiscal and monetarymeasures through short-term technical missions.

B. Credit Monitoring and Administration

43. The Ministry of Economy and Finance which was placed under the direct authority ofthe President was responsible for implementing the program. Given the limited number ofqualified staff and the weak administrative capacity of the Government in general and specificlack of experience in economic management, it was found necessary to address this deficiencywith experienced technical experts to assist in the monitoring of the program. Technical expertswere hired to advise the Ministry of Economy and Finance on coordination of fiscal and

- 12 -

monetary policy, public investment programming, and statistics. Meanwhile, the UNDP technicalassistance that was to have been provided during the course of the project, however, frequentlywas not sufficiently timely nor effective in meeting project objectives.

1. Credit Disbursements and Procurement

44. Financing was limited to imports procured from eligible countries. Financing under theAfrican Facility was limited to imports procured from contributors to the Facility and Part IIcountries of IDA. Financing for foodstuffs was limited to SDR1.8 million of disbursementsunder IDA and the African Facility. The import and distribution of goods was to be handled bynormal commercial channels selected by the importer. Direct imports by the public sector werein accordance with IDA procurement guidelines. Imports over US$200,000 equivalent were tobe based on ICB, with the respective contracts reviewed by IDA, and imports of less than thisamount were to be carried out through limited international bidding with no fewer than threequotations. Direct purchase was allowed for import contracts of less than US$50,000 equivalentup to an aggregate of US$1.0 million equivalent. No expenditure under contracts of less thanUS$10,000 were eligible for financing. Retroactive financing up to SDR 700,000 equivalent forIDA and the African Facility Credits was made available for expenditures prior to January 1,1987. At effectiveness two Special Accounts were set up, with US$1.0 million and US$500,000from IDA and the African Facility Credits, respectively.

45. Disbursements under the IDA and African Facility Credits were effected through twospecial accounts that were established on terms and conditions satisfactory to IDA. Thedisbursement of the funds was administered by BNSTP. It kept separate accounting records fordisbursement of foreign exchange and repayments of counterpart funds. The funds under thecredits were used for eligible expenditures mainly for importing consumption goods, agriculturalmachinery, light industrial machinery, and raw materials. The staff in charge of the creditsreportedly did a good job keeping track of disbursement, but a January 1989 supervision missionrecommended as a matter of urgency that a disbursement seminar be held in Sao Tome andPrincipe. It was thought to be useful that World Bank disbursement personnel spend timeworking with the national staff who fill out the disbursement applications.

2. Reporting and Auditing

46. A February 1989 supervision mission requested the departments responsible for managingSAC I to initiate a quarterly reporting system of progress under the credit, including a status ofcounterpart funds deposited for imports under balance of payments support. Regarding auditing,the separate accounts for the SAC I were to be audited annually by independent auditorsacceptable to IDA. Unfortunately, auditing was delayed and the first audit took place at the endof 1989, almost 18 months after the first tranche release. A final audit was completed in July1992.

3. Tranche Release and Closing

47. The second tranche review recommended to the Board in December 1988 that the releaseof some of the funds under IDA and African Facility Credit was merited by the progress madeon the macroeconomic front. But because less than satisfactory progress had been made on theadministrative reform measures (specifically on the reform of the civil service and of the cocoaexport tax system) and because additional time was needed to complete the public enterprise study

- 13 -

to implement the related administrative reforms, the tranche review recommended that theoriginal tranching be modified to include a third tranche. The new second tranche was for SDR2 million and the third tranche for SDR 1.9 million. On this basis, the second tranche conditionswere considered met and the third tranche would be met once the administrative reform measureswere implemented and assuming continued satisfactory progress on the structural adjustmentprogram. The second tranche was released in January 1989. The third tranche reviewrecommended to the Board on July 1989 the release of the third tranche on the basis ofsubstantial progress made in meeting the tranche release conditions for the Credit'sstructural/administrative reform measures.

