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Kingdom of Lesotho: 2019 Article IV Consultation—Press Release; Staff Report; and Statement by the Executive Director for Kingdom of Lesotho

Author(s):
International Monetary Fund. African Dept.
Published Date:
April 2019
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Context

1. A four-party political coalition came to power in 2017 with a mandate to cement peace and entrench reform. Patronage-driven politics and military interference have resulted in decades of instability in Lesotho, while politicization of the civil service has compromised effective public service delivery. The coalition has been supported by a regional peace-keeping force, and a dialogue between the government and opposition parties began on reforms recommended by the Southern African Development Community (SADC) to depoliticize the civil service, increase Parliamentary oversight of the military, and amend the constitution to reduce chronic political instability.

Real GDP per Capita

(Percent of South Africa’s GDP per capita)

Source: Penn World Tables, IMF World Economic Outlook

2. Lesotho’s growth model has run into difficulties. Despite a high degree of economic integration, Lesotho’s standard of living remains far below that of the other Southern African Customs Union (SACU) members. Growth has recently been driven by capital-intensive industries such as mining and finance, with little impact on job creation. The textile industry, which expanded rapidly in the late 90s and early 2000s thanks to preferential access to US markets through the African Growth and Opportunity Act, has since stagnated. Political instability, low human capital, and unstable and burdensome regulations combine to constrain private sector development (Annex IV). Access to credit is also an issue in the context of a financial sector which is liquid and profitable but plays a limited role in intermediating credit to local entrepreneurs. With unemployment at around 25 percent, over half of the population living under the $1.90 poverty line, and one of the highest rates of HIV infection in the world, social indicators suggest the depth of the development challenge ahead (Table 6).

Table 1.Lesotho: Selected Economic Indicators, 2015/16–2023/241
Population (1,000; 2016 est.)2,204
GNI per capita (U.S. dollars; 2016 est.):1,270
Poverty rate (percent, 2011 est.):57
2015/162016/172017/182018/192019/202020/212021/222022/232023/24
Act.Act.Est.Projections
(12-month percent change, unless otherwise indicated)
National account and prices
GDP at constant prices2.12.70.52.93.1-0.23.64.21.4
GDP at constant prices (exc. LHWP-2 project)2.12.70.52.70.71.92.32.53.0
GDP at market prices (billions Maloti)32.134.134.837.641.043.447.351.955.6
Consumer prices (average)4.36.24.54.85.95.75.55.55.5
Consumer prices (eop)7.54.44.94.96.05.65.55.55.5
GDP deflator7.73.51.64.95.76.15.35.25.7
External sector
Terms of trade (deterioration -)12.8-3.90.4-0.71.50.40.40.40.3
Average exchange rate
(Local currency per U.S. dollar)13.814.11 3.0..................
Nominal effective exchange rate change (– = depreciation) 2-8.9-11.18.2..................
Real effective exchange rate (– = depreciation) 2-6.8-6.811.4..................
Current account balance
(Including official transfers, percent of GDP)-4.3-8.4-4.8-8.4-14.2-4.8-9.1-1 5.6-9.2
Current account (exc. LHWP-2 project, percent of GDP)-4.1-7.9-4.2-7.3-4.2-1.9-1.3-1.2-0.9
Gross international reserves
(Months of imports, excluding imports for LHWP-2)6.24.53.73.53.43.43.33.23.2
Money and credit
Domestic credit to the private sector8.25.88.39.68.711.0.........
Reserve money22.73.19.03.54.58.8.........
Broad money6.48.817.46.13.95.9......
Interest rate (percent) 3/6.37.07.0..................
(in percent of GDP)
Public debt43.237.638.846.849.551.751.450.751.1
External public debt38.733.130.736.136.136.535.734.734.8
Domestic public debt4.64.58.210.713.415.215.715.916.3
Central government fiscal operations
Revenue and grants47.841.342.941.341.942.442.041.841.7
Of which: SACU revenue20.013.317.714.71 5.215.915.61 5.41 5.4
Of which: grants3.03.62.42.82.52.52.42.42.4
Recurrent expenditure35.937.136.735.434.033.633.332.932.8
of which: wages, including social contributions15.415.515.616.316.316.01 5.715.31 5.2
Capital expenditure13.112.29.611.111.311.110.710.310.2
Overall balance-1.2-8.0-3.4-5.2-3.4-2.3-2.0-1.4-1.3
(Excluding grants)-4.2-11.6-5.8-7.9-5.9-4.7-4.4-3.8-3.6
Statistical discrepancy/Arrears2.80.12.90.50.0-0.5-0.4-0.4-0.4
Sources: Lesotho authorities, World Bank, and IMF staff estimates and projections.

The fiscal year runs from April 1 to March 31.

IMF Information Notice System trade-weighted; end of period.

12-month time deposits rate.

Sources: Lesotho authorities, World Bank, and IMF staff estimates and projections.

The fiscal year runs from April 1 to March 31.

IMF Information Notice System trade-weighted; end of period.

12-month time deposits rate.

Table 2a.Lesotho: Fiscal Operations of the Central Government, 2015/26–2023/241,2(In millions of Maloti)
2015/162016/172017/182018/192019/202020/212021/222022/232023/24
Act.Act.Est.Projections
Revenue15,32114,05214,91415,53417,15018,40819,89121,70723,209
Tax revenue 36,3286,3976,3147,0577,8398,2538,9589,85410,544
Taxes on income, profits, and capital gain3,6443,7263,4873,9604,2404,4424,7985,2455,602
Taxes on property00000005054
Taxes on goods and services2,6832,6692,8263,0973,5983,8104,1584,5584,887
Taxes on international trade000000000
Grants9661,2298221,0471,0231,0721,1501,2411,316
Budget support15368211212213214214215215
Project grants9528626118358108589361,0261,100
Non-tax revenue1,6281,9061,6241,8912,0622,1832,3832,6122,800
Property Income6998515447548228719501,0421,117
Sales of goods and services9161,0411,0701,1241,2251,2971,4161,5521,664
Other non-tax revenue131510131415171819
SACU6,3994,5196,1545,5386,2266,9007,4008,0008,550
Expense11,51412,62312,77013,29013,92514,57515,76717,06218,273
Compensation of employees4,9305,2775,4366,1416,6756,9337,4257,9548,469
Wages and salaries4,5924,8844,9335,5966,1546,3866,8347,3137,788
Social contributions338393503545522547591641681
Use of goods and services2,9203,4663,3233,1143,1493,1933,4333,6903,967
Interest payments2672473273136498339631,0921,200
Domestic7638113116384542657772848
External191209214197265290307320352
Subsidies251415310280280297324355381
Grants1,1061,2581,112827730773844925991
Social benefits1,3541,4151,5681,7921,7941,8602,0302,2252,385
Other expenses687544693821648686748820880
Gross operating balance3,8071,4292,1452,2443,2253,8344,1244,6464,937
Nonfinancial assets4,1954,1583,3434,1804,6244,8145,0795,3665,651
Domestically financed2,5702,7022,2602,4082,4802,6262,8663,1423,369
Externally financed1,6241,4561,0831,5722,1442,2882,4122,6242,882
Net lending(+)/borrowing (-) (Overall fiscal balance)-388-2,729-1,198-1,936-1,399-981-955-720-714
Transactions in financial assets and liabilities-1,270-2,750-657-1,936-1,399-981-955-720-714
Financial assets-734-2,554289-155666730513737863
Domestic-734-2,554289-155666730513737863
Deposits-734-2,570270-155666730513737863
Central bank-775-2,536281-155666730513737863
Commercial banks41-34-11000000
Loans01619000000
Financial liabilities5361969451,7812,0651,7101,4671,4571,577
Domestic408418881,5001,300900700700800
of which: Change in domestic arrears007002000-200-200-200-200
Foreign12815557281765810767757777
Disbursements6735954727691,4001,4301,4761,5971,782
Amortization-434-388-415-456-569-620-709-840-1,005
Statistical discrepancy88221-542000000
Sources: Lesotho authorities and IMF staff estimates and projections.

The fiscal year runs from April 1 to March 31.

Data for 17/18 and 18/19 are presented on a modified cash basis to correctly reflect current year expenses.

Other taxes are not shown in the table.

Sources: Lesotho authorities and IMF staff estimates and projections.

The fiscal year runs from April 1 to March 31.

Data for 17/18 and 18/19 are presented on a modified cash basis to correctly reflect current year expenses.

Other taxes are not shown in the table.

Table 2b.Lesotho: Fiscal Operations of the Central Government, 2015/16–2023/241,2(Percent of GDP)
2015/162016/172017/182018/192019/202020/212021/222022/232023/24
Act.Act.Est.Projections
Revenue47.841.342.941.341.942.442.041.841.7
Tax revenue319.718.818.118.819.119.018.919.019.0
Taxes on income, profits, and capital gain11.410.910.010.510.410.210.110.110.1
Taxes on property0.00.00.00.00.00.00.00.10.1
Taxes on goods and services8.47.88.18.28.88.88.88.88.8
Taxes on international trade0.00.00.00.00.00.00.00.00.0
Grants3.03.62.42.82.52.52.42.42.4
Budget Support0.01.10.60.60.50.50.50.40.4
Project grants3.02.51.82.22.02.02.02.02.0
Non-tax revenue5.15.64.75.05.05.05.05.05.0
Property income2.22.51.62.02.02.02.02.02.0
Sales of goods and services2.93.13.13.03.03.03.03.03.0
Other non-tax revenue0.00.00.00.00.00.00.00.00.0
SACU20.013.317.714.715.215.915.615.415.4
Expense35.937.136.735.434.033.633.332.932.8
Compensation of employees15.415.515.616.316.316.015.715.315.2
Wages and salaries14.314.314.214.915.014.714.414.114.0
Social contributions1.11.21.41.51.31.31.21.21.2
Use of goods and services9.110.29.58.37.77.47.37.17.1
Interest payments0.80.70.90.81.61.92.02.12.2
Domestic0.20.10.30.30.91.31.41.51.5
External0.60.60.60.50.60.70.60.60.6
Subsidies0.81.20.90.70.70.70.70.70.7
Grants3.43.73.22.21.81.81.81.81.8
Social benefits4.24.24.54.84.44.34.34.34.3
Other expenses2.11.62.02.21.61.61.61.61.6
Gross operating balance11.94.26.26.07.98.88.79.08.9
Non-financial assets13.112.29.611.111.311.110.710.310.2
Domestically financed8.07.96.56.46.16.16.16.16.1
Externally financed5.14.33.14.25.25.35.15.15.2
Net lending(+)/borrowing (-) (Overall fiscal balance)-1.2-8.0-3.4-5.2-3.4-2.3-2.0-1.4-1.3
Transactions in financial assets and liabilities-4.0-8.1-1.9-5.2-3.4-2.3-2.0-1.4-1.3
Financial assets-2.3-7.50.8-0.41.61.71.11.41.6
Domestic-2.3-7.50.8-0.41.61.71.11.41.6
Deposits-2.3-7.50.8-0.41.61.71.11.41.6
Central bank-2.4-7.40.8-0.41.61.71.11.41.6
Commercial banks0.1-0.10.00.00.00.00.00.00.0
Loans0.00.00.10.00.00.00.00.00.0
Financial liabilities1.70.62.74.75.03.93.12.82.8
Domestic1.30.12.64.03.22.11.51.31.4
of which: Change in domestic arrears0.00.02.00.50.0-0.5-0.4-0.4-0.4
Foreign0.40.50.20.71.91.91.61.51.4
Disbursements2.11.71.42.03.43.33.13.13.2
Amortization-1.4-1.1-1.2-1.2-1.4-1.4-1.5-1.6-1.8
Statistical discrepancy2.80.10.90.00.00.00.00.00.0
Sources: Lesotho authorities and IMF staff estimates and projections.

The fiscal year runs from April 1 to March 31.

Data for 17/18 and 18/19 are presented on a modified cash basis to correctly reflect current year expenses.

Other taxes are not shown in the table.

Sources: Lesotho authorities and IMF staff estimates and projections.

The fiscal year runs from April 1 to March 31.

Data for 17/18 and 18/19 are presented on a modified cash basis to correctly reflect current year expenses.

Other taxes are not shown in the table.

Table 3.Lesotho: Monetary Accounts, 2015/16–2020/211,2(Maloti millions, unless otherwise indicated)
2015/162016/172017/182018/192019/202020/21
Act.Act.Act.Projections
I. Monetary Survey
Net foreign assets15,79513,26813,38513,07013,52113,840
Central bank12,2679,6028,6589,14310,11411,083
Commercial banks3,5283,6674,7273,9273,4072,757
Net domestic assets-5,966-2,573-831253315810
Claims on central government (net)-3,972-1,368-1,630-808-1,389-1,893
Central bank-4,772-2,198-2,734-2,711-3,592-4,497
Commercial banks8008301,1041,9042,2042,604
Claims on private sector5,5195,8426,3276,9327,5348,366
Other items (net)-7,593-7,421-5,607-5,957-5,924-5,761
Broad money (M2)9,82910,69212,55413,32313,83614,650
Currency outside banks9079351,0541,1761,2001,271
Deposits8,9229,75711,50012,14712,63613,379
II. Central Bank
Net foreign assets12,2679,6028,6589,14310,11411,083
Gross reserves13,98411,15510,09810,68811,52812,370
Net domestic assets-10,428-7,706-6,591-7,003-7,878-8,649
Claims on central government (net)-4,772-2,198-2,734-2,711-3,592-4,497
Claims on private sector77908996105111
Other items (net) 2-5,733-5,598-3,947-4,388-4,390-4,263
Reserve money1,8391,8962,0662,1392,2362,434
Currency in circulation1,1671,2001,3501,4901,5271,617
Commercial bank deposits621649678649709816
Liabilities to other sectors000000
Memorandum items:(12-month percent change, unless otherwise indicated)
Reserve money22.73.19.03.54.58.8
Broad money6.48.817.46.13.95.9
Narrow money (M1)15.56.622.96.93.75.9
Narrow money (M1) (Maloti millions)4,9275,2546,4576,9027,1577,578
Cred it to the private sector8.25.88.39.68.711.0
Cred it to the private sector (percent of GDP)17.217.218.218.518.419.3
Velocity (GDP/broad money)3.33.22.82.83.03.0
Sources: Lesotho authorities and IMF staff estimates and projections.

