1. Our Lesotho authorities thank staff for the constructive engagement and policy advice during the recent Article IV Consultations and look forward to further interactions on policies that can help raise output and improve the economy’s resilience. They broadly agree with staff’s assessment of the macroeconomic challenges facing the economy and the policy recommendations.
2. The economy continues to grapple with vulnerabilities emanating from declining Southern African Customs Union (SACU)1 revenues, a relatively undiversified economic base, a high public sector wage bill as well as a recent build-up of domestic arrears. Given these challenges, the authorities acknowledge that implementing adjustment measures has become critical. Accordingly, the recently tabled FY2019/20 National Budget proposes an ambitious reform agenda tailored towards addressing these development challenges. The authorities concur with staff on the importance of a well-executed reform agenda and are determined to implement the agreed measures, since broad political consensus has been established.
3. Lesotho has made significant progress towards restoring peace and stability since the coalition government took office in June 2017. This has been supported by the implementation of the National Reform Agenda. At the same time, a new National Strategic Development Plan (NSDP II) covering the period 2019—2023, whose theme is “inclusive growth, private sector–led jobs and reduced unemployment”, has been launched. The Plan identifies four sectors – agriculture, manufacturing, technology, and tourism and creative industry– to drive job creation in the economy. Accordingly, allocations in the new national budget are focused towards development of these sectors. In addition, the Lesotho National Development Corporation (LNDC) will be restructured to better serve its mission of private sector development.
Recent Economic Developments and Outlook
4. Following weak growth in 2017, the Lesotho economy recovered modestly to 1.9 percent in 2018, owing to improved performance in mining, manufacturing, and financial services. Agricultural output remained subdued due to prolonged dry spells, given the country’s dependence on rain-fed agriculture. In the medium term, growth is expected to firm up, boosted by the construction sector, particularly the implementation of Phase II of the Lesotho Highlands Water Project (LHWP II), which is set to commence later this year. Downstream benefits of the LHWP II are expected to provide further growth impetus over the forecast horizon. Similarly, the primary sector is expected to pick up in the medium term supported by strong growth in the mining sector, reflecting strong demand and favorable prices.
5. Inflationary pressures continued to ease in line with global developments in recent periods, remaining below 5.0 per cent throughout 2018. Going forward, inflation dynamics will be mainly affected by international oil prices and the exchange rate of the South African Rand. As a result, the average annual inflation rate is expected to increase from 4.7 percent in 2018, to 5.9 percent and 5.7 percent in 2019 and 2020, respectively.
6. The external sector position improved during the fourth quarter of 2018, boosted by surpluses in the capital and financial accounts that outweighed the effect of the widening current account deficit. Gross international reserves increased, reaching 4.5 months of imports at the end of 2018, from 3.9 months of imports in 2017. Going forward, the current account is expected to remain in deficit due to upward pressure on imports from construction activities related to mining investment and implementation of the LHWP II.
Fiscal Policy and Public Financial Management Reforms
7. To address underlying fiscal vulnerabilities and restore macroeconomic stability, the authorities are committed to implementing a set of fiscal stabilization measures. In this regard, they are taking steps aimed at containing spending and closing loopholes. Starting with the recently-passed FY2019/20 budget, significant spending adjustments have been made, amounting to a reduction equivalent to 2.2 percent of GDP. Importantly, the authorities are focusing on reducing the wage bill, through a hiring and wage freeze. To protect economic growth and employment, capital spending has been allowed to record a modest increase of 0.5 percentage points. These measures will see the fiscal deficit decline from 5.2 percent in FY2018/19 to 3.4 percent of GDP in FY2019/20.
8. To enhance domestic revenue mobilization, the authorities will implement a set of measures including the introduction of a levy on the sale of tobacco and alcohol, an increase in the fuel levy, and additional VAT on telecommunications. The authorities also intend to increase fees and charges that have remained stagnant over many years during the course of FY2019/20. As a result, revenues for FY2019/20, are expected to rise by 3.4 percentage points of GDP to 46.0 percent of GDP.
9. Government also plans to implement a Tax Modernization Program which will include, inter alia, the implementation of a VAT non-compliance detection solution, upgrading border IT infrastructure, introducing coordinated border management and launching a national single window. In addition, the Lesotho Revenue Authority (LRA) has implemented a Voluntary Disclosure Program (VDP)2 and Small Business Taxation (SBT) scheme. As part of the 2019/20 budget, Government will further scale up the VDP program, replace the current zero rating on exports of natural resources with a VAT exemption, to reduce revenue leakages emanating from high VAT refunds claimed by the mining industry.