48. The original closing date for the credits was March 31, 1989. In February 1990 theclosing date was extended for the second time by one year to March 31, 1991 because of initialdelays in signing and declaring the credits effective. The second tranche was released inDecember 1988; the third tranche in June 1989. The delays in start up and subsequently insplitting the second tranche into two, as well as the weak administration for foreign exchange bythe BNSTP, meant that disbursements lagged. The closing date was extended by a further yearto March 31, 1992 to allow remaining funds to be disbursed.

C. IDA Performance

49. IDA gave high priority to SAC I. During the course of supervision missions, emphasiswas placed on macroeconomic issues, especially the exchange rate framework and fiscaldiscipline, as well as institutional issues. To familiarize civil service staff in Sao Tome andPrincipe with the SAP, a joint Government/Bank/Fund seminar was conducted in November1988. An audience of an estimated 150 staff participated in a question and answer session lastingfour hours. The purpose of the seminar was to familiarize the civil servants with the objectivesand implications of the SAP. In early 1989, a Joint Bank/Fund mission joined with thegovernment in successfully concluding negotiations on the Policy Framework Paper (PFP).

D. Borrower Performance

50. The Government placed high priority on SAC I, and Government ownership wassignificant. The Government gave greater priority, however, to the national elections over theSAP during the period of political transition. Especially noteworthy is the continued commitmentto the SAP following the political transition in 1991. The shortfalls in loan performance can beattributed to gaps in commitment for selected reform program elements such as civil servicestreamlining. In other instances, shortfalls can be attributed to insufficient capacity rather thana reluctance to move forward. External factors, namely the decline in cocoa prices, contributedto shortfalls in Government revenue and an inability to meet deficit reduction targets. Inrecognition of the Government's commitment to reform, continued support of the internationalcommunity was evidenced. The Round Table Conference conducted in February 1989 was aforum in which international donors pledged their commitment to financial assistance to helpclose the balance of payments gap.

- 14 -

6. ASSESSMENT AND LESSONS LEARNED

51. Under SAC I, STP made significant progress in some important areas of the reformprogram. During this period, the Government focussed mainly on stabilization measures tocorrect macroeconomic distortions, and there was movement from a centrally planned to an openeconomy with a market orientation. Notwithstanding key changes in the Government's economicteam in early 1988 and again in January 1989 that delayed implementation of the macroeconomicprogram, a series of measures introduced in mid-1988 and reinforced in 1989 kept the overallprogram on track. This occurred despite a sharp decline in the international cocoa price and adeterioration in the country's terms of trade.

52. The Government successfully reduced the overvaluation of the domestic currency througha more flexible exchange rate policy. It also achieved some progress in controlling the fiscaldeficit which contributed to slowing down credit expansion and improving price stability in theeconomy. Trade liberalization has improved the incentives for production and export. Import andexport administrative procedures have been simplified. The dismantling of price controls and theelimination of all subsidies on imported foodstuffs and petroleum products is notable. Privateand public enterprises are allowed to export and import all products directly, with the exceptionof petroleum products which are imported under a bilateral agreement with Angola.

53. In 1990, however, the program was not consistently pursued in part because of upcomingelections. By end-1990 at the completion of the program, most of the macroeconomic targets andobjectives remained largely unmet. Also, structural reforms began to fall behind schedule. In1991, the economic and financial situation showed further signs of deterioration, as theadjustment policies that were to have been implemented in the latter part of 1990 and 1991 werepostponed because of national elections held in early 1991. Subsequently, with the peacefultransition to a multi-party democracy in early 1991, more concerted implementation of theprogram has resumed and the macroeconomic situation has stabilized.

A. Administrative Capacity

54. The objectives of the program were very ambitious in relation to the Government'sadministrative capacity. Outstanding measures associated with institutional reforms, namely inthe civil service, public enterprises and the tax system suffered from a lack of adequate andtimely technical assistance and studies. In retrospect, the relatively weak administrative capacitysuggests that the timetable for the institutional reforms was too short and the program was tooambitious.