The fiscal year runs from April 1 to March 31.

Including valuation changes.

Sources: Lesotho authorities and IMF staff estimates and projections.

The fiscal year runs from April 1 to March 31.

Including valuation changes.

Table 4.Lesotho: Balance of Payments, 2015/16–2023/241(US$ millions, unless otherwise indicated)
2015/162016/172017/182018/192019/202020/212021/222022/232023/24
Act.Act.Est.Projections
Current account-93-204-126-236-394-135-274-501-306
Trade balance-756-729-795-815-929-760-857-1,011-891
Exports, f.o.b.9409011,1371,1991,2571,3781,4661,5611,661
Imports, f.o.b1,6961,6311,9322,0142,1872,1382,3232,5712,553
Services (net)-255-260-330-331-397-342-423-541-507
Primary income (net)300311351340333335345354369
Secondary income (net)619475648569599633661697723
Official transfers502354512433458488508534553
Of which: SACU revenue464321473401422452471495514
Other transfers117120136135141144153163170
Capital account49404055354122303568352
Current and capital account-44-164-86-181-41-13306746
Financial account-111-247-18-71-41-13306746
Foreign direct investment-107-65-44-40-46-47-50-53-55
Portfolio investment222222233
Other investment-12934868-41-16457246
Of which:
Public sector (net)171013214140383947
Disbursements4941535694939499107
Central government4942385694939499107
Other public sector0-115000000
Amortization-32-31-40-34-53-54-56-60-60
Change in reserve assets123-217-61-404447334652
Errors and omissions-67-836811100000
Memorandum items:
Nominal GDP (millions of Maloti)32,06034,05934,79737,57340,96443,37547,34151,89355,634
Nominal GDP (millions of USD)2,3262,4232,6772,7172,7752,8433,0153,2133,344
Gross international reserves
(US$ millions)949841851692705734745769798
(Months of imports)6.144.503.693.093.323.112.792.933.10
(Months of imports, excluding imports for LHWP-2)6.174.533.743.453.433.403.273.213.16
National currency per US$13.814.113.013.8
(in percent of GDP)
Current account-4.3-8.4-4.8-8.4-14.2-4.8-9.1-15.6-9.2
Current account (exc. LHWP-2 project)-4.1-7.9-4.2-7.3-4.2-1.9-1.3-1.2-0.9
Trade Balance-32.5-30.1-29.7-30.0-33.5-26.8-28.4-31.5-26.7
Current and capital account-1.9-6.8-3.2-6.7-1.5-0.51.02.11.4
Official grants21.414.619.016.216.517.216.916.616.5
(12-month percent change)
Exports of goods and services
Percent change (Maloti terms)35.6-0.312.312.312.113.19.49.59.6
Percent change ($US terms)9.0-2.721.95.05.19.46.46.56.4
Imports of goods and services
Percent change (Maloti terms)14.6-0.58.810.317.7-0.713.816.51.3
Percent change ($US terms)-7.9-2.517.83.410.2-3.910.613.3-1.6
Imports of goods and services (excl. LHWP)
Percent change (Maloti terms)14.3-0.88.79.76.57.67.78.68.2
Percent change ($US terms)-8.2-2.717.63.0-0.34.14.75.55.1
Sources: Lesotho authorities and IMF staff estimates and projections.

The fiscal year runs from April 1 to March 31.

Sources: Lesotho authorities and IMF staff estimates and projections.

The fiscal year runs from April 1 to March 31.

Table 5.Lesotho: Financial Soundness Indicators 2013–2018(End of period, percent)
201320142015201620172018
(In percent)
Core FSIs
Regulatory capital to risk weighted assets12.113.116.118.917.817.9
Regulatory Tier 1 capital to risk-weighted assets11.412.214.417.220.920.2
Non-performing loans net of provisions to capital11.05.56.55.86.45.8
Non-performing loans to total gross loans3.73.83.93.74.43.7
Return on assets4.83.13.43.32.43.4
Return on equity42.731.433.628.418.028.6
Interest margin to gross income55.958.358.358.059.660.4
Non-interest expenses to gross income52.852.352.854.762.260.7
Liquid assets to total assets35.341.940.431.936.336.1
Liquid assets to short-term liabilities71.659.862.947.352.852.9
Net open position in FX to capital32.15.514.431.924.623.6
Sectoral distribution of loans
Domestic residents100.0100.0100.0100.0100.0
Deposit takers0.20.00.00.00.0
Central bank0.00.00.00.00.0
Other financial corporations0.00.50.50.41.9
General government0.00.00.00.00.0
Nonfinancial corporations40.039.135.036.330.8
Households59.760.464.463.467.3
Nonresidents0.00.00.00.00.0
Additional FSIs
Capital to assets (leverage ratio)12.610.911.911.111.5
Large exposures to capital154.7182.8124.4107.180.782.1
Gross assets position in derivatives to capital0.10.30.81.64.60.2
Gross liabilities position in derivatives to capital7.03.76.70.10.33.4
Trading income to total income4.84.84.63.63.13.8
Personnel expenses to total income51.852.149.548.946.146.1
Customer deposits to total non-interbank loans125.1172.9163.6154.6184.6179.8
FX loans to total loans0.00.00.00.00.00.0
FX liabilities to total liabilities3.90.00.10.10.30.0
Source: IMF Financial Soundness Indicators.
Source: IMF Financial Soundness Indicators.
Table 6.Lesotho: Sustainable Development Goals
20052010201520162017
Goal 1: No Poverty
Poverty headcount ratio at $1.90 a day (2011 PPP) (% of population)..59.6......
Urban poverty headcount ratio at national poverty lines (% of urban population)..39.6......
Goal 2: Zero Hunger
Prevalence of undernourishment (% of population)11.712.712.912.8..
Prevalence of wasting, weight for height (% of children under 5)..........
Goal 3: Good Health and Well-Being
Maternal mortality ratio (modeled estimate, per 100,000 live births)746587487....
Mortality rate, neonatal (per 1,000 live births)43.441.639.338.737.9
Goal 4: Quality Education
Literacy rate, adult total (% of people ages 15 and above)..........
Lower secondary completion rate, total (% of relevant age group)31.341.0..42.043.2
Pupil-teacher ratio, primary41.633.833.133.832.9
Goal 5: Gender Equality
Nondiscrimination clause mentions gender in the constitution (1=yes; 0=no)....1..1
Proportion of seats held by women in national parliaments (%)11.724.2252522.9
Goal 6: Clean Water and Sanitation
People using at least basic sanitation services (% of population)19.631.843.8....
People using at least basic drinking water services (% of population)68.169.971.6....
Goal 7: Affordable and Clean Energy
Access to electricity (% of population)10.318.927.929.7..
Access to electricity, rural (% of rural population)4.69.914.815.7..
Goal 8: Decent Work and Economic Growth
GDP growth (annual %)3.56.12.83.2-2.3
Unemployment, youth total (% of total labor force ages 15–24) (modeled ILO estimate)47.836.338.039.038.5
Goal 9: Industry, Innovation, and Infrastructure
New business density (new registrations per 1,000 people ages 15–64)..1.5......
Goal 10: Reduced inequality
Average transaction cost of sending remittances to a specific country (%)....13.815.915.9
Personal remittances, received (% of GDP)35.625.814.814.815.6
Goal 11: Sustainable Cities and Communities
Urban population (% of total)22.224.826.927.327.7
Urban population growth (annual %)3.43.12.92.82.8
Population living in slums (% of urban population)35.1........
Goal 12: Sustainable Consumption and Production
Renewable electricity output (% of total electricity output)100100100....
Renewable energy consumption (% of total final energy consumption)555352....
Goal 13: Climate Action
PM2.5 air pollution, mean annual exposure (micrograms per cubic meter)26.422.426.526.9..
CO2 emissions (kg per PPP $ of GDP)0.60.5......
Terrestrial and marine protected areas (% of total territorial area)......0.30.3
Goal 14: Life Below Water
Aquaculture production (metric tons)13001,0011,050..
Total fisheries production (metric tons)463451,0531,102..
Goal 15: Life on Land
Forest area (% of land area)1.41.41.61.6..
Goal 16: Peace, Justice, and Strong Institutions
Tax revenue (% of GDP)3738413437
Overall level of statistical capacity (scale 0 – 100)7166665862
Goal 17: Partnerships for the Goals
Individuals using the Internet (% of population)2.63.925.027.4..
Net official development assistance and official aid received (current US$ millions)68.4256.183.1112.3146.8
Source: World Development Indicators
Source: World Development Indicators

Value Added by Industry

(Percent of GDP)

Sources: Country authorities and staff estimates.

3. The public sector wage bill expanded to one of the largest in the world when revenues from the SACU were buoyant, creating fiscal rigidities that have resulted in financing issues.1 From FY 2005/06 to FY 2013/14, SACU revenues increased from 14 percent of GDP to 24 percent. Over the same period, the wage bill doubled as a percent of GDP, largely due to salary hikes rather than an expansion of the public-sector work force. When SACU revenues fell after FY 2014/15, reflecting lower South African import growth, the wage bill remained high, resulting in a depletion of Lesotho’s fiscal and reserve buffers over the following years. By late FY2017/18, the government had run out of space to draw down deposits further without threatening their reserve target (120 percent of M1 plus all callable deposits).2 Rather than allow any risk to the peg to the rand, and with local debt markets shallow, the government began to delay certain domestic payments, resulting in a build-up of government payment arrears.3

Recent Economic Developments

4. The economy is recovering following very weak growth in 2017/18, though declining SACU revenues are putting pressure on the external position. Enhanced political stability, an increase in production in the diamond sector, and stronger growth in the textile sector (which benefited from a weaker rand) are expected to result in growth of just under 3 percent in FY 2018/19. Lower SACU revenues, however, offset stronger textile and diamond exports, resulting in a current account deficit of 8½ percent of GDP, and continued pressure on reserves. The external position has been weaker than the level consistent with medium term fundamentals and desirable policies (Annex I).

5. Lower SACU revenues and expenditure rigidities posed challenges for fiscal policy. The 2018/19 budget included some revenue measures, such as an increase in the VAT rate to bring it into line with other countries in the region, and an increase in VAT on telecommunications and electricity. However, these were insufficient to offset lower SACU revenues and higher expenditures, resulting in a deficit of over 5 percent of GDP. Moreover, attempts to finance the deficit also initially fell short, as bonds auctioned in the first half of the year were only 50 percent subscribed. The resulting financing gap led to further arrears accumulation, as the government sought to preserve government deposits at the CBL, and hence international reserves, at adequate levels.

6. Government payment arrears have begun to have an impact on the broader economy. While the banking system, dominated by South African banks, remains well capitalized and profitable, NPLs are expected to creep up, albeit from a low base (Table 5). Credit to the private sector remains broadly in line with nominal GDP growth, with the banks continuing to hold much of their asset base in South Africa, and inflation remains subdued. The government’s ad hoc issuance of 600 million in one-year paper in December helped to alleviate the domestic payment arrears and stabilize the situation.

Outlook and Risks

7. Over the next three years, growth is expected to be driven by construction related to the second phase of the Lesotho Highlands Water Project (LHWP-II). In addition to the project (Box 1), production of diamonds and textiles have positive prospects. Inflation is expected to pick up somewhat as the VAT rate hike is passed-through and economic conditions improve mildly. Over the medium term, it is expected to converge to 5.5 percent, in line with South African inflation.

Box 1.The Lesotho Highlands Water Project

A new phase of the LHWP is about to start. The first phase of the LHWP was completed in 1998 and included dams and tunnels to export water to South Africa. Phase II will add another dam and tunnel with investments amounting to over 50 percent of Lesotho’s GDP over the next 8 years, fully financed through capital grants from South Africa.1 While the import component is expected to be high, the size of the project implies a substantial growth and employment impact. At its peak, LHWP-I employed over 3,000 workers.

Project cash flows are expected to have two peaks. Construction of a major road is expected to take place in FY 2019/20. After a low-activity year, construction of the dam and diverting tunnel will begin in FY 2021/22. After the project is completed, water will be delivered to South Africa in exchange for a royalty. These peaks are a major driver of the country’s projected growth path.

1 A hydropower component may be considered in the future and would have to be financed by Lesotho.

8. While overall risks are tilted to the downside, upside risks stem from the national reform agenda, which offers a roadmap to enhancing stability. The country is currently debating a multi-sectoral reform program which, if enacted, could strengthen governance and accountability. Such a program could also be supported by the international community, including a potential Millennium Challenge Compact,4 and provide a more stable environment for investment. However, achieving substantial progress on economic and political reforms will require attaining a greater degree of consensus than has been evident in the recent past.

9. A deterioration of fiscal discipline would be the major downside risk. Fiscal consolidation is required to restore the external balance: a failure to consolidate the fiscus in line with the FY2019/20 budget would force the authorities to choose between a further depletion of government deposits at the CBL, with negative consequences for reserves and ultimately for the peg to the rand, or to maintain deposits at the cost of continuing to accumulate arrears, which could further undermine procurement, growth, and financial stability. PFM weaknesses also pose challenges to economic policy making, with lax expenditure controls potentially imperiling budget discipline.

10. External risks largely center on spillovers from South Africa. Downgrades of South African debt and disruptions to the power supply could induce capital flight and weaken growth, which could in turn depress SACU revenues and remittances. Political tensions and slow progress in South Africa’s structural reforms could worsen the already declining longer-term trend for SACU revenues. On the upside, if structural reforms were accelerated after elections, growth and SACU revenues could be boosted (Annex II).

11. Another El Niño-related drought may hit Lesotho this year. The Food and Agriculture Organization has identified Lesotho as being at high risk of drought that could increase malnourishment among vulnerable populations and lead to higher expenditures on food subsidies and crisis management.5 The cost of the response to the 2016 drought was estimated at 2 percent of GDP by the UN.