10. In an effort to strengthen Public Financial Management (PFM), on April 1, 2019, the authorities launched an upgrade to the Integrated Financial Management Information System (IFMIS) which aims to improve the quality of financial statements, reduce delays in payment of suppliers and enhance commitment controls. The new IFMIS will eliminate the need for the paper-based systems and introduce automated tracking of invoicing and payments. To enhance budget controls and better align spending with available resources, a Cash Management Unit has been established. Further, to regulate the volatility in SACU revenues and entrench debt sustainability, the Ministry of Finance will propose a fiscal rule to be passed into law, during the current fiscal year.
Financial Sector Development
11. Lesotho’s financial sector remains sound with relatively low non-performing loans (NPLs). That said, the authorities remain vigilant in monitoring the emergence of vulnerabilities, including rising household indebtedness and credit concentration. They recognize the need to extend information coverage beyond the formal sector. For this reason, the credit bureau aims to improve information on informal lenders by licensing them as Microfinance institutions (MFIs). In addition, significant progress has been made in strengthening the supervision of the non-bank financial sector in view of its growing size and potential to develop systemic impacts. The authorities are also working with key stakeholders to strengthen the supervision of cooperatives. At the same time, the Central Bank of Lesotho (CBL) is undertaking extensive financial education and awareness campaigns to minimize the proliferation of Ponzi schemes. Further, the authorities have requested Fund technical assistance to facilitate the development of a secondary market for government debt.
12. To address challenges in the banking sector, including credit growth, the authorities have enacted the Security Interest and Movable Property and Insolvency bills. At the same time, a credit registry has been established with the aim of improving access to credit. A credit scoring system is currently being developed. Further, a securities market has been established and one commercial bank is considering issuing commercial paper. In addition, the authorities have taken significant steps to strengthen Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) frameworks and practices with the assistance of Fund TA.
13. The authorities continue to make progress in further deepening financial inclusion. The Ministry of Finance and the CBL are strengthening collaboration between all stakeholders in providing financial services, including the Banks, Mobile Network Operators, Micro-finance Institutions, NGOs, partner ministries and development partners. Mobile money, which has grown at a fast pace, provides a promising avenue to increase financial inclusion, where the majority of the rural population has limited or no access to financial services. The authorities will continue to closely monitor developments in this sector with a view to manage potential risks.
14. In line with the NSDPII, which focuses on private sector led development, our authorities have developed an agenda to actively attract investment, improve the business climate and enhance human capacity development. In this regard, government aims to roll out several initiatives to attract investment, including the development of industrial parks. They have organized an investment laboratory, to allow both investors and government to collaborate on the modalities necessary to boost investment. The laboratory, which has been operational since March 2019, has registered more than 80 investors, with potential for establishing businesses and creating employment. Thus far, investor interest has been expressed in agri¬business, tourism and creative industry, technology and manufacturing. Further, the authorities plan to implement measures to deepen financial markets and develop the capital market.
15. To promote SME development, Government is implementing financial and business support initiatives to help start-ups and other small businesses. An apprenticeship strategy has been developed with the main objective to address the existing skills mismatch between training institutions and the needs of the industry. Through this strategy, an institutionalized program will expose graduates of universities and higher learning institutions to industry and business practices in order to match the needs of the market or enable self-employment. Furthermore, the authorities intend to roll-out an entrepreneurship training program across training institutions to strengthen education outcomes.
16. As part of an effort to strengthen the fight against corruption, the authorities are considering a new anti-corruption bill that will increase the independence of the Directorate of Corruption and Economic Offences (DCEO). They are also implementing an asset declaration framework for public servants. To mitigate the impact of droughts on agricultural production, the authorities, are scaling up irrigation infrastructure as a way to insulate climate disruptions. In this regard, support will be provided to the Smallholder Agricultural Development Project (SADP) to cater for scale and climate disruptions.
17. Having taken appropriate measures to respond to recent political and economic challenges, the authorities are progressing with efforts to implement a package of measures that will strike a balance between fiscal consolidation and protecting growth, employment and other social objectives. In addition, the authorities are exploring options to diversify revenue sources and reduce reliance on volatile SACU revenues. Overall, the recommendations proposed by staff in the fiscal, financial and structural reform areas are in line with the authorities’ agenda to pursue rapid and inclusive growth within a stable macroeconomic environment. In this regard, they wish to express appreciation to the Fund for the valuable technical assistance that Lesotho has received through the years.