55. Lessons Learned. The program's primary risk which was articulated at the outset,pertaining to the limited administrative capacity in the public sector to make decisions andimplement the proposed reforms therefore, proved important. Further, the limited experienceof the Government which has been dealing with a very complex and ambitious agenda in adifficult economic environment, coupled with limited political support, has rendered the tasks tobe quite challenging. Structural reforms require not only the analytical capacity to propose majorchanges, but also the capacity to implement them. Implementation plans need to develop inrelation to the capacity of the agencies undertaking reform.

- 15 -

B. Consistency in Implementation

56. The experience of Sao Tome and Principe illustrates the importance of consistency inimplementation. The adjustment process initially proceeded well, but implementation wassidetracked. Much less time was devoted to the program than was necessary and hence,administrative capacity was exacerbated by the need to attend to the political transition. Thesituation was further exacerbated by foreign exchange constraints, precipitated by sharply fallingworld market prices for cocoa, growing debt service obligations, and additional spending onhousing that was not included in the approved public investment program.

57. Lessons Learned. The appropriate timing of implementation of a complex set of reformsis an essential ingredient of success. If adjustment proceeds from the outset but is deterredbecause of external and internal circumstances, important gains may be diminished. It should notbe unexpected that implementation would be delayed by transitions in the political order. To theextent that such transitions are known during the course of program design, it is important tobuild these considerations into implementation establishing timetables and conditions ofeffectiveness. In such cases, priorities on several strategic interventions would recognize theimpact of such events as well as the scarcity of implementation capacity.

C. Risks

58. One of the main vulnerabilities of the project was its linkage with cocoa prices. Certainlythe structure of agriculture production in which cocoa was and continues to be the main area ofcomparative advantage suggests that the cocoa sector be bolstered as part of an adjustmentprogram. The extensive reliance on cocoa export revenues as a means of financing the publicsector indicates the precariousness of the economy generally, as well as the tenuousness of effortsthat build on an uncertain and vulnerable foundation

59. Lessons Learned. Adjustment programs need to build on a country's strengths and giventhat cocoa is a product for which Sao Tome and Principe is well-known suggests that it wasappropriate to focus on this subsector in an adjustment program. Simultaneously, however, itis also well-known that reliance on a single commodity for the sustenance of the economy canjeopardize adjustment efforts. Hence, to the extent that agricultural diversification strategies canbe built in to reform programs, it would ameliorate -- admittedly over time - the precariousnessof the economy.

D. Flexibility in Tranching

60. The experience of Sao Tome and Principe illustrates the need for flexibility in modifyinginitial tranching conditions and thereby accommodating local circumstances. Two factors wereimportant in the Government's performance in the adjustment program. First, the internationalprice of cocoa, the main source of export revenues, dropped by 25 percent from mid-1987 tomid-1988. This decline led to a critical shortage for foreign exchange which would preclude theability to finance a minimum level of imports. Without the minimal level of imports, theGovernment's ability to maintain its commitment to the reform program would have beenseverely constrained.

61. Given the progress that was demonstrated in terms of the macroeconomic measures thathad been implemented, the credit's original tranching specifications were modified. But also,

- 16 -

there was some concern about delays in the implementation of the institutional reforms as wellas the strength of macroeconomic performance that suggested the need to split the second tranche.The third tranche release was conditioned on the implementation of the outstandingadministrative measures and continued satisfactory progress on the macroeconomic side.

62. Lessons Learned. The Bank's strategy for supervising loan progress needs to beadaptive and flexible in the context of changes in internal and external circumstances. In thiscase, the third tranche was created to acknowledge the progress made and to permit additionalprogress in those areas that lagged behind at the time of the release of the second tranche.

- 17 -

PART II: PROGRAM REVIEW FROM THE BORROWER'S PERSPECTIVE I/

Report on the First Structural Adjustment and Special African Facility Credit, CR-1825 andA-29-STP.

The First Structural Adjustment Credit, for US$7 million equivalent, was signed in June1987, its object being to support the economic recovery program.

The third tranche of the credit was disbursed not in March 1989 as originally planned butslightly behind schedule in June 1989, as a result of the significant progress achieved.