Authorities Views

The authorities acknowledged the downside risks. They noted the implications of insufficient fiscal consolidation, and clarified that discussions were underway to obtain external support in the event of a drought. However, they also noted large upside risks reflecting the underlying potential of the country, including in horticulture, medicinal cannabis, mining, and textiles.

Policy Discussions

Discussions focused on short term measures to improve fiscal discipline and bring expenditures into line with available resources. Over the medium term, the mission proposed measures to enhance public service delivery and to recast the role of the government with a view to enabling the private sector to act as the engine of growth.

A. Restoring Fiscal Discipline

12. The FY 2019/20 budget envisages a major adjustment aimed at addressing fiscal imbalances and bringing expenditures into line with available resources while expanding public works programs to increase employment opportunities (Box 2). The key expenditure measure is a zero cost of living wage adjustment, coupled with a hiring freeze. The government is attempting to lead by example, with Ministers taking a five percent pay cut. The budget also seeks to cut travel and per diem costs, which typically amount to 2 percent of GDP each year. On the revenue side, the authorities plan to increase the VAT on telecommunications from 9 to 12 percent, introduce a levy on alcohol and tobacco, and raise the levy on fuel. Taken together, staff assess that these measures would result in a projected deficit of 3.4 percent of GDP, compared to 5.2 percent in FY 2018/19.6 The baseline also assumes some continued expenditure restraint over the medium term, reflected in a falling wage-to-GDP ratio and a narrowing of the fiscal deficit.

Box 2.The FY 2019/20 Budget

The FY 2019/20 budget, which aims for a near 4 percent of GDP consolidation, introduces several measures to bring the deficit in line with available resources. If implemented, the measures will reduce the level of arrears, align resource allocation with strategic priorities, and increase spending efficiency. Major elements of the budget include:

  • The introduction of a 30 percent levy on tobacco and 15 percent levy on alcohol;
  • A 30 cent per liter increase in the fuel levy;
  • An increase in the VAT on telecommunications from 9 to 12 percent;
  • Zero increase in civil service wages and a hiring freeze;
  • An alignment of per diems with those used by the UN;
  • Cuts to the number of international travel days and to the size of delegations.
  • Elimination of the interest benefit provided on loans to parliamentarians and the possibility of loan write-off following a mid-term election.
  • A M300 million public works program to provide 8,500 temporary jobs and internships.
FY2018/19FY2019/20FY2019/20
Est.BudgetProj.
Revenue41.344.341.9
Tax Revenue18.819.219.1
Taxes on income, profits, and capital gain10.510.510.4
Taxes on goods and services8.28.88.8
Grants2.82.52.5
Non-tax revenue5.07.35.0
SACU14.715.215.2
Expense35.432.834.0
Compensation of employees16.316.316.3
Use of goods and services8.37.77.7
Interest payments0.81.01.6
Subsidies0.70.40.7
Grants2.21.71.8
Social benefits4.84.14.4
Other expenses2.21.61.6
Nonfinancial assets11.112.611.3
Net lending/borrowing-5.2-1.2-3.4
Transactions in financial assets and liabilities-5.2-1.2-3.4
Financial Assets-0.43.91.6
Domestic-0.43.91.6
Deposits-0.43.91.6
Foreign0.00.00.0
Financial Liabilities4.75.05.0
Domestic4.03.23.2
of which: Change in domestic arrears0.60.00.0
Foreign0.71.91.9
Sources: Country authorities and staff estimates.
Sources: Country authorities and staff estimates.

13. Absent a fiscal adjustment in 2019/20 the economy would face continued financing gaps and weakened medium-term growth prospects. The expenditure cuts in the budget, while very much in line with previous Fund advice, have proven difficult to implement in the past. An alternate scenario includes additional wage and hiring pressures, and weak expenditure controls (Text table). Significantly higher deficits would prove difficult to finance, resulting in a possible reemergence of expenditure arrears, a continued drawdown of government deposits, and undesirable cuts to spending on social programs and capital investment.

Baseline scenario
2018/192019/202020/212021/22
Real GDP (ex. LHWP-2)2.70.71.92.3
Total revenue (percent GDP)41.341.942.442.0
Recurrent expenditure (percent GDP)35.434.033.633.3
Capital expenditure (percent GDP)11.111.311.110.7
Fiscal balance (percent GDP)-5.2-3.4-2.3-2.0
Domestic arrears (percent GDP)0.50.0-0.5-0.4
Public debt (percent GDP)46.849.551.751.4
Current account (percent GDP, excluding LHWP-2)-7.3-4.2-1.9-1.3
Reserve coverage (months of imports, excluding LHWP-2)3.53.43.43.3
Alternate scenario
2018/192019/202020/212021/22
Real GDP (ex. LHWP-2)2.71.21.40.3
Total revenue (percent GDP)41.341.441.841.3
Recurrent expenditure (percent GDP)35.435.535.935.7
Capital expenditure (percent GDP)11.111.311.110.7
Fiscal balance (percent GDP)-5.2-5.4-5.2-5.1
Domestic arrears (percent GDP)0.51.31.51.6
Public debt (percent GDP)46.851.554.457.5
Current account (percent GDP, excluding LHWP-2)-7.3-5.8-4.2-3.8
Reserve coverage (months of imports, excluding LHWP-2)3.52.72.21.6
Sources: Country authorities and staff estimates.
Sources: Country authorities and staff estimates.

Authorities’ Views

The authorities expressed their firm commitment to implementing the approved budget, noting that political consensus had been formed on the agreed measures, reflecting a widespread acknowledgement of the gravity of the country’s macroeconomic situation.

Medium-Term Fiscal Objectives

14. The FY2019/20 budget represents a good step towards restoring fiscal and debt sustainability, but further reforms will be needed over the medium term to entrench stability and lay the foundation for more effective fiscal management. Reform of public sector employment will remain the overarching priority. With SACU revenues volatile and likely on a long-term downward trend, Lesotho cannot afford a wage bill-to-GDP ratio at current levels. In this context, it will be important to ensure that the proposed new measures in the budget to create a M300 million public works and internship program represent a temporary (two-year) arrangement, as currently envisaged. In addition to lowering salaries in real terms and controlling new hires, broader comprehensive civil service reforms are desirable, including improving payroll control and a review of establishment lists to match jobs to existing skills within the civil service, as well as to identify redundancies and overstaffing.7 Over the longer term, the goal should be instituting a performance-based wage system.

15. Savings could also be generated by rationalizing expenditures in other areas. Costs have greatly outpaced projected demand under the PPP contract with the largest hospital, and there may be room to save funds by making greater use of local health facilities. An expensive tertiary student loan program costs around 2 percent of GDP and subsidizes the richest segment of the population. Many of the beneficiaries, study and remain in South Africa, while the majority of the rest work in the public sector in Lesotho. Loan repayment rates are extremely low.

16. While domestic revenue mobilization is relatively high, there is some room to broaden the tax base. In particular, eliminating special incentives such as discretionary reduced rates for mining royalties would provide a more level playing field for business. Addressing issues of profit shifting, removing the exemption for income related to life insurance, and introducing recurrent property taxes could also provide additional revenues without undue burden on the private sector.

17. Ensuring that the most vulnerable are protected from the impact of adjustment will require a stronger social safety net. The authorities are currently implementing a number of initiatives to enhance the coverage and efficiency of social protection schemes, with support from international donors (text table). Eliminating ghost pensioners and limiting access for individuals with a private pension is expected to increase the efficiency of the Old Age Pension, which is the largest component of the social safety net with a budget of M700 million. Data collection to extend the National Information System for Social Assistance (NISSA) to all rural areas is expected to be completed by April, which will support this process. The government is currently attempting to expand the Child Grant Programme (CGP), albeit at a slower pace than hoped. The CGP has the potential to be a very effective tool for protecting the most vulnerable from economic fluctuations. Its effectiveness could be enhanced through accelerating its expansion, increasing the size of the benefits, and integrating the program with the bursary scheme for secondary school students to reduce drop-out rates.

18. On current policies, Lesotho’s risk of debt distress is assessed to be moderate, with some space to absorb shocks. The risk of external debt distress is being revised from “low” in the 2017 Article IV to “moderate”, weaker GDP growth projections, arrears, expanded debt coverage and data revisions, and inclusion of large contingent liabilities (Annex III). The assessment highlights the importance of addressing underfunding of the pension fund, preserving a conservative debt management strategy – including continuing to rely on concessional external financing where available, and gradually developing the domestic debt market.

Main Social Assistance Program(As of end FY 17/18)
ProgramNumber of BeneficiariesTarget GroupImplementing MinistryBudget (millions Maloti)Percent of GDP
Old Age Pension90,000Universal to all above 70 not receiving civil service pension.Finance7212.1
Child Grant Programme30,000Poor households with children under 18.Social Development580.2
Orphans and Vulnerable Children Bursary Programme23,000Orphan/vulnerable children under 18 enrolled in secondary school.Social Development610.2
Public Assistance12,000Poor under 70.Social Development630.2
School Feeding400,000All children attending primary school.Education1800.5
Sources: Country authorities and staff estimates.
Sources: Country authorities and staff estimates.

19. Over the medium-term, implementation of a fiscal rule could smooth volatility and entrench debt sustainability. A rule could facilitate efforts to i) preserve international reserves at desirable levels, ii) ensure long-term debt sustainability, and iii) mitigate the volatility resulting from SACU revenues.8 However, given the weaknesses in public expenditure management and a complicated political environment, there will be a premium on simplicity and traction when designing the rule. Improvements in expenditure controls, budget credibility, and data reporting will be important preconditions for the establishment of an effective fiscal anchor.

Authorities’ Views

The authorities noted their intention to bring down the wage bill as a share of GDP over the medium term, including by addressing workforce issues. They are also committed to cutting waste in government expenditures, and stressed that the FY2019/20 budget contains a number of measures to reduce non-priority expenses. They agreed with the importance of enhancing the social protection system, noting the ongoing initiatives to modernize the social grants systems underway at the Ministry of Social Development, with the support of the World Bank. The authorities concurred with the DSA and the “moderate” risk rating, and announced that they are considering introducing a fiscal rule.

Public Financial Management

20. Although some progress has been made since the last Article IV, Lesotho continues to suffer from PFM weaknesses. The authorities recently began enforcing the closure of monthly accounts, which has helped stabilize fiscal reporting. A newly-established Cash Management Unit is helping to better utilize cash balances and prepare warrant releases that reflect available resources. A planned April 2019 upgrade to the IFMIS offers potential for more rigorous and comprehensive financial management, but requires careful implementation to avoid problems during the transition. The following PFM areas also need urgent attention:

  • Arrears management. A survey of arrears is needed to assess the size of the problem, and formulate a plan for arrears clearance.
  • Expenditure controls. Lack of enforcement of expenditure discipline undermines budgetary and cash management. Line ministries should be incentivized to provide Treasury with monthly reconciled bank and payroll statements, as well as quarterly cash and procurement plans. This should also facilitate the avoidance of arrears going forward.
  • Budgeting processes. Budgeting practices are often delayed, leaving little time to ensure that the proposed budget aligns with desired policy measures. More timely and reliable macroeconomic data and projections, drawing on recent IMF TA, would strengthen fiscal analysis and budget projections.
  • Bank reconciliation. Attempts to ensure reconciliation of even current flows have not yet proved successful. It will be vital to ensure that reconciliation takes place after the adoption of the new IFMIS.
  • Debt management. Stronger debt management capacity would help better match the government’s financing needs with available sources of financing. This will involve careful assessment of market appetite during budget planning, and consideration of how best to access the potential demand from longer term institutional investors (Box 3), much of which is currently channeled to South Africa.

21. While there are technical solutions to the PFM issues identified above, progress will also require strong political consensus. A politicized environment undermines accountability and complicates efforts to ensure budget discipline and service delivery. It has, for example, proven difficult to impose sanctions on officials that approve procurement outside of proper budgetary channels, or failed to meet their reporting obligations.9 Clarifying responsibilities and holding officials to account for results will be essential to improve public financial management.

Authorities’ Views

The authorities noted that they have increased pressure on spending units to respond to the arrears survey. Month-end procedures by the Treasury are becoming a more regular practice, and measures are underway to extend the maturity of domestic debt issuances. However, the lack of compliance by spending units on reporting requirements complicates efforts to control spending. They noted the government’s commitments under the SADC reform process to attain a more professional public service, including through strengthening of the Public Service Commission

Box 3.Developing the Domestic Debt Market

With external debt terms hardening, and SACU revenues lumpy and volatile, there is a need to develop domestic bond markets. While Lesotho is still eligible for concessional finance, it is facing increasingly hardened terms as its income has grown (e.g. it has now graduated to IDA blend terms). Domestic debt will offer a substitute financing source and reduce exposure to exchange rate risk present even in concessional external debt.

Demand is currently concentrated in shorter maturities and largely confined to the banking sector. The average bid-to-offer ratio between 2014 and 2017 was 2.4 for T-bills, while demand for longer-term bonds has tended to fall short. There is a need to expand the market beyond the commercial banks, whose asset profile steers them towards T-bills. Non-bank financial institutions account for around half of financial sector assets, a large proportion of which is invested abroad, and with very low exposure to domestic government bonds.

Measures could be considered to support market development:

  • More frequent issuances than the current quarterly auctions could create more pricing reference points and facilitate cash and debt management.
  • Issuance in South Africa could be investigated to take advantage of the larger supply of funds and greater liquidity of the Johannesburg Stock Exchange, while limiting exposure to exchange rate risk.
  • A draft Pension Bill may impose domestic asset requirements on the industry. However, it will be important that any new framework does not hamper pension funds from optimizing their asset allocation. Better aligning the instruments offered with potential demand would be the preferred way to increase take-up.

