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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2019-06-26
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2019-07-29
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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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“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. http://hdl.handle.net/10986/32141 License: CC BY 3.0 IGO.”
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