Publication: Country Economic Memorandum for Sao Tome and Principe - Background Note 2: Is it Sustainable for Sao Tome and Príncipe to Have a Large Current Account Deficit and a Fixed Exchange Rate?
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Date
2019-06-26
ISSN
Published
2019-06-26
Author(s)
Arteta, Carlos
Kirby, Patrick
Abstract
Is it sustainable for São Tomé and
Príncipe to have a large current account deficit and a fixed
exchange rate peg? Sao Tomé and Príncipe (STP) pegs its
currency, the dobra, to the euro and has both persistent
current account deficits and a persistent inflation
differential with the Euro Area. In other countries, these
characteristics have proved to be unsustainable over time,
as rising debt and a worsening trade imbalance leads to the
abandonment of the peg. This note examines whether this
might be the case in STP, and finds that, despite some
vulnerabilities, there does not appear to be an immediate
threat to the peg, as the country’s current account deficits
seem to be determined not by its trade balance but by its
capital balance, which is largely sustained by inflows of
aid and remittances. This background note has four sections:
the first examines the general theoretical conditions for
the sustainability of exchange rate pegs, the second
assesses whether these conditions exist or are relevant for
STP, a small, open economy with a small financial sector,
and the third provides analysis of the drivers of the
country’s current account deficit. Policymakers could
mitigate risks to the peg by broadening the country’s
revenue base, developing a domestic debt market, and
diversifying exports.
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Citation
“Arteta, Carlos; Kirby, Patrick. 2019. Country Economic Memorandum for Sao Tome and Principe - Background Note 2: Is it Sustainable for Sao Tome and Príncipe to Have a Large Current Account Deficit and a Fixed Exchange Rate?. © World Bank, Washington, DC. http://hdl.handle.net/10986/32141 License: CC BY 3.0 IGO.”