B. Advancing Private Sector Growth and Human Capital Development

22. With one-quarter of the labor force – and one-third of youths – unemployed, job creation is a key economic challenge facing Lesotho. The new National Strategic Development Plan (NSDP-II) sets out an agenda for private sector led-growth, identifying tourism, agriculture, manufacturing, and technology and innovation as the key drivers of job creation. It envisages supporting measures to improve the business climate, governance, human capital, and infrastructure. Staff welcomes this approach, and notes the efforts underway to attract investment and diversify the export base. However, realizing Lesotho’s full potential will require a significant transformation of the role of the public sector. In particular, the government must ensure that expenditures are aligned with policy goals; that the private sector is provided with a clear, transparent and stable policy environment, and that public services are provided in a transparent, equitable and efficient manner.

23. Reorienting expenditures in favor of growth will require addressing the high public sector wage bill, which also distorts the skills available in the economy. For example, 64 percent of the tourism development agency’s budget goes toward wages, while only 11 percent is used for marketing, falling far below peer countries. In education, the wage bill grew from 69 percent of the recurrent ministerial budget in FY 2011/12 to 77 percent in 2016/17, while the School Feeding program declined from 12 to 8 percent. While the number of public employees in Lesotho is in line with peers, the wage premium, particularly the 60 percent premium for highly-educated workers, is a drag on private sector employment. The high wage bill discourages the acquisition of skills relevant to the private sector, resulting in a significant pool of unemployed graduates. At the same time, only 10 percent of secondary students are able to benefit from scholarships covering tuition, books and boarding, resulting in many students dropping out due to financial constraints (Figure 3).

Marketing and Wage Bill in Tourism Promotion Agencies

(Percent)

Sources: Country authorities and staff estimates.

24. Private sector growth will also be strongest in the context of policy stability, where new regulations are considered carefully prior to implementation. The introduction of a wool and mohair licensing requirement has proved disruptive for farmers (Box 4). In mining, the authorities are creating a new regulatory authority and considering additional regulations to increase domestic beneficiation. Staff agrees on the importance of an independent, well-resourced agency that can effectively regulate the industry and limit political interference and governance concerns. However, further regulations aimed at increasing domestic beneficiation need to be discussed with stakeholders, and only implemented on the basis of a careful study of the technical and economic feasibility.

Box 4.Wool and Mohair Licensing Regulations

Lesotho’s wool and mohair were traditionally auctioned in South Africa. Around 100,000 farmers own sheep and goats in Lesotho, producing around USD 30 million per year in wool and mohair. The farmers are mostly located in the highlands and, for many of them, wool and mohair are their major source of livelihood. Historically, after the wool and mohair was sheared in government or association-operated sheds, it was shipped to Port Elizabeth, to be auctioned through a South African broker.

In 2018, the authorities introduced new licensing requirements to trade wool and mohair. Only licensed agents may now export wool and mohair produced in Lesotho and obtaining such a license requires an extremely large storage facility, which constitutes a significant barrier to entry. Only one company has secured a license, creating a de-facto monopsony through whom farmers have to market their production. The authorities have, however, noted that other companies have expressed interest in applying for licenses.

While the full effect of the regulations remains to be seen, farmers have expressed strong opposition. The authorities noted that farmers will benefit from lower transportation costs and brokering commissions under the new regulations. They also noted that additional beneficiation will take place in Lesotho, including warehousing and marketing. However, mohair farmers have reported long delays in receiving payments, and a lack of transparency in pricing and payments.

25. The need for policy certainty also extends to industrial relations. In the textile industry, the government intervened in the conflict between workers and employers in mid-2018, mandating a 67 percent increment that was later reversed in court. The resulting unrest reportedly led to the suspension of two large investment projects. The authorities should provide a stable and flexible framework for industrial negotiations. There is also room to enhance the wage determination process (Annex IV).

26. Government intervention should focus on addressing market failures, enhancing competition, and time-limited programs to support innovation. While the government has attempted to drive growth through the Lesotho National Development Corporation (LNDC, whose mandate is focused on inward and large-scale investment) and the Basotho Enterprises Development Corporation (BEDCO, which focuses on SMEs), governance concerns, instability, and an unwillingness to cut off support from underperforming endeavors has at times undermined their objectives. In the last decade, the LNDC has had 7 different heads, and is currently being restructured in line with World Bank advice. BEDCO has maintained some of the same companies in its incubators for decades. The government should divest from businesses that have already prospered, or where underperformance has been chronic, for example through privatization. The authorities should be cautious in ensuring that the latest support programs for entrepreneurs announced in the FY 2019/20 budget do not replicate the challenges described above.

27. Business climate reforms must include strengthening the fight against corruption. The private sector considers corruption a major obstacle for doing business (Annex IV). The Directorate on Corruption and Economic Offences (DCEO) is implementing an asset declaration for public servants, and Cabinet is considering a new anti-corruption bill that would increase the independence of the DCEO. While staff welcomes these reforms and urges their timely implementation, it is also important to improve the collaboration between the DCEO and the Directorate of Public Prosecutions with a view to ensuring that prosecutions take place expeditiously.

28. Structural reforms could result in a significant payoff in terms of jobs and growth. Staff estimates suggest that the measures discussed to facilitate business, promote competition, and review spending inefficiencies in health and education could, if combined with the financial sector reforms discussed below, raise GDP per capita by over 10 percent over the medium term.10 They could also have a significant impact on unemployment. In the short term, the largest share of the gains would come from a better business environment, while labor market, goods market, and financial markets reforms would also contribute (Annex IV). Over the long-term human capital reforms, such as containing HIV and improving the quality of primary education, could drive higher growth.

Impact of Structural Reforms in Lesotho

Source: Staff estimates.

Authorities’ Views

The authorities agreed that competition is a key driver of growth, but considered that regulations may be justified in the short run to induce domestic beneficiation. They noted their intention to consider additional licenses in the wool and mohair sector. The authorities expressed their commitment to consult stakeholders on reforms to the mining regulatory framework and noted their goal of limiting discretionary powers in setting royalties. They reiterated their commitment to fighting corruption. They noted that increasing private sector participation in SOEs is being considered, which could boost the Maseru Securities Market and the domestic capital market. They recently announced the creation of an investment lab, which will seek out and facilitate greater private sector investment, and an apprenticeship strategy to address the skills needs of industry.

C. Increasing Financial Sector Stability and Inclusion

29. While the banking system is sound and profitable, indebted households and concentration risks require close monitoring. Profitability remains high, driven by significant intermediation margins with returns on equity in the range of 28 percent as of December 2018. Bank lending is highly concentrated, with the ratio of large exposures to capital of some banks reaching 220 percent. The credit bureau considerably improved information availability, but currently only covers information from formal financial institutions on households.11 Since household borrowing from informal sources is unobserved, banks may not have a full picture of household indebtedness.

Capital Adequacy Ratios

(Percent)

Sources: IMF Financial Soundness Indicators and IMF staff. Note: The minimum CAR is 8%.

30. Progress has been made on the frameworks for AML/CFT supervision of financial institutions, but strong enforcement will be necessary. Lesotho has taken a number of steps to strengthen its Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) framework in line with Fund TA. However, the recent national assessment identified AML/CFT supervision of financial institutions and Designated Non-Financial Businesses and Professions (DNFBPs) as a major vulnerability and there have been no prosecuted case so far. To intensify AML/CFT supervision, Lesotho’s Financial Intelligence Unit (FIU) should be independent and adequately resourced. Supervisory arrangements between the CBL and the FIU should be clear and streamlined. Demonstrating effective implementation will be essential ahead of the next assessment by the FATF regional body.

31. The banking system’s contribution to growth remains limited. Credit to the private sector has remained stagnant at about 17 percent of GDP in the past five years, well below income group peers. To improve access to formal credit, structural reforms are necessary. The lack of bankable projects, high credit costs, inadequate legal frameworks and processes to settle financial disputes and property rights all contribute to anemic levels of credit to the private sector, with corporate lending concentrated in the few larger firms. The passage of the two bills on Security Interest and Movable Property and Insolvency are a good step towards resolving some of these issues. However, current land registries, property rights and lengthy financial dispute settlements render collateralized lending de facto uncollateralized. With settlements taking years and losses being recognized as per IFRS 9 long before the collateral can be claimed, banks are hesitant to extend further credit to the private sector.

Loans and Deposit Growth

(Annual percentage change and percent)

Sources: IMF Financial Soundness Indicators and IMF staff.

32. Strengthening regulatory frameworks for pension funds and financial cooperatives must be a priority to contain risks and protect the poorest (Annex V). NBFIs12 in Lesotho represent almost half of the country’s financial system, excluding the CBL. The authorities noted that the Pensions Bill is expected to be passed by Parliament in 2019. However, delays in the approval of the Financial Cooperative Bill continue to leave financial cooperatives13 inadequately supervised. The largest financial cooperative, Boliba, exists in a regulatory limbo, continuing to accept deposits despite governance concerns, while the disclosure of 2017 and 2018 audits is still pending. The passage of the Financial Cooperative Bill will provide the Ministry of Small Business Development, Cooperatives, and Marketing (MoSBDCM) with more powers to address troubled financial cooperatives, but capacity constraints may limit the effectiveness of supervision. Instead, transferring supervisory powers over all deposit-taking financial institutions to the CBL would be a better approach. This way, structural issues could be addressed, and financial cooperatives could potentially enhance financial inclusion.

Authorities’ Views

The authorities noted that credit concentration is closely monitored and within stipulated prudential limits. The authorities are extending the credit bureau to include information on informal lenders by licensing them as MFI. There is progress in NBFI supervision towards the implementation of the risk based supervisory approach. The establishment of Boliba’s new committee was noted as a milestone in addressing governance issues. The authorities stressed the importance of developing the secondary market for government debt, and requested additional technical assistance.

Other Surveillance Issues

33. While data are broadly adequate for surveillance, there remains room to enhance data transparency and reliability. In addition to the PFM issues noted above, which constitute the key priority area for capacity development (see Annex VI), there are several data issues that require attention:

  • Strengthening national account statistics is a priority which should be institutionalized through MOUs among government units. TA recommendations on national accounts should be implemented.
  • Coverage of the fiscal data should be expanded to include the largest extra budgetary units. In addition, contingent liabilities and guarantees of extra-budgetary funds should be included in debt reports. Guarantees should also be fully and transparently disclosed.
  • To improve financial surveillance, the coverage of monetary and financial statistics should be expanded to include the NBFIs’ financial accounts. TA recommendations on monetary and financial statistics should be implemented within the agreed target completion dates.

Authorities’ Views

The authorities agreed on the importance of institutionalizing data sharing arrangements and supporting compilation of national accounts. They noted ongoing improvements in the recording of fiscal guarantees.

Staff Appraisal

34. The prospect of permanently lower SACU revenues presents Lesotho with both a challenge and an opportunity. Buoyant inflows over the past years were used to finance the creation of a large public sector. Yet this public sector has provided too little in the way of public goods. With government wages and benefits, travel, and generous tertiary education allowances consuming so much of the budget, outcomes in health, education, and infrastructure remain inadequate. Now with buffers depleted, the pension fund underfunded, and debt assessed as at moderate risk of distress, an adjustment is needed to allow for the clearance of payment arrears, buttress debt sustainability and international reserves, and strengthen the external position.

35. A fiscal adjustment should not just restore macroeconomic sustainability, but also lay the groundwork for stronger and more inclusive growth. A gradual reduction in the wage bill will encourage private sector labor force participation and will free up resources to support the priorities of the NSDP-II. In this context, a large public works and internship program could be a step backwards. Addressing PFM deficiencies and a selective broadening of the tax base, complemented by improvements to tax administration, will reduce arrears while easing the burden of adjustment. Improving efficiency in health and education can support better outcomes at a lower cost to the fiscus. Improving debt management, maintaining a cautious approach to external debt contraction, and addressing contingent liabilities such as that of the public-sector pension fund will complement the fiscal consolidation and underpin debt sustainability.

36. As well as reorienting expenditures in support of growth, the government should take measures to strengthen the business climate. A stable regulatory framework is critical to attract investment. Existing licensing requirements could be re-evaluated, implementation of disruptive new regulations avoided, and early and regular consultation with the private sector could limit uncertainty. Government intervention in the economy should seek to address market failures while promoting competition and efficiency, and avoid creating new monopolies and opportunities for rent-seeking.

37. The authorities’ agenda to enhance the financial sector’s contribution to growth should be enacted expeditiously. The passage of the draft bills on Security Interest and Movable Property and Insolvency will be an important step in ensuring that the sector can provide the support necessary for structural reforms to bear fruit. Strong enforcement of the AML/CFT framework will demonstrate that the regulatory regime is in line with good international practice. Legislation to improve the regulation of the non-bank financial sector is needed to underpin the financial inclusion agenda.

38. The FY2019/2020 budget contains many positive elements that should help to restore fiscal, and hence external, stability. However, consistent and rigorous implementation will be key to ensure that the envisaged measures are fully effected. Moreover, it should be one element in a series of broader reforms that can allow Lesotho to fulfil its potential and attain higher and more inclusive growth for its population.

40. Staff recommends that the next Article IV consultation for Lesotho be held on the standard 12-month cycle.14

Figure 1.Lesotho: Recent Economic Developments

Sources: Country authorities, WDI, and staff estimates.

Figure 2.Lesotho: External Imbalances

Sources: Country authorities and staff estimates.

Figure 3.Lesotho: Inefficient Expenditure Explains Weak Educational Outcomes

Sources: Country authorities, WDI, and staff estimates.

Figure 4.Lesotho: Inefficient Expenditure Explains Weak Health Outcomes

Sources: Country authorities, World Bank, IMF FAD Expenditure Assessment Tool (EAT), and staff estimates.

Annex I. External Sector Assessment

The external position of Lesotho in FY 2018/19 was weaker than the level consistent with medium term fundamentals and desirable policies. Fiscal consolidation is required to restore the external balance and to stem the drawdown of international reserves.

Background

1. The current account deficit increased to 8.4 percent of GDP in 2018/19 reflecting a fall in SACU revenues. SACU revenues increased to 17.7 percent of GDP in FY 2017/18 from 13.3 in FY 2016/17, still significantly below the recent peak of 24.1 in FY2014/15. SACU revenues have declined again in FY 2018/19 and are expected to remain subdued owing to sluggish growth in South Africa. Rapid import growth, even in a depressed economic context with fiscal cash rationing, and weaker export of services offset stronger diamond exports and led to a worsening of the trade balance. For the medium term, imports are expected to grow rapidly as construction of the Lesotho Highlands Water Project Phase II begins leading to a worsening of the current account. However, the project will be financed with capital grants from South Africa.