Given that the country's weak administrative capacity had been identified as a seriouspotential obstacle to timely implementation of the SAC, it must be acknowledged that appropriatemeasures were not taken to reduce this risk; the effects of the situation are still being felt today.Large sums were spent on financing foreign technical assistance and especially on the preparationof studies, which the Government did not utilize as well as it might have done. We believe thatin the future the World Bank should play a larger role in these institutional issues; in otherwords, it should help the Government to identify areas in which training could improve theimplementation of the SAC, and propose a schedule as part of the measures in the economicpolicy matrix. It should be emphasized that the Government's institutional capacity is still theAchilles heel of the country.

As regards structural reform and the expansion of export products, it would seem, aftera review of the Agricultural Enterprises Rehabilitation Project, that the said project was notadequately appraised with regard to the difficulties of predicting the international price of aproduct like cocoa and applying this to Sao Tome. One of the main errors of the program wasits focus on cocoa production, which led to an emphasis on retaining an outdated structure ofagricultural production, based on plantations. In our view, the project ought to have had othercomponents, such as food production for sale in the region and other, higher-yield exportproducts.

As already noted, the project should also have made provision for the gradualtransformation of the structure of agricultural production, based on family production parcels;the new land distribution project is going some way to remedying this defect.

As regards the process of reforming the public enterprises, we believe that only one sidereally got involved in this. A process was devised without any proper institutional basis oroperational framework, and this was partly responsible for the constant postponement of theimplementation of plans to privatize, liquidate or rehabilitate public enterprises.

However, past experience is being used to reshape this process, which now has alegitimate institutional basis and a largely defined operating framework. It is expected thatspecific actions will be undertaken in this area in the future.

In brief, the greatest achievement of the First Structural Adjustment Program was of apsychological nature, in that it convinced the authorities that there were no alternatives toadjustment if the country wished to achieve sustained growth. Another gain was the experienceacquired, which made it possible to prepare a more realistic Second Program.

3/ Received from Elsa Cardoso, the Coordinator, Studies and Advisory Office, Sao Tome, February 10, 1993.

- 18 -

PART III: STATISTICAL INFORMATION

TABLE 1. BASIC CREDIT DATA

1. Project Timetable

Initiating Project Brief February 1987Initiating Memorandum February 1987Letter of Development Policy May 1987Negotiations May 1987Board Approval June 1987Credit Agreement September 1987Effectiveness January 1988Original Credit Closing March 1989Actual Credit Closing March 1992Last Disbursement June 1992

2. Credit Disbursements (Cumulative)(US$ Million)

FY87 FY88 FY89 FY90 FY91

(i) Planned 2.03 4.56 6.84 7.01(ii) Actual 0 2.03 5.48 6.94 7.01(iii) (ii) as % of (i) 0 44.5 80.1 99.0

- 19 -

3. Use of Bank Resources

A. Staff Inputs(including African Facility)

FY86 FY87 FY88 FY89 FY90 FY91 FY92 FY93

LENA 22.8LENN 11.3LENP 18.6SPN 1.6 43.6 39.4 11.7 7.4 0.9PCR 3.5 8.0

TOTAL STAFF INPUTS: 168.8

B. Mission Data(Including African Facilities)

No. of No. of StaffYear weeks persons weeks

Appraisal 1987 2.85 8 22.8Supervision I 1988 3.11 4 42.6Supervision II 1989 3.94 2 39.4Supervision III 1990 3.90 3 11.7Supervision IV 1991 1.85 4 7.4Supervision V 1992 0.90 2 0.9Completion 1992 3.50 2 3.5

TABLE 2 - MATRIX OF POLICY ACTIONS

Orie0 tagetArea SAC I: Objectives date Objectives met ad date

1- Exchange rate a) Devalue the dobra from 45.25 to 100 (54%) to the SDR. May 31 1987 Successive devaluation of the STP dobra, coupled with improved prcepolicy b) Satisfactory progreaa in the impiementation of an exchange rate reforn. Mid-1988 stability led to a real depreciation of about 75 % between mid 1987 and

c) Establish a Domestic Price Index, end 1988.

