São Tomé and Príncipe's Fiscal Challenge 2025

São Tomé and Príncipe's Fiscal Challenge: Understanding the Core Investment Risk in 2025

When evaluating investment opportunities in São Tomé and Príncipe (STP), understanding the country's fiscal situation requires looking beyond headline debt figures to identify a fundamental structural problem that threatens long-term sustainability.

The Core Problem: A Collapsing Business Model

São Tomé and Príncipe faces a critical structural challenge that can be summarized simply: the country's economic model is running out of money.

For decades, STP has operated on a development model where approximately 90% of public investment comes from external sources—primarily grants and concessional loans from international donors. External aid has historically accounted for 40% of total fiscal revenue. This isn't just reliance on foreign assistance; it's an economy fundamentally built on it.

The problem? This funding is disappearing rapidly.

Grant inflows collapsed from 30.7% of GDP (2000-2009) to just 11% (2015-2019). Net Official Development Assistance (ODA) declined from 24% of GDP (2004-2008) to 14% (2019-2023). These aren't minor adjustments—they represent a fundamental withdrawal of the financial foundation supporting the country's public sector.

Think of it this way: imagine a business where 90% of operational funding comes from a benefactor who is steadily reducing their contributions by half every few years. Unless that business rapidly develops alternative revenue sources, it faces inevitable crisis—regardless of how well-managed it might otherwise be.

Why This Matters More Than Debt Levels

Investors often focus on debt-to-GDP ratios, and STP's figures tell a confusing story. Depending on the source and methodology, public debt is reported anywhere from 43.6% to 91.6% of GDP for 2024, with projections ranging from 28.1% to 79.4% for 2025-2027.

This wide variance reflects different treatments of state-owned enterprise (SOE) debt, particularly obligations of EMAE, the electricity company, whose arrears alone represent approximately 22-23% of GDP.

But here's the critical insight: the specific debt percentage matters less than the trajectory and what's driving it.

Even the optimistic projections showing debt declining to 43.6% of GDP come with a massive caveat—they assume continued access to concessional (low-interest) financing and successful SOE reforms. The problem is that the country's traditional source of such financing is drying up, creating a dangerous dependency spiral.

The Debt Distress Classification: What It Really Means

STP is officially classified as being in "debt distress" despite having what might seem like manageable debt levels. This classification isn't primarily about the total debt burden—it's about specific unresolved external arrears to bilateral creditors (Angola, Brazil, and Equatorial Guinea), representing about $10.7 million or 1.3% of GDP.

While these figures are relatively small in absolute terms, the "debt distress" label carries severe practical consequences:

• Restricted market access: The country cannot access commercial financing at reasonable rates
• Limited borrowing options: New borrowing must be concessional (low-interest), but such financing is increasingly scarce
• Credibility damage: The unresolved arrears signal institutional weakness in managing financial obligations

For investors, this classification matters because it indicates the country lacks the financial flexibility to respond to shocks or fund development initiatives without external support—support that is steadily diminishing.

The IMF Lifeline: Anchor or Dependency?

São Tomé and Príncipe secured a new 40-month Extended Credit Facility (ECF) with the IMF in December 2024, providing approximately $24 million. This program serves as the country's primary macroeconomic anchor, focusing on:

• Fiscal consolidation (reducing deficits from 4.2% of GDP in 2023 to 2.9% in 2025)
• SOE reform, particularly restructuring EMAE
• Building foreign exchange reserves (which nearly depleted to $0.51 million in December 2023 before recovering to $71 million by mid-2025)
• Improving revenue collection through VAT system consolidation

The IMF program represents genuine progress and demonstrates commitment to reform. However, it also highlights the core problem: STP lacks the domestic economic capacity to sustain itself without continuous external financial support.

The external debt service for 2025 is projected at just $10.5 million—an entirely manageable figure precisely because virtually all existing debt is concessional (with an effective interest rate of only 1.0%). But this low debt service cost depends entirely on continued access to such favorable financing.

The State-Owned Enterprise Crisis

Compounding the fiscal challenge is the insolvency of key state-owned enterprises, particularly EMAE. The electricity company's arrears to its fuel supplier (ENCO) alone represent approximately 23% of GDP—more than half the country's official public debt in some calculations.

This isn't just an accounting problem. EMAE's losses create a continuous fiscal drain, requiring either government subsidies (increasing deficits) or accumulating arrears (creating contingent liabilities). Until these SOEs are genuinely reformed or restructured, they represent a persistent threat to fiscal stability.

The government has committed to developing an EMAE restructuring plan by December 2025, but restructuring insolvent utilities in small island economies is notoriously difficult, often requiring politically painful tariff increases or service reductions.

The Path Forward

São Tomé and Príncipe is attempting a difficult but necessary transition from aid-dependent development to self-sustaining fiscal management. Success requires:

1. Revenue mobilization: Dramatically improving tax collection efficiency and expanding the tax base
2. Expenditure discipline: Reducing unproductive spending while protecting essential services
3. SOE reform: Eliminating the fiscal drain from loss-making state enterprises
4. Economic diversification: Developing revenue-generating sectors (tourism, specialized agriculture) that can expand the domestic tax base

The IMF program provides a framework for these reforms, but implementation capacity in a small island state with limited human capital and institutional depth remains uncertain.

What This Means for Investors

The declining ODA model creates several specific investment implications:

Liquidity Risk: The structural shortage of foreign exchange—regardless of legal guarantees—poses persistent challenges for capital mobility and profit repatriation. When reserves nearly depleted to $0.51 million in late 2023, this wasn't theoretical risk; it was reality.

Sustainability Questions: Any investment thesis assuming government support, infrastructure development, or policy stability must account for a public sector operating under severe and worsening fiscal constraints.

Timing Sensitivity: The 2025-2027 period represents a critical transition. If domestic revenue mobilization succeeds and SOE reforms take hold, the country could establish a more sustainable fiscal path. If these efforts falter while ODA continues declining, a more severe fiscal crisis becomes likely.

Sectoral Implications: Investments requiring government partnership, regulatory support, or public infrastructure face elevated risk. Projects with independent revenue streams and minimal reliance on government capacity are relatively more attractive.

Investment Conclusion

For investors, São Tomé and Príncipe's core challenge isn't excessive debt—it's an economic model in fundamental transition. The country is attempting to wean itself from grant dependency while simultaneously managing legacy arrears, reforming insolvent SOEs, and building domestic revenue capacity.

This creates a binary outcome scenario: successful transition could establish a more stable, sustainable fiscal foundation by 2027-2028, making current entry points attractive. Failure to execute reforms while external support continues declining could trigger a more severe fiscal crisis.

The 2025 outlook shows commitment to reform and some positive indicators (improving reserves, declining deficits). However, the underlying structural problem—collapsing ODA without adequate replacement revenue—means investors should approach opportunities with clear understanding that they're essentially betting on successful execution of a difficult economic transformation, not investing in an already-stable environment.

For risk-tolerant investors with long time horizons and projects that don't depend on government capacity or infrastructure, opportunities exist. For those requiring fiscal stability, regulatory predictability, or government partnership, the current environment suggests waiting for clearer evidence that the transition is succeeding before committing substantial capital.