Current Account Balance

(In percent of GDP)

Source: Country authorities.

2. Foreign direct investment (FDI) inflows slowed and other investment outflows grew, putting pressure on international reserves to finance the current account deficit. FDI inflows reached 4.6 percent of GDP in FY 2015/16, reflecting investments in diamond mines, but have since declined to less than 2 percent. Other investments have shifted from an inflow of 8.2 percent of GDP in FY 2014/15 to an outflow of 3.2 in FY 2017/18 as commercial banks have significantly increased their net foreign assets.

External Financing

(In percent of GDP)

Source: Country authorities.

3. As a result, gross international reserves have continued to decline in months of imports. In March 2018, gross international reserves stood at USD 851 million, a slight increase with respect to the previous year because of the appreciation of the rand. However, coverage in terms of months of imports is estimated to have fallen to 3.5 in FY 2018/19 from a peak of just over 6 in FY 2015/16, and as of January 2019, gross international reserves had declined further to USD 792 million. Maintaining a robust level of reserves is critical to sustaining confidence in the peg to the rand. A cost-benefit panel model suggests an optimal level of reserves to be around 4 months of imports.1 The authorities have targeted reserve coverage of at least 120 percent of M1 plus callable deposits, which they believe provides confidence that the link to the rand can be maintained.2 Staff concur that this level would be adequate to maintain the peg, but note that the government has only maintained reserves at the target at the cost of running up delays in making domestic payments. Fiscal consolidation will be required to eliminate the arrears while keeping reserves at an adequate level.

4. Real and nominal effective exchange rate movements continue to follow South African developments closely. The depreciation trend from 2011 to 2015 was partly offset by a slow appreciation that accelerated in December 2017 and early 2018. Global turmoil in flows to emerging markets contributed to a sharp depreciation of the rand that extended until September 2018. The exchange rate has appreciated slightly since.

Real and Nominal Effective Exchange Rates

(Index, 2010=100)

Source: Staff estimates.

Assessment

5. Staff assesses that Lesotho’s position in FY 2018/19 is weaker than the level consistent with medium-term fundamentals and desired policies. The EBA-lite current account deficit norm of 4.3 percent of GDP is significantly lower than the expected 8.4 percent for FY 2018/19. The difference is driven by a substantial policy gap, particularly on fiscal stance and public health expenditure. Similarly, the real exchange rate is found to be overvalued. The estimated 9.4 percent REER gap for FY 2018/19 represents an increase from the 2.6 percent in FY 2016/17 reflecting strong import growth despite the slowdown in economic activity and inflation. The expected further deterioration of the current account calls for fiscal consolidation to restore the external position to a sustainable level. Reducing public sector wages in real terms would, over the medium term, reduce the distortions in the labor market and help to enhance competitiveness.

Current Account and Real Exchange Assessments(Index, 2010=100)
Current Account Actual-8.4%
Current Account Norm-4.3%
Current Account Gap-4.0%
o/w Policy gap-3.8%
REER Gap9.4%
Source: Staff estimates.
Source: Staff estimates.
Annex II. Risk Assessment Matrix
Source of main risksRelative LikelihoodExpected impact on the economy if risk is realizedRelative ImpactPossible remedial policy
Global Risks
Rising protectionism and retreat from multilateralism.HighHigher tariff and non-tariff barriers will reduce competitiveness and weaken demand for Lesotho’s exports.HighAdvance structural reforms to reduce income inequality and increase competitiveness and diversification.

Implement the remaining SADC recommendations in a timely manner.
Weaker-than-expected global growth, including significant slowdown in China, or key advanced and emerging economies.HighDepressed global demand translates into weaker Lesotho exports to the rest of the World, in particular to the main trading partner, SA, and to a lesser extent, the U.S. and EU. An economic slowdown in SA would reduce SACU transfers, which form a substantial portion of fiscal revenues.HighAdvance structural reforms to reduce income inequality and increase competitiveness and diversification.
Domestic Risks
Renewed political instability.HighPolitical instability would delay reform implementation, particularly for the needed fiscal consolidation efforts.HighImplement the remaining SADC recommendations in a timely manner, ideally by the May 2019 deadline.
El-Nino related drought materializes.HighWeaker-than-expected harvests result in food shortages and a spike in food prices. Food security, particularly in rural areas, could be compromised.HighImplement fiscal consolidation to create fiscal space for additional food subsidies and crisis management. Mobilize concessional/grant financing to support food security action plan.
Insufficient fiscal adjustment to stagnation in SACU transfers.HighLesotho’s fiscal and external position would decline sharply with negative repercussions for the stability of the peg to the rand and domestic arrears.HighImplement fiscal consolidation and seek concessional financing by reengaging with donors.
Annex III. Debt Sustainability Analysis 1,2
Lesotho: Joint Bank-Fund Debt Sustainability Analysis
Risk of external debt distressModerate
Overall risk of debt distressModerate
Granularity in the risk ratingSome space
Application of judgementNo

Lesotho’s risk of external debt distress has been revised from “low” in the 2017 Article IV to “moderate,” reflecting weaker GDP growth projections, expanded debt coverage, larger deficits, and the inclusion of large contingent liabilities. The overall risk of debt distress is also assessed to be moderate. The moderate risk tool suggests some space to absorb shocks. The results of the DSA highlight the importance of addressing underfunding of the pension fund, preserving a cautious debt management strategy, and developing the domestic debt market. Fiscal consolidation, particularly addressing the high public-sector wage bill, are needed to reduce external imbalances and mitigate vulnerabilities.

Public Debt Coverage

1. Lesotho’s public debt data covers the central government, the central bank, and publicly-guaranteed debts for SOEs (Table 1). Debt coverage is similar to the previous DSA, but the tailored contingent liability shock captures the unaccounted subsectors of the public sector. Specifically, the contingent liability shock captures shortfalls of the pension fund, estimated to be between 10.3 and 20.7 percent of GDP,3 and applies the default 2 percent GDP shocks to capture non-guaranteed SOE debt since comprehensive estimates of non-guaranteed SOE debt are not available. The contingent liability stress test also includes 5 percent of GDP for a financial market shock and 35 percent of the PPP capital stock, which is estimated to be 3.2 percent of GDP. External debt is defined based on currency-criterion as there is no foreign holdings of local-currency debt. Domestic arrears are included in the debt stock.

Table 1.Lesotho: Coverage of Public Sector Debt and Design of the Contingent Liability Stress Test
Subsectors of the public sectorSub-sectors covered
1Central governmentX
2State and local government
3Other elements in general government
4o/w: Social Security fund
5o/w: Extra budgetary funds (EBFs)
6Guarantees (to other entities in the public and private sector, including to SOEs)X
7Central bank (borrowed on behalf of the government)X
8Non guaranted SOE debt

The default shock of 2 Percent of GDP will be triggered for countries whose government-guaranteed debt is not fully captured under the country’s public debt definition (1.). If it is ready included in the government debt (1.) and risks associated with SoE’s debt not guaranteed by the government is assessed to b negotiable, a country team may reduce this to 0 percent.

1The Country’s coverage of public debtThe central government, central bank, government-guaranteed debt
DefaultUsed for the analysisReasons dor deviations from the default settings
2Other elements of the central government not captured in 10 percent of GDP20.7
3SoE’s debt (guaranteed and not guaranteed by the government 1/2 percent of PPP stock2.0
4PPP35 percent of GDP1.1
5Financial market (the default value of 5 percent of GDP is the minimum value)5 percent of PPP stock5.0
Total (2+3+4+5)(in percent of GDP)28.8

The default shock of 2 Percent of GDP will be triggered for countries whose government-guaranteed debt is not fully captured under the country’s public debt definition (1.). If it is ready included in the government debt (1.) and risks associated with SoE’s debt not guaranteed by the government is assessed to b negotiable, a country team may reduce this to 0 percent.

The default shock of 2 Percent of GDP will be triggered for countries whose government-guaranteed debt is not fully captured under the country’s public debt definition (1.). If it is ready included in the government debt (1.) and risks associated with SoE’s debt not guaranteed by the government is assessed to b negotiable, a country team may reduce this to 0 percent.

Background

2. Lesotho’s total public debt increased to 38.8 percent of GDP in FY 2017/18 from 37.6 percent (Table 2).4 The increase was observed in both domestic and external borrowing and was partially offset by growth in nominal GDP and appreciation of the rand. External debt continues to account for most of total debt (79.1 percent) and is largely owed to multilateral creditors. Domestic debt grew from 4.5 to 8.2 percent of GDP in FY 2017/18 as authorities issued new bonds of M400 million and accumulated arrears of M700 million. The gradual increase in the share of domestic debt, by tapping into the large pool of assets held by the pension fund and insurance companies, is a goal of the authorities for the medium-term.5

Table 2.Lesotho: Stock of Outstanding Debt, 2013/14–2017/18
2013/142014/152015/162016/172017/18
(in million USD)
Domestic Debt111120120104214
External Debt828825841849899
Multilateral724692709727775
IDA308273292295331
ADF191167167159165
EIB6710295127135
IMF7968706561
Other7883858283
Bilateral98129132123124
China EXIM Bank4357545049
Kuwait Fund2529292726
Saudi Fund1423232322
Abu Dhabi Fund310161517
India EXIM Bank77665
Other64336
Commercial65000
Total9399459619531,114
(in percent of GDP)
Domestic Debt4.04.44.64.58.2
External Debt34.534.538.733.130.7
Multilateral30.228.932.628.326.4
IDA12.911.413.411.511.3
ADF8.07.07.76.25.6
EIB2.84.24.45.04.6
IMF3.32.83.22.52.1
Other3.33.43.93.22.8
Bilateral4.15.46.14.84.2
China EXIM Bank1.82.42.51.91.7
Kuwait Fund1.11.21.31.10.9
Saudi Fund0.60.91.10.90.7
Abu Dhabi Fund0.10.40.70.60.6
India EXIM Bank0.30.30.30.20.2
Other0.30.20.20.10.2
Commercial0.20.20.00.00.0
Total38.538.843.237.638.8
Sources: Country authorities and staff estimates.Note: Domestic Debt includes arrears and guarantees.
Sources: Country authorities and staff estimates.Note: Domestic Debt includes arrears and guarantees.

Assumptions

3. The macroeconomic framework is broadly in line with the previous DSA, though GDP growth is now slightly lower (Table 3). Real GDP growth for the medium term has been revised downwards from an average of 3.1 percent to 2.6 percent, reflecting delays in the second phase of the Lesotho Highlands Water Project (LHWP-II) and in implementing fiscal consolidation. Long run real GDP growth is revised downwards to around 3 percent, reflecting recent evidence of tighter domestic constraints and a more adverse external environment. Inflation projections are slightly higher at around 5.5 percent in line with monetary developments in South Africa. A primary fiscal deficit of 0.8 percent on average is expected for the medium term based on the consolidatory stance envisaged in the FY 2019/20 budget. Over the long run, fiscal deficit is now projected to average 0.4 percent of GDP as opposed to a 0.6 percent surplus in the previous DSA, reflecting higher capital expenditures. On the external sector, weaker export growth and the secular decline in remittances from South Africa are expected to deteriorate the current account balance slightly over the medium term with respect to the previous DSA, with the large deficit still reflecting the high import component of the LHWP-II. Over the long run, the current account balance is expected to remain negative.

Table 3.Lesotho: Macroeconomic Assumptions
2017 DSA2018 DSA2017 DSA2018 DSA
2017–222018–232023–372024–38
Real GDP Growth (Percent)3.12.53.42.9
Inflation (Percent)5.55.55.15.5
Primary Deficit (Percent of GDP)1.60.8-0.60.4
USD Export Growth (Percent)7.96.57.36.3
USD Import Growth (Percent)8.65.34.65.2
Non-interest Current Account Balance (Percent of GDP)-8.3-9.6-2.1-2.7
Net FDI (negative = inflow)-0.7-1.6-0.7-1.7
Grant element of new public sector borrowing (in percent)42.326.942.320.8
External Debt (Percent of GDP)34.535.730.334.5
Public Sector Debt (Percent of GDP)42.650.240.851.0
Sources: IMF Country Report No. 18/54 and staffs estimates and projections.
Sources: IMF Country Report No. 18/54 and staffs estimates and projections.

4. Debt assumptions take account of the latest information on new borrowing. The government has recently signed a semi-concessional loan of M1.4 billion with the Export-Import Bank of China to build a road of 92km connecting Ha Mpiti and Sehlabathebe. Signature of a USD 20 million World Bank loan in the context of the Agriculture Productivity Program for Southern Africa is expected in the next few months.

5. External borrowing at concessional terms is expected to decline moderately, while remaining significant. Concessionality is assumed to be lower than in the previous DSA, reflecting the latest terms Lesotho has obtained. Furthermore, as Lesotho grows and graduates from some concessional borrowing sources and the domestic market develops, concessionality is expected to further decline over time. However, concessional external borrowing will remain critical for financing large investment projects, as was discussed in the previous DSA. In line with the authorities’ medium-term goals, the development of the domestic market is assumed to continue. By FY 2038/39, domestic borrowing is expected to account for around one-third of total debt.

6. The realism of the macroeconomic framework is confirmed by several checks (Figures 3 and 4). The path for external debt accumulation remains largely unchanged with respect to the previous DSA. The current account deficits, which have in the recent past been partly funded by the drawdown of international reserves, are expected to be financed in the medium-term with the support of capital transfers, in particular those financing the LHWP-II (which is administered by the Lesotho Highlands Development Authority, which is not consolidated with the fiscus). With respect to the previous DSA, higher public debt is expected for the medium term as GDP growth has been lowered, while a larger domestic debt component will result in higher interest rates. The DSA projects a significant shift in borrowing assumptions towards less concessional external borrowing and more domestic debt, reflecting the likely availability of financing. The fiscal multiplier is assumed to be small due to high import content, and the negative impact of fiscal consolidation on GDP growth is expected to be partially offset by the beginning of the LHWP-II (unless the project experiences further delays) and positive developments in mining and textiles. Real exchange rate depreciation is also expected to contribute to the projected increase of the public debt. Unexpected changes in debt have not been significant over the past 5 years.