2- Trade Poticy a) Allow the private ector to compete with ECOMEX for all impors and exporta May 31, 1988 Government elimninated ECOMEX's import monopoly power except for(except in 6 main commnodities). six basic commodities. Import licensing system determnines foreign

b) Prepare an 1987 foreign exchange budget in coordination with IDA and IMF. May 31, 1987 exchange accesa and bilateral barter arrangements continue.c) Limit ECOMIN scope of activity to the ale of food aid an food security stock

management. May 31, 1987d) Produce an audit of the financial situation of ECOMEX. March 1988e) Present an action plan to restructure ECOMEX's arcounts. Mid-19880 Convert all quantitative taxes into ad-valorem rates. March 19S8g) Remove all quantitative impoon restrictions. Mid-1988

3- Fcl policy a) Reduce current account fil deficit to Db 85 million. 1987 Deficit improved from 10% of GDP in 1986 to 6% in 198S, butb) Increase all import duties in proportion to the devaluation. May 31, 1987 deteriorated in 1989 to more than 8 %. Gov needs to improve revenuesc) Increase all sales taxes by 15%. May 31, 1987 and maintain tight lid on current pending. In 1989 there were priced) Increae airport fees in foreign exchange termrs. May 31, 1987 increases for export conunodities, 6 import products, petroleume) Increae the excise tax on petroleum products in proportion to the devaluation. May 31, 1987 products, electricity and telecommunications. Taxes on alcoholicf) Limit overall public ector wage and alary inremase by 10% on average over the beverages and tobacco were raised 50 %.

1986 level. 1987 A fiscal program for 1989, including a public sector investment programg) Reduce foreign travel expenditure by half in foreign exchange terms, was approved. h) Limit unclassified expenditures from the Fundos Centrais to Db 81 million on an The Gov. has completed a civil ervice census and has launched a

annual basis. UNDP-sponsored program to strengthen the Administrative Reformi) Eliminate transfers and credit to lms-making public enterprises. Program.) Reduce the size of civil service according to a plan agreed.k) Establish targets for the current accounts deficits in 1988 in consultation with the May 31, 1987

IMF and IDA.I) Inplement an action plan to reduce the size of the civil ervice. Mid-1988

4- Public a) Agreement on a list of priority public enterprises to prepare a study for their By '89 the Gov. has taken the following actions: i) initiated phase actionEnterptises restructuring. program to reform PE's and adopted recommendations on a) privatized

b) Adoption of a plan to close or privatize the enterprises according to the rerults of Mid-1988 the beer and brick companies; b) restructured the publishing company;the study. c) liquidated the poultry company and the two trade enterprises;

ii)created public Enterprise Reformn Unit to implement studies'recommendations; iii) adopted action plan for next phase of reformprogram.

TABLE 2 - MATRIX OF POLICY ACTIONS

Oiga taretArem SAC I: Objectives date Objectives met and date5- Monetary policy a) Limit domestic credit to Db 401 million. 1987 Dramatic reduction in rate of growth of credit from 28% in 1987 to

b) Use of domestic counterpart funds of non-grant non-project aid to reduce BNSTP Mid-1988 12% in 1988 and about 10% in 1989. Measured inflation moved fromclaims on the Central Gov. over the adjustment period. 25% in 1987 to 40% in 1988 and approximately 36% in 1989.

c) Review the interest rate structure to achieve positive real interest rates. The Gov. has agreed to initiate a study to eparate the functions ofd) Undertake a study to separte the functions of the Central Bank from its commercial 1988 commercial and central banking within BNSTP. The Govy. also adjusted

bank functions. the interest rate structure in 1987 which became positive for a period.e) Adopt a credit target. Interest rates were reduced in 1988 and rates became negative through

end-1989.6- Investment a) Agree with IDA and ADF on the size and composition of the 1987 PIP. May 31, 1987 Size and composition have been scaled down, but projects continue to be

policy b) Request IDA and ADF for approval to implement projects not included in the PIP approved outside established PIP process. There is an urgent need towhose total coss exceed USS500,000. improve both evaluation and monitoring of the PIP.

c) Carry out only projects which meet an acceptable rate of return (10%).d) Agree with IDA and ADF on the size and composition of the 1988 PIP.