Country Classification and Determination of Scenario Stress Tests

7. Lesotho has a medium debt carrying capacity (Table 4). Debt carrying capacity is determined by a composite indicator that includes the World Bank’s Country Policy and Institutional Assessment score, world economic growth, and Lesotho’s real growth rate, import coverage of reserves, and remittances. Lesotho’s debt carrying capacity is assessed to be medium.

Table 4.Lesotho: Debt Carrying Capacity

8. Lesotho does not qualify for other tailored stress tests. Apart from the contingent liability tailored shock described above, Lesotho’s economic characteristics do not trigger any of the tailored stress tests on natural disasters, commodity prices, and/or market financing risk module.

External Debt Sustainability Analysis

9. All external debt sustainability indicators remain below their corresponding thresholds in the baseline scenario (Table 5 and Figure 1).6 In the medium term, the present value (PV) of PPG external debt-to-GDP is expected to reach a maximum of 27.4 percent by

Table 5.Lesotho: External Debt Sustainability Framework, Baseline Scenario, 2017–2038(In percent of GDP, unless otherwise indicated)
ActualProjectionsAverage 8/
201720182019202020212022202320282038HistoricalProjections
External debt (nominal) 1/30.736.136.136.535.734.734.834.234.432.935.2
of which: public and publicly guaranteed (PPG)30.736.136.136.535.734.734.834.234.432.935.2
Change in external debt-2.45.40.10.3-0.8-0.90.1-0.20.0
Identified net debt-creating flows-0.16.311.53.26.212.57.01.8-0.70.35.0
Non-interest current account deficit4.18.213.64.18.415.08.53.71.03.46.8
Deficit in balance of goods and services42.042.147.838.842.448.341.837.131.752.040.6
Exports43.745.346.649.749.949.850.951.658.5
Imports85.887.494.488.592.398.192.888.690.2
Net current transfers (negative = inflow)-24.2-20.9-21.6-22.3-21.9-21.7-21.6-21.9-20.6-29.5-21.8
of which: official-19.1-15.9-16.5-17.2-16.9-16.6-16.5-16.8-15.6
Other current account flows (negative = net inflow)-13.7-13.0-12.6-12.4-12.1-11.6-11.7-11.4-10.1-19.2-12.0
Net FDI (negative = inflow)-1.7-1.5-1.7-1.7-1.7-1.7-1.7-1.7-1.7-2.6-1.6
Endogenous debt dynamics 2/-2.5-0.3-0.40.7-0.6-0.80.2-0.3-0.1
Contribution from nominal interest rate0.60.50.60.70.60.60.60.70.9
Contribution from real GDP growth-0.2-0.9-1.10.1-1.3-1.4-0.5-1.0-1.0
Contribution from price and exchange rate changes-3.0
Residual 3/-2.3-0.9-11.4-2.8-7.0-13.5-7.0-2.00.8-1.4-4.7
of which: exceptional financing0.00.00.00.00.00.00.00.00.0
Sustainability indicators
PV of PPG external debt-to-GDP ratio25.026.226.927.426.826.226.426.728.0
PV of PPG external debt-to-exports ratio57.157.957.755.053.852.651.851.847.8
PPG debt service-to-exports ratio4.83.55.45.15.05.04.84.54.6
PPG debt service-to-revenue ratio5.24.06.46.46.36.36.25.66.5
Gross external financing need (Million of U.S. dollars)120.9224.3401.1141.3279.8507.3311.6189.9150.1
Key macroeconomic assumptions
Real GDP growth (in percent)0.52.93.1-0.23.64.21.43.03.03.72.6
GDP deflator in US dollar terms (change in percent)9.9-1.3-1.02.72.32.32.72.42.40.41.8
Effective interest rate (percent) 4/2.11.71.81.91.91.81.92.32.81.42.0
Growth of exports of G&S (US dollar terms, in percent)21.95.05.19.46.46.56.46.57.03.76.0
Growth of imports of G&S (US dollar terms, in percent)17.83.410.2-3.910.613.3-1.65.65.72.34.8
Grant element of new public sector borrowing (in percent)28.227.027.327.726.326.122.816.125.7
Government revenues (excluding grants, in percent of GDP)40.538.639.440.039.639.439.441.541.545.940.1
Aid flows (in Million of US dollars) 5/703.5103.696.298.695.476.979.181.6139.0
Grant-equivalent financing (in percent of GDP) 6/3.53.43.43.33.23.22.62.53.1
Grant-equivalent financing (in percent of external financing) 6/64.958.058.659.458.657.551.745.156.6
Nominal GDP (Million of US dollars)2,6772,7172,7752,8433,0153,2133,3444,2937,315
Nominal dollar GDP growth10.51.52.12.46.16.54.15.55.54.14.4
Memorandum items:
PV of external debt 7/25.026.226.927.426.826.226.426.728.0
n percent of exports57.157.957.755.053.852.651.851.847.8
Total external debt service-to-expo rts ratio4.83.55.45.15.05.04.84.54.6
PV of PPG external debt (in Million of US dollars)668.9711.8745.5777.9809.0843.0882.81147.12046.9
(PVt-PVt-1)/GDPM (in percent)1.61.21.21.11.11.21.51.7
Non-interest current account deficit that stabilizes debt ratio6.52.813.53.79.215.98.53.91.0
Sources: Country authorities; and staff estimates and projections.

Includes both public and private sector external debt.

Derived as [r- g – p(1+g)]/(1+g+p+gp) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and p = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Current-year interest payments divided by previous period debt stock.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

Assumes that PV of private sector debt is equivalent to its face value.

Historical averages are generally derived over the past 10 years, subject to data availability, whereas projections averages are over the first year of projection and the next 10 years.

Sources: Country authorities; and staff estimates and projections.

Includes both public and private sector external debt.

Derived as [r- g – p(1+g)]/(1+g+p+gp) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and p = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Current-year interest payments divided by previous period debt stock.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

Assumes that PV of private sector debt is equivalent to its face value.

Historical averages are generally derived over the past 10 years, subject to data availability, whereas projections averages are over the first year of projection and the next 10 years.

Figure 1.Lesotho: Indicators of Public and Publicly Guaranteed External Debt under Alternative Scenarios, 2018–2028 1/

Sources: Country authorities; and staff estimates and projections.

1/ The most extreme stress test is the test that yields the highest ratio in or before 2028. Stress tests with one-off breaches are also presented (if any), while these one-off breaches are deemed away for mechanical signals. When a stress test with a one-off breach happens to be the most exterme shock even after disregarding the one-off breach, only that stress test (with a one-off breach) would be presented.

2/ The magnitude of shocks used for the commodity price shock stress test are based on the commodity prices outlook prepared by the IMF research department.

FY 2020/21 from a level of 25.0 percent in FY 2017/18. In the longer term, it is expected to increase modestly to 28.0 percent. All other indicators of external debt sustainability remain well below the thresholds.

10. Stress tests show that Lesotho’s external debt vulnerabilities could emerge in the event of a realization of a contingent liabilities shock or a major shock to exports (Table 7 and Figure 1). The threshold of PV of PPG external debt-to-GDP would be breached if a large contingent liabilities shock, emerging mainly from the unfunded pension fund, were to be realized. Even absent the contingent liabilities shocks, the threshold would still be breached in the case of a large negative exports shock or other flows. All other indicators of external debt sustainability remain below the thresholds.

Table 6.Lesotho: Public Sector Debt Sustainability Framework, Baseline Scenario, 2017–2038(In percent of GDP, unless otherwise indicated)
ActualProjectionsAverage 6/
201720182019202020212022202320282038HistoricalProjections
Public sector debt 1/38.846.849.551.751.450.751.151.450.037.751.0
of which: external debt30.736.136.136.535.734.734.834.234.432.935.2
Change in public sector debt1.27.92.72.2-0.2-0.70.4-0.2-0.1
Identified debt-creating flows-0.88.31.10.5-1.3-2.2-1.1-0.3-0.10.90.3
Primary deficit2.54.31.80.30.0-0.7-0.90.50.52.40.5
Revenue and grants42.941.341.942.442.041.841.743.443.448.642.4
of which: grants2.42.82.52.52.42.42.41.91.9
Primary (noninterest) expenditure45.445.743.742.842.041.140.843.943.950.942.9
Automatic debt dynamics-3.34.0-0.70.1-1.3-1.5-0.3-0.8-0.6
Contribution from interest rate/growth differential0.1-1.4-1.00.5-1.3-1.5-0.2-0.7-0.5
of which: contribution from average real interest rate0.3-0.30.40.40.50.60.50.80.9
of which: contribution from real GDP growth-0.2-1.1-1.40.1-1.8-2.1-0.7-1.5-1.5
Contribution from real exchange rate depreciation-3.4
Other identified debt-creating flows0.00.00.00.00.00.00.00.00.00.00.0
Privatization receipts (negative)0.00.00.00.00.00.00.00.00.0
Recognition of contingent liabilities (e.g., bank recapitalization)0.00.00.00.00.00.00.00.00.0
Debt relief (HIPC and other)0.00.00.00.00.00.00.00.00.0
Other debt creating or reducing flow (please specify)0.00.00.00.00.00.00.00.00.0
Residual2.15.01.91.31.11.51.50.00.0-1.21.3
Sustainability indicators
PV of public debt-to-GDP ratio 2/31.037.940.742.942.942.543.144.244.0
PV of public debt-to-revenue and grants ratio72.391.797.3101.0102.2101.7103.3101.9101.4
Debt service-to-revenue and grants ratio 3/5.614.79.59.513.212.813.014.313.4
Gross financing need 4/4.910.45.84.45.54.64.56.76.3
Key macroeconomic and fiscal assumptions
Real GDP growth (in percent)0.52.93.1-0.23.64.21.43.03.03.72.6
Average nominal interest rate on external debt (in percent)2.01.61.91.91.91.91.92.32.81.42.0
Average real interest rate on domestic debt (in percent)5.6-0.83.63.64.44.94.34.74.80.23.9
Real exchange rate depreciation (in percent, + indicates depreciation)-10.40.3
Inflation rate (GDP deflator, in percent)1.64.95.76.15.35.25.75.55.56.15.5
Growth of real primary spending (deflated by GDP deflator, in percent)-6.13.6-1.3-2.31.72.00.73.03.05.32.3
Primary deficit that stabilizes the debt-to-GDP ratio 5/1.3-3.6-0.9-1.80.20.0-1.30.70.63.4-0.6
PV of contingent liabilities (not included in public sector debt)0.00.00.00.00.00.00.00.00.0
Sources: Country authorities; and staff estimates and projections.

Coverage of debt: The central government, central bank, government-guaranteed debt. Definition of external debt is Currency-based.

The underlying PV of external debt-to-GDP ratio under the public DSA differs from the external DSA with the size of differences depending on exchange rates projections.

Debt service is defined as the sum of interest and amortization of medium and long-term, and short-term debt.

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period and other debt creating/reducing flows.

Defined as a primary deficit minus a change in the public debt-to-GDP ratio ((-): a primary surplus), which would stabilizes the debt ratio only in the year in question.

Historical averages are generally derived over the past 10 years, subject to data availability, whereas projections averages are over the first year of projection and the next 10 years.

Sources: Country authorities; and staff estimates and projections.

Coverage of debt: The central government, central bank, government-guaranteed debt. Definition of external debt is Currency-based.

The underlying PV of external debt-to-GDP ratio under the public DSA differs from the external DSA with the size of differences depending on exchange rates projections.

Debt service is defined as the sum of interest and amortization of medium and long-term, and short-term debt.

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period and other debt creating/reducing flows.

Defined as a primary deficit minus a change in the public debt-to-GDP ratio ((-): a primary surplus), which would stabilizes the debt ratio only in the year in question.

Historical averages are generally derived over the past 10 years, subject to data availability, whereas projections averages are over the first year of projection and the next 10 years.

Table 7.Lesotho: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2018–2028(In percent)
Projections 1/
20182019202020212022202320242025202620272028
PV of debt-to GDP ratio
Baseline26.226.927.426.826.226.426.726.726.726.726.7
A. Alternative Scenarios
A1. Key variables at their historical averages in 2018–2028 2/261817123-2-3-2-1-10
B. Bound Tests
B1. Real GDP growth2628292928282828292929
B2. Primary balance2629333333333334343535
B3. Exports2633464544454544434241
B4. Other flows 3/2633393938383837373635
B5. Depreciation2634252524242425262627
B6. Combination of B1-B52635373736363635353534
C. Tailored Tests
C1. Combined contingent liabilities2637404039404042434444
C2. Natural disastern.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.
C3. Commodity pricen.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.
C4. Market Financingn.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.
Threshold4040404040404040404040
PV of debt-to-exports ratio
Baseline5858555453525553535252
A. Alternative Scenarios
A1. Key variables at their historical averages in 2018–2028 2/583834245-4-6-4-2-10
B. Bound Tests
B1. Real GDP growth5858555453525553535252
B2. Primary balance5863676665656967686867
B3. Exports5879123120117115121115111108104
B4. Other flows 3/5870797776747874727068
B5. Depreciation5858403938374039404141
B6. Combination of B1-B55877718483818581807876
C. Tailored Tests
C1. Combined contingent liabilities5880807978788283868685
C2. Natural disastern.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.
C3. Commodity pricen.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.
C4. Market Financingn.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.
Threshold180180180180180180180180180180180
Debt service-to-exports ratio
Baseline35555555445
A. Alternative Scenarios
A1. Key variables at their historical averages in 2018–2028 2/35444322110
B. Bound Tests
B1. Real GDP growth35555555445
B2. Primary balance35555566666
B3. Exports36888891010109
B4. Other flows 3/35666566666
B5. Depreciation35554443334
B6. Combination of B1-B536777677777
C. Tailored Tests
C1. Combined contingent liabilities35666665556
C2. Natural disastern.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.
C3. Commodity pricen.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.
C4. Market Financingn.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.
Threshold1515151515151515151515
Debt service-to-revenue ratio
Baseline46666666566
A. Alternative Scenarios
A1. Key variables at their historical averages in 2018–2028 2/46555432210
B. Bound Tests
B1. Real GDP growth47777766666
B2. Primary balance46777777777
B3. Exports47788889999
B4. Other flows 3/46777788888
B5. Depreciation48877775556
B6. Combination of B1-B547777787777
C. Tailored Tests
C1. Combined contingent liabilities46777777777
C2. Natural disastern.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.
C3. Commodity pricen.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.
C4. Market Financingn.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.
Threshold1818181818181818181818
Sources: Country authorities; and staff estimates and projections.

A bold value indicates a breach of the threshold.

Variables include real GDP growth, GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Includes official and private transfers and FDI.

Sources: Country authorities; and staff estimates and projections.

A bold value indicates a breach of the threshold.

Variables include real GDP growth, GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Includes official and private transfers and FDI.

Overall Risk of Public Debt Distress

11. All public debt sustainability indicators remain below their corresponding thresholds in the baseline scenario (Table 6 and Figure 2). The PV of public debt-to-GDP is expected to reach a maximum of 44.4 percent by FY 2024/25 from a level of 31.0 percent in 2017/18. Afterwards, it is expected to decline gradually, stabilizing around 44.0 percent in the long term. All other indicators of public debt sustainability also remain well below the thresholds.

Figure 2.Lesotho: Indicators of Public Debt under Alternative Scenarios, 2018–2028

Sources: Country authorities; and staff estimates and projections.

1/ The most extreme stress test is the test that yields the highest ratio in or before 2028. The stress test with a one-off breach is also presented (if any), while the one-off breach is deemed away for mechanical signals. When a stress test with a one-off breach happens to be the most exterme shock even after disregarding the one-off breach, only that stress test (with a one-off breach) would be presented.

12. The realization of a contingent liabilities shock would expose Lesotho’s public debt vulnerabilities (Table 8 and Figure 2). The threshold of PV of public debt-to-GDP would be breached in the event of a large contingent liabilities shock, as the ratio would rise to 66 percent in 2019/20. Real GDP growth, primary balance, exports, and other flows stress tests also lead to breaches. All other indicators of public debt sustainability remain below the thresholds.

Table 8.Lesotho: Sensitivity Analysis for Key Indicators of Public Debt, 2018–2028
Projections 1/
20182019202020212022202320242025202620272028
PV of Debt-to-GDP Ratio
Baseline3841434343434444444444
A. Alternative Scenarios
A1. Key variables at their historical averages in 2018–2028 2/3841434547495253545555
B. Bound Tests
B1. Real GDP growth3843495253566062646769
B2. Primary balance3846565655565857575757
B3. Exports3846595958596059585756
B4. Other flows 3/3847555554555655545453
B5. Depreciation3844434138363532302825
B6. Combination of B1-B53843474443434444444342
C. Tailored Tests
C1. Combined contingent liabilities3866696868687070696968
C2. Natural disastern.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.
C3. Commodity pricen.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.
C4. Market Financingn.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.
Public debt benchmark5555555555555555555555
PV of Debt-to-Revenue Ratio
Baseline9297101102102103107102102102102
A. Alternative Scenarios
A1. Key variables at their historical averages in 2018–2028 2/9298102107113118126122124126128
B. Bound Tests
B1. Real GDP growth92103116122127134143143148153158
B2. Primary balance92111132133132134138132132131130
B3. Exports92109139140139141144136133131129
B4. Other flows 3/92112130130129131134127125123122
B5. Depreciation921071039891878475696459
B6. Combination of B1-B5921031111041021031061021019998
C. Tailored Tests
C1. Combined contingent liabilities92158162163162164168160159158157
C2. Natural disastern.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.
C3. Commodity pricen.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.
C4. Market Financingn.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.
Debt Service-to-Revenue Ratio
Baseline159101313131212131514
A. Alternative Scenarios
A1. Key variables at their historical averages in 2018–2028 2/15991414141414151718
B. Bound Tests15991414141414151718
B1. Real GDP growth1510111515161616192122
B2. Primary balance159131815151517212118
B3. Exports159101414141415161717
B4. Other flows 3/159101414141414151716
B5. Depreciation1510111313131211111212
B6. Combination of B1-B515991513131312151614
C. Tailored Tests
C1. Combined contingent liabilities159221917171724272119
C2. Natural disastern.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.
C3. Commodity pricen.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.
C4. Market Financingn.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.
Sources: Country authorities; and staff estimates and projections.

A bold value indicates a breach of the benchmark.

Variables include real GDP growth, GDP deflator and primary deficit in percent of GDP.

Includes official and private transfers and FDI.

Sources: Country authorities; and staff estimates and projections.

A bold value indicates a breach of the benchmark.

Variables include real GDP growth, GDP deflator and primary deficit in percent of GDP.

Includes official and private transfers and FDI.

13. The mechanical signal for the overall risk of public debt distress is moderate. This result reflects the moderate risk signal for PPG external debt and the public sector debt stock indicator breaching the threshold under some shocks.

Risk Rating and Vulnerabilities

14. Lesotho’s risk of external debt distress has been revised from “low” to “moderate,” with some space to absorb shocks. All external and public debt and debt service indicators for the baseline remain below their respective thresholds, but shocks to contingent liabilities, exports and other flows lead to breaches. The DSA results highlight the importance of addressing the financing gap at the pension fund and continuing with a cautious debt management strategy focused on financing projects with high economic returns through concessional sources. Development of a domestic debt market would also prove critical to deal with contingent liabilities shocks.

Authorities’ Views

Authorities concurred with the DSA and the “moderate” risk rating. They agreed with the need to better monitor domestic contingent liabilities in order to have a comprehensive view of the debt. The authorities highlighted the need for the Debt Department and the public pension fund to agree on a strategy to address the underfunding of the latter. They also agreed that prudent debt management must continue in the medium term, in particular by pursuing financing with a significant grant element and that stronger capacity in the Cash Management Unit would support the forecasting of financing needs. Finally, authorities noted that work has begun on developing a Debt Policy Framework that will guide new decisions on guarantees, contingent liabilities, and unsolicited proposals.

Annex IV. Growth Impact of Structural Reforms

The new National Strategic Development Plan (NSDP-II) aims to support inclusive, private sector-led growth by improving the business climate, accumulating human capital, building enabling infrastructure, and strengthening governance and accountability systems. This annex considers structural reforms in those areas and quantifies their potential impact on growth and job creation.

1. Corruption is a significant institutional weakness in Lesotho. Corruption is perceived as a major obstacle to doing business by the private sector in Lesotho, with high prevalence of bribes and lack of transparency in policymaking.1,2 The authorities understand the concern and are working to address it with a new law to strengthen the independence of the anticorruption agency and the ongoing implementation of an asset declaration requirement for public servants first legislated in 2006.

Institutions in Lesotho

(Index, 10=P75)

Sources: World Bank, World Economic Forum, Frasier Institute.

Note: P75 = 75th percentile of developing and emerging countries.

2. The legal framework fails to solve disputes efficiently. Politicization of the judiciary is a concern. The Court of Appeal was paralyzed for almost two years because of a legal battle over its presidency, which drew significant international attention. Enforcement of contracts is weak and resolving insolvency takes 2.6 years with a recovery rate of 28 cents per dollar on average, as opposed to 2 years and 43 cents of recovery on average in the rest of the SACU region.3 A new insolvency bill is expected to streamline the process and reduce costs.

3. Burdensome and unstable regulations hinder private investment. An onerous license regime exists, and new licenses are created without full buy-in of relevant stakeholders. The 2018 wool and mohair regulations have disrupted the market and raised strong opposition among farmers. Discussions on a new mining bill are still ongoing, creating uncertainty for the industry. Under the Private Sector Competitiveness and Economic Diversification Project, supported by the World Bank and the African Development Bank, the authorities have worked extensively on reducing red tape, e.g. with the introduction of a one-stop shop (OBFC) for licensing. There is room to expand the role of the OBFC, for instance to cover work permits for foreigners, and to streamline regulations. In the case of work permits, removing the requirement of signatures by the PS and Minister could significantly speed up the process, which sometimes takes more than 6 months for a 2-year permit. The authorities are working on a new licensing bill to introduce a risk-based approach and replace pre-inspection with post-inspection requirements to further reduce the number of days needed to start a business, currently 29. The need for trading licenses and annual renewal of tourism licenses can also be reconsidered.

4. There is room to strengthen flexibility of the labor market. The labor movement in Lesotho is fragmented and strikes are rare. However, wages are inflexible and their link to productivity is weak. The minimum wage in the textile industry is binding and was subject of controversy lately when the government intervened ad-hoc after negotiations stalled. Limiting the role of the government to mediating between the parties in industrial relations conflicts, as stipulated by law, while guaranteeing the unions right to pursue peaceful industrial action would lead to more efficient labor market outcomes. The industry could boost productivity by introducing a wage structure that combines a fixed amount and bonuses for meeting production targets. Companies already operating under such a system are reporting positive results. The weak link between pay and productivity in Lesotho also emerges from the massive public wage bill. Public servant wages are significantly higher than those of workers in the private sector, particularly for the highly-educated. Wage increases in the public sector are not linked to productivity and every worker receives an automatic annual notch increase of around 2.5 percent until they reach the highest pay point for their category, in addition to the cost of living adjustment paid to everyone.

Labor Market Flexibility in Lesotho

(Index, 10=P75)

Source: World Economic Forum.

Note: P75 = 75th percentile of developing and emerging countries.

5. Monopoly power limits productivity growth across the economy. Market concentration is high in Lesotho owing to extensive regulations and significant participation of the public sector in the production of goods and services. The new wool and mohair license left local farmers with only one broker through whom they can sell their production. The dairy industry is characterized by monopolies in processing and distribution. Distribution fees collected by the Lesotho National Dairy Board have in the past been used to bailout the processing plant, in what amounts to a regressive tax. Staff welcomes the authorities’ desire to promote competition in the industry through new processing plants and the use of distribution fees to provide technical assistance to farmers. Staff encourages authorities to not raise the distribution fees as that tax would disproportionately hurt the poor. The government owns shares in a number of companies that do not provide essential services such as a hotel, a brewery, and a brick manufacturer, among others. Underperformance of some of these companies has been chronic, and the authorities are considering divesting by selling their shares on the Maseru Securities Market with the dual goal of promoting economic efficiency and boosting domestic market development. The authorities are encouraged to consider the introduction of regulations to promote competition and consumer protection, noting that even if the market size in Lesotho is small, the strong integration with the other SACU countries offers opportunities to leverage economies of scale. Price intervention is also discouraged as it promotes misallocation of resources.

Competition in the Goods Market in Lesotho

(Index, 10=P75)

Source: World Economic Forum.

Note: P75 = 75th percentile of developing and emerging countries.

6. Access to credit is a major impediment for small and medium enterprises. The financial sector in Lesotho is liquid and profitable, yet its ability to intermediate capital between savers and local entrepreneurs is very limited. With credit to the private sector at the lowest level in the region, the financial sector channels domestic savings outwards to South Africa. For example, the pension fund for public employees owns assets for M5 billion, of which only 3 percent is invested in Lesotho. High fees for banking services also hurt financial inclusion and limit the possibility for poor people to borrow formally. The authorities have already taken some measures to improve access to credit. A credit registry has been created and a credit scoring system is being developed. At present, it mainly covers individuals, particularly public employees, but it is expected to be extended to companies. CBL regulations have directed banks to offer a zero-cost bank account for low-income households to foster financial inclusion. The Maseru Securities Market has been created but has no listings. A commercial bank is considering issuing commercial paper. Mortgages, the financial product with the fastest growth recently in the country, are an example of success of reforms after the 2010 Land Act was passed and registration of land titles was streamlined.

Financial Market’s Contribution to Growth in Lesotho

(Index, 10=P75)

Sources: World Bank and World Economic Forum.

Note: P75 = 75th percentile of developing and emerging countries.

7. Lesotho’s labor force suffers from a lack of relevant skills. Educational outcomes are poor despite large spending (Figure 3). While primary completion has risen, over half of the labor force has not completed primary education. Public expenditures in education are large but unproductive. In primary and secondary education, the wage bill accounts for close to 80 percent of the ministerial budget leaving marginal amounts to provide for materials, school feeding, and capital expenditures. While there may be some overstating of primary teachers, the high wage bill mostly reflects high teacher wages, which are on average 8 times the GDP per capita, whereas in South Africa the ratio is 3. Teachers with a college diploma receive a substantially higher wage without additional responsibilities. Limited incentives exist for teachers to relocate to rural areas leading to a very uneven distribution of teachers across the country. Lack of skills is a major concern for the private sector, particularly in skilled occupations such as managers, chefs, engineers, and technicians. The authorities are encouraged to partner with the private sector to develop the specific skills needed in the labor market.

Figure 3.Lesotho: Drivers of Debt Dynamics – Baseline Scenario

1/ Difference between anticipated and actual contributions on debt ratios.

2/ Distribution across LICs for which LIC DSAs were produced.

3/ Given the relatively low private eternal debt for average low-income countries, a ppt change in PPG external debt should be largely explained by the drivers of the external debt dynamics equation.

Educational Attainment in Lesotho

(Percent)

Source: Barro-Lee Educational Attainment Data.

8. Spending inefficiencies contribute to poor health outcomes. Health outcomes deteriorated dramatically in the 1990s with the spread of the HIV epidemic. At 23.6 percent, Lesotho has the second highest HIV prevalence in the world, just after Eswatini. While new infections have been curbed and treatment has expanded with support from the Millennium Challenge Corporation, costs for the health system are high and labor productivity is low. HIV-associated diseases, such as tuberculosis, are also very prevalent. In addition, payments to private health providers are not linked to performance, leading to uneven and low-quality service delivery (Figure 4). The authorities should review the health expenditure framework to better align incentives and improve service delivery with support from the World Bank.