7- Pricing policy a) Eliminate price controls for all domestically produced and imported goods, except The Government eliminated price subsidies for all essential commoditiesfor rice, beans, milk, ugar, wheat, flour and cooking oil. and has implemented an action plan to achieve full operating cost

b) Establish a methodology for the adjustment of prices of controlled goods. recovery for fuels.c) take initial action for the gradual increase of the prices of controlled goods. March 1988d) Adjust the rtail prices of petroleum products and electricity. Mid-198S

8- Cocoa sector a) Allow exporting enterprises to maintain 30% of their export proceeds in special May 31, 1987 The Govemrnent has approved an action plan to reform the cocoa exportCentral Bank accounts abroad for the purchase of the necessary productive inputs. tax system. It will also implement some measures to improve the cocoa

b) Settle existing wage arrears owed to workers. marketing and distribution system.c) Base wages on a combination of fixed wages and productivity bonuses. May 31, 1987d) Introduce payment by piecework wherever possible. May 31, 1987e) Increase the fixed portion of wages by 30% over the 1986 level for the field

workers and team leaders. May 31, 1987f) Present a plan for the phase ettlemnent of the internal debt of the cocoa state End of 1987

enterprises.g) Plan to reform the cocoa export tax system. End of 1987

9- Energy Policy a) Agree with IDA on the contracting of the technical assistance needed for the long May 31, 1987term rehabilitation of the power sector.

b) Contract the needed technical assistance for EMAE. End of 1987c) Agreement on a new tariff for fuels, electricity and water. Mid-1988

10- Foodcrop a) Initiate a foodcrop diversification study included the cocoa rehabilitation project. End of 1987 Government has distributed about 8,000 ha between 1985-88, over halfproducers b) Extend the measures related to foodcrop production to the renaining agricultural of which became smallholder plots.

enterprises. Mid-1988c) Present a plan with external technical assistance for the land distribution. March 1988

- 22 -

TABLE 3. KEY ECONOMIC INDICATORS

Indicator 1985 1986 1987 1988 1989 1990 1991 1992

GDP g.r. 8.6 0.9 -2.3 1.9 1.6 2.5 1.5 3

GDY/CAP g.r. -0.1 -1 4.9 0.2 -4.1 -2.5 0.5 0.6

Total Consump./GDP 111.0 116.8 110.4 107.0 111.9 121.0 125.0 127.0

CPI g.r. N.A. N.A 25 40 35 30 38 40

Debt Service L/ 5.1 4.5 5.4 4.9 5.0 6.7 14.0 16.8

DS/XGS La 17.2 61.8 93.9 54.6 92.6 241 133 125

DS/GDP 8.2 6.5 9.7 10.1 10.9 14.2 24 21.2

Gross Invest./GDP 13.2 13.6 15.3 19.8 26.4 27.4 28 30

Gov. Revenue/GDP 25.8 24.5 26.1 25.6 21.8 20.1 19.9 22.1

Gov. Expendit./GDP 36.9 58 53.2 54.9 78.5 81.6 77.5 92.9

Export g.r. -30.2 24.5 -23.4 10.8 -45.7 -25.7 24.6 -0.9

Imports g.r. -13.8 -17.8 -19.2 15.6 27.1 -20.5 15.2 5.8

Current Acct. US$ (millions) L -18.5 -10.2 -12.7 -16.6 -18.6 -21.3 -18.6 -16.7

Current Acct./GDP Ld -29.8 -33.7 -27.9 -28.8 -48.3 44.6 -57.7 -70.2

a After rescheduling and refinancing.& Including official transfers./c Before rescheduling in US$ million.