Figure 4.Lesotho: Realism Tools

Figure 5.Lesotho: Qualification of the Moderate Category, 2018–2028 1/

Sources: Country authorities and staff estimates and projections.

1/ For the PV debt/GDP and PV debt/exports threshols, x is 20 percent and y is 40 percent. For debt service/Exports and debt service/revenue thresholds, x is 12 percent and y is 35 percent.

Health Outcomes

(Lesotho vs. comparators)

Source: World Bank.

Note: P75 = 75th percentile of developing and emerging countries.

9. An ambitious program of reforms could deliver large gains in growth and employment. We estimate the gains in output and employment of an ambitious reform package that addresses the weaknesses discussed in this appendix using panel data analysis.4 Implementing these reforms could raise GDP per capita by more than 10 percent over the medium term, while slashing unemployment. Over a quarter of these gains would come from a better business environment to promote private sector development most importantly through tackling of corruption and strengthening auditing standards. Labor market, goods market, and financial markets reforms would contribute a fifth of the gains each, mainly via enhanced flexibility of wage determination, easier access to loans and venture capital, and development of the domestic equity market. Human capital reforms, such as containing HIV prevalence and improving the quality of primary education, would take longer to materialize, but even partial progress attained within a 5-year horizon would contribute 11 percent of the gains.

Growth Impact of Individual Structural Reforms in Lesotho
Institutions
Bureaucracy costs
Efficiency of legal framework in settling disputes
Irregular payments and bribes
Licensing restrictions
Property rights
Protection of minority shareholders’ interests
Resolving Insolvency
Strength of auditing and reporting standards
Transparency of government policymaking
Labor Market
Flexibility of wage determination
Hiring and firing practices
Pay and productivity
Financial Market
Ease of access to loans
Financing through local equity market
Legal rights index
Regulation of securities exchanges
Venture capital availability
Goods Market
Agricultural policy costs
Burden of customs procedures
Business impact of rules on FDI
Effectiveness of anti-monopoly policy
Extent of market dominance
Intensity of local competition
Human Capital
HIV prevalence
Quality of primary education
Source: Staff estimates.Note: A darker color denotes stronger impact on growth
Source: Staff estimates.Note: A darker color denotes stronger impact on growth
Annex V. Leveraging Lesotho’s Financial System

While the banking system is sound, emerging risks require close monitoring. To leverage the full potential of Lesotho’s financial system, structural reforms, a deepening of the capital market and the practical implementation of regulatory frameworks are key. These efforts combined with the newly established financial inclusion agenda have the potential to increase financial access and inclusion.

1. While the banking system is sound and profitable, government payment arrears are an emerging concern for both the financial system and the private sector. Profitability remains high, driven by significant intermediation margins. Banks’ capital buffers appear sufficient but have shrunk in the last year (according to the CBL’s latest stress test). Government arrears are slowly translating into financial difficulties for businesses in Lesotho, a significant part of which depend on government contracts. Banks are reporting a moderate pick-up in NPL levels which may impact banks’ profitability. NPL’s could lead to curtailed investment, drive down tax revenue, and force additional cuts to fiscal spending, if arrears were to accumulate further.

2. Notable progress has been made in establishing the regulatory framework for banking supervision, but implementation will be key. Following the successful issuance of guidelines, the practical implementation of Basel II requirements should be established and the supervision of all deposit taking financial institutions centralized at the CBL. The CBL should closely monitor whether banks conduct business in line with sound corporate governance and accounting principles. More granular data to enable comprehensive financial surveillance would be desirable to support above efforts.

3. The increased provision of mobile money services is an indicator of progress in financial access and inclusion. Transaction values and volumes, the number of agents, mobile money accounts and the type of usage (salary, bill payments) are steadily growing, allowing previously-excluded socioeconomic groups to access financial services. Telecommunication companies are providing insurance products and are also planning to extend microloans in the next months. Banks are catching up by launching e-wallets and establishing their own agent networks. Post Bank is awaiting CBL approval to start issuing mobile money, and a decision is expected soon. While the increased access to financial services contributes to financial deepening and inclusion, the authorities should continue to closely monitor any potential build-up of financial risks.

Mobile money usage

(In million maloti)

Sources: Country authorities and IMF Staff estimations.

4. The low income “saving account” offers formal financial access but awareness needs to be increased to expand usage. In December 2017, the CBL issued a Directive on Banking Fees and Charges instructing banks to offer saving accounts to individuals earning a monthly gross income of less than M3,000 at zero cost. In practice, banks started to offer transactional accounts, rather than saving accounts, for which few individuals have yet applied. The reason appears to be a lack of awareness among qualifying individuals and Know Your Customer (KYC) practices which require verifying documents when opening new accounts. Obtaining these takes time and chief officers providing them are not always available. The Electronic Signature Bill is being considered to provide a digital solution to procedural challenges. Given that banks must comply with KYC implying costs, outreach should be driven by national authorities.

5. Liquidity requirements need to be reviewed. Banks currently meet their LAR mainly through the holding of T-bills and gross deposits with other banks. The latter inflates liquid reserves. As previously recommended, the regulation should be amended to include net interbank positions to obtain a meaningful measure of liquidity. The limited number of liquid assets in Lesotho may suggest a need for a reduction in the minimum liquidity requirement – South Africa, for example, has an LAR of 20 percent. The mission understands the desire to encourage development of longer-term financing instruments. However, it believes that artificially classifying government bonds as liquid in the absence of a secondary market would be inappropriate.

6. The capital market should be deepened. Commercial banks short-term funding structure naturally limits their appetite for medium and long-term treasury bonds. The large asset base of the pension and insurance sectors offer a more natural source of demand. For planned auctions to be successful it will be key that the MOF and CBL liaise closely with asset managers of the respective institutions and align auction calendars, maturity profiles, and interest rates with market appetite. Supporting local capital market development as described above would help introduce competition and lower costs. Developing a secondary market for government paper could also incentivize banks to participate in longer-term auctions.

Annex VI. Capacity Development Strategy

Public financial management is the key priority area for CD in Lesotho. Weak expenditure controls, financial reporting, and budgeting processes hinder the efficient allocation of resource and hamper surveillance. Other key weaknesses are in non-bank supervision,1 where the enforcement of AML/CFT provisions will be important ahead of the ESAAMLG assessment in 2022. Further progress in deepening the government securities market and national accounts will also be critical. TA providers, in coordination with the country team, should consider potential synergies across CD providers to better leverage Fund resources.2

Key Overall CD Priorities Going Forward

PrioritiesObjectives
Public financial managementBudget execution and control
Public financial managementFiscal reporting
Strengthen macroeconomic and financial statistics compilation and dissemination for decision makingNational accounts and government finance statistics
Financial sector supervisionOversight of non-bank sector, enforcement of AML/CFT regulations, and deepening of government securities market development

Main Risks and Mitigation

1. The authorities’ ownership of and the commitment to implement TA recommendations on a technical level is quite strong. However, in the context of a four-party coalition, elements that require cooperation from line ministries complicates implementation of some TA recommendations. Capacity and resource constraints can also limit the effectiveness of TA. Functional departments should consider the speed with which the authorities can absorb and implement TA recommendations when planning missions. Factoring in political appetite for reform and election cycles would also help mitigate some of these risks.

Authorities’ Views

The authorities are eager to benefit further from IMF TA, and broadly share AFR’s views on TA priorities. Absorption capacity can be limited at times due to resource constraints, but the scope and timing of the missions are generally in line with needs. The authorities also actively participate in a range of training modules, both online and in person, which help supplement and reinforce TA recommendations. The authorities have stressed the need for longer-term support on PFM issues and noted the importance of a resident advisor as they had previously had with IMF/EU support.

Annex VII. Implementation of Recommendations from 2017 Article IV Consultation
RecommendationStatus of Implementation
Accelerate fiscal consolidation, with focus on expenditure measures, complemented by selective revenue measures.The FY 2019/20 budget strives for a substantial consolidation through both revenue and expenditure measures. The VAT rate on telecommunications was increased, a levy on alcohol and tobacco was introduced, and fuel levies were raised. On the expenditure side, the budget proposes zero wage adjustment and a hiring freeze, as well as several measures that aim to cut travel and operating costs of government. The overall deficit is projected to fall by nearly 2 percent of GDP.
Address chronic PFM weaknesses.Some progress was made in addressing PFM issues. The authorities began closing the monthly accounts to produce more stable fiscal data. Monthly reconciliation has proceeded but at an uneven pace. Expenditure controls continue to be weak and a quarterly survey of arrears has yet to be finalized.
Increase external financing, with a focus on grant and/or concessional borrowing.The authorities did not access significantly higher levels of external borrowing. Instead, increased financing came through domestic channels.
Increase cap on treasury bill issuances.The authorities raised the cap on t-bill issuances from M 700 million to M 1.5 billion.
Cut red tape and evaluate existing private sector development programs to create more broad-based growth.A new NSDP was introduced in December 2018, which will support development of labor-intensive industries such as manufacturing and tourism. However, the authorities introduced contentious regulations in the mohair industry and a disruptive increase in the minimum wage for textile workers, which may discourage future foreign investment.
Introduce supervisory architecture for non-bank financial institutions to support financial stability and increase the financial sector’s contribution to growth.The Pension Bill, Financial Institutions Act, Financial Cooperatives Act, Insolvency Bill, and Security Interest in Movable Property Bill have been drafted but have yet to be tabled in Parliament.
1Customs and excise duties collected by SACU members are pooled and distributed quarterly, based on a revenue-sharing formula negotiated by the member countries. The allocation formula includes a correction mechanism that can exacerbate trends.
2While a reserve target of 120 percent of M1 plus all callable savings deposits (“M1 Plus”) is a relatively conservative approach, it helps to account for the stability of the peg since its inception.
3In the absence of a comprehensive survey of arrears, staff have estimated a stock of arrears of just over 2 percent of GDP. However, this is subject to significant uncertainty.
4In December 2018 Lesotho was re-selected to continue developing a second compact, a process which typically takes two to three years to complete. The amount of the second compact is not yet determined; the first compact totaled about $360 million, disbursed over several years.
6Staff have taken a more conservative stance on the projected FY 2019/20 fiscal outturn than the budget, assuming lower estimated returns on some measures, in particular those related to non-tax revenues as well as grant and social benefit spending, and higher interest payments.
7Both the Fund and the World Bank have provided technical assistance on broader civil service reform.
8See “Fiscal Rules: Coping with Revenue Volatility in Lesotho and Swaziland”, African Departmental Paper No.17/05 for a discussion of potential fiscal rules which could be appropriate for Lesotho. The report suggests that the use of a structural balance target could smooth the growth impact from revenue shocks while helping preserve reserve adequacy.
9Principal Secretaries of Ministries are political appointees in Lesotho.
10The elasticities of growth and unemployment to a series of reforms were estimated using a panel regression. The resulting coefficients are then used to calculate the potential impact of Lesotho moving to the 75th percentile of the sample of developing and emerging economies.
11Information on indebtedness of businesses is not included in the credit bureau. Also, ongoing efforts to include MFIs and money lenders should be finalized.
12NBFI include all financial institutions operating in Lesotho except for banks: Financial cooperatives, insurance corporations, pension funds, money market funds (MMF) and non MMF investment funds (referred to as collective investment schemes), microfinance institutions, asset management companies, brokers and money lenders.
13The Financial Institution Regulation stipulates in Article 4, section 1, that financial cooperatives with total deposits or assets equal to or more than 5 million maloti should apply for a license to the CBL to operate. Financial cooperatives below this threshold remain with the MoSBDCM.
14An assessment of the implementation of the previous Article IV recommendations can be found in Annex VII.
1See “Guidance Note: Assessing Reserve Adequacy in Credit-Constrained Economies (IMF 2016).
2Reserves are adequate by other metrics: as of end-December 2018, they stood at almost 80 percent of broad money and 500 percent of short-term debt, compared with a rule-of-thumb threshold of 20 percent and 100 percent respectively.
1Prepared by the staffs of the International Monetary Fund (IMF) and the International Development Association (IDA). Approved by David Robinson (AFR), Nathan Porter (SPR), and Paloma Anos Casero (IDA).
2This DSA updates the previous Joint DSA dated February 14, 2018 (IMF Country Report No. 18/54). This DSA applies the revised joint Bank-Fund Debt Sustainability Framework for Low-Income Countries. Under this framework, Lesotho’s debt carrying capacity remains at medium based on the composite indicator consistent of the 2018 October WEO and the 2017 CPIA.
3These estimates are based on two valuations conducted by actuarial firms, with the larger gap calculated on a solvency basis, the smaller on a funding basis.
4The fiscal year runs from April 1 to March 31.
5A medium-term Debt Management Strategy (DMS) is under development and is expected to be completed and released with the FY 2019/20 budget.
6The LHWP II project is financed by capital grants, which are a key driver of the residuals.
1Caution must be exercised with interpreting perception-based indicators as the ones presented in this annex. Given their standardized nature, these indicators may not be a comprehensive measure of the business environment. Concerns about sample size and geographic coverage may also be in order.
2Corruption is ranked as the second most problematic factor for doing business in the World Economic Forum’s 2017 Executive Opinion Survey and the third one for medium firms in the World Bank’s 2016 Enterprise Survey.
3World Bank’s 2019 Doing Business.
4The methodology follows Prati, A., Onorato, M. G., and Papageorgiou, C. 2010. “Which reforms work and under what institutional environment? Evidence from a new data set on structural reforms.” Review of Economic Studies. Reforms are defined using different indicators as discussed in this annex and their return in terms of per capita growth rate is estimated with a panel regression including lagged per capita GDP, and country and time fixed effects. Reforms are calibrated to reach the levels of the 75th percentile of the sample of developing and emerging economies. Reforms are assumed to be implemented over the medium term, with human capital reforms to take place over a longer horizon.
1The CBL would be the main recipient of TA on non-bank supervision.
2For example, AML/CFT CD from LEG in coordination with bank supervision CD from MCM.

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