This paper reviews economic developments in Lesotho during 1990–94. During the six years (1988/89–1993/94) under the IMF-supported programs, real GDP growth has averaged 6.5 percent, and investment has risen rapidly, owing to activities related to the Lesotho Highlands Water Project and substantial foreign private direct investment. Real gross national product growth averaged only 3.3 percent, owing to a decline in remittances, as a major retrenchment of mine workers in South Africa occurred during this period. The government’s budgetary position improved substantially during the six-year period.


This paper reviews economic developments in Lesotho during 1990–94. During the six years (1988/89–1993/94) under the IMF-supported programs, real GDP growth has averaged 6.5 percent, and investment has risen rapidly, owing to activities related to the Lesotho Highlands Water Project and substantial foreign private direct investment. Real gross national product growth averaged only 3.3 percent, owing to a decline in remittances, as a major retrenchment of mine workers in South Africa occurred during this period. The government’s budgetary position improved substantially during the six-year period.

I. Introduction

Lesotho’s geographical location is unique: the country is completely surrounded by South Africa and is situated in a difficult, high mountain region. Its topography is very rugged, and its resource base is quite limited. The population is currently estimated at 1.9 million, growing by about 2.6 percent per annum. The per capita income in 1993 was US$666, and the literacy rate is high--among the highest in Africa. Lesotho’s main natural resource is water, which is now being exploited under the Lesotho Highlands Water Project (LHWP) for export to South Africa. The first phase of the project (called Phase 1A) began in 1988 and is slated to be completed in 1997, when water will begin to be exported to South Africa’s industrial heartland--the Pretoria-Witwatersrand-Vreeniging (PWV) Area--via a dam and two long underground tunnels.

Lesotho’s agricultural sector is small, accounting for less than 10 percent of GNP. However, it is the largest source of employment and contributes to the incomes of at least 65 percent of households. The development of the agricultural sector is constrained by (i) the limited availability of arable land (only 13 percent of total land area); (ii) low marginal productivity because of the poor quality of soil; (iii) a system of land tenure that encourages overgrazing and inefficient use of available arable land; (iv) extensive soil erosion; and (v) unpredictable climatic conditions, punctuated by occasional severe and prolonged droughts. The secondary sector has been a source of vitality to the economy, as a result of sustained growth of manufacturing and construction. The tertiary sector (including government services), however, remains the largest contributor to GDP. Finally, Lesotho’s economy has extensive interlinkages with the South African economy through the Common Monetary Area (CMA), the Southern African Customs Union (SACU), and the labor mobility arrangements.

Lesotho’s economy has expanded rapidly in recent years through a recovery program supported by the International Monetary Fund under its structural adjustment facility (SAF) and enhanced structural adjustment facility (ESAF). In the mid-1980s, prior to the reform efforts, Lesotho’s economic performance was characterized by low and uneven economic growth, widening budget deficits, and serious balance of payments problems. During the six years (1988/89-1993/94) under the Fund-supported programs, real GDP growth has averaged 6.5 percent, and investment has risen rapidly, owing to activities related to the LHWP and substantial foreign private direct investment. Real GNP growth averaged only 3.3 percent, owing to a decline in remittances, as a major retrenchment of mine workers in South Africa occurred during this period.1/ The Government’s budgetary position improved substantially during the six-year period. The overall budget balance turned around from a deficit of more than 9 percent of GNP in 1988/89 to a surplus of over 3 percent of GNP in 1993/94. The rate of inflation was reduced and moved into single digits in 1993/94. The balance of payments strengthened substantially, and the official foreign exchange reserves rose from less than one month of imports in 1988/89 to more than four months of imports at the end of 1993/94.

II. Overall Developments in Aggregate Supply and Demand

1. Aggregate supply

Following a period of relatively slow growth in the first half of the 1980s, output has expanded rapidly in Lesotho over the last few years following the Government’s adoption, with Fund support, of a structural adjustment program. Since 1988/89, real GDP has grown at an average annual rate of 6.5 percent, despite a substantial drop in agricultural output caused by a severe drought that began in 1991 and has only recently abated. The decline in agricultural output has been offset by continued strong growth in the manufacturing sector, which has benefited from government programs to attract foreign investment. Real GDP growth has also been spurred by construction activity related to the LHWP, 1/ which is expected to peak in 1994/95. Real GNP, which traditionally has been nearly double real GDP because of substantial remittances from Basotho employed in the mines in South Africa, has grown at a more modest 3.2 percent annual average rate since 1988/89, owing primarily to the retrenchment of workers in the South African gold mines. Workers’ remittances remain the single most important sector of Lesotho’s economy, exceeding value added in the primary and secondary sectors combined.

2. Aggregate demand

The rise in activity related to the LHWP has been reflected in a shift in the composition of aggregate demand, with private consumption falling from 59 percent of total expenditure in 1988 to 45 percent in 1993 and gross fixed capital formation (GFCF) rising from 22 percent to 35 percent of aggregate expenditure in the same period (Appendix III, Table III). The increase in investment is almost entirely attributable to the LHWP, with project-related capital formation representing 12 percent of aggregate expenditure in 1993 (versus 3 percent in 1988). Government consumption as a percentage of aggregate expenditure remained constant at 13 percent between 1988 and 1993, while government GFCF fell from 10 percent to 7 percent. Exports also remained roughly constant at about 6 percent of aggregate expenditure, while private investment rose from 8 percent of aggregate expenditure in 1988 to 16 percent in 1993. Private consumption increased by 78 percent in nominal terms between 1988 and 1993 while the consumer price index doubled in that period, suggesting that private consumption declined in real terms. This decline in private consumption occurred despite a slight increase in real imports in the period 1988-93. The increase in imports is attributable to capital formation, mainly in the context of the LHWP, as net factor income from abroad actually declined slightly in real terms between 1988 and 1993. Gross national savings (excluding unrequited transfers) rose from 6.3 percent of GNP in 1988/89 to 17.6 percent in 1992/93, reflecting an increase in private savings from 11.5 percent of GNP to 18.3 percent and an increase in public savings from minus 5.2 percent of GNP to minus 0.7 percent.

III. Main Sectoral Developments

1. Agriculture

The share of agriculture in GDP declined from 20 percent in 1988 to 10 percent in 1993, reflecting partly the consequences of the severe drought during 1991-93 (Appendix III, Table I). 1/ Rainfall was normal during the current growing season (1993/94), although the harvest is still expected to be below the pre-drought levels. Even in a good year, Lesotho is a net importer of staple foodstuffs (maize and wheat), with domestic production averaging about 60 percent of requirements. Moreover, despite its relatively large share of GDP, agriculture plays a relatively smaller role in Lesotho’s economy than in many other developing countries. First, with nearly 30 percent of Lesotho’s labor force employed in South Africa, GNP is a more appropriate measure of Basotho economic activity than is GDP. Agriculture’s share of GNP was only 11 percent in 1988 and only 6 percent in 1993. Second, most Basotho participating in the agricultural sector do so only to supplement their incomes from other sources. According to one survey among households participating in the agricultural sector, barely half own any cattle (with the average agricultural household owning 2.5), only one in six own any sheep (with the average agricultural household owning 2.4) and only one in six own any goats (with the average agricultural household owning 2.1). Some 70 percent of the agricultural households surveyed did not produce enough field crops to be self-sufficient. These households accounted for 28 percent of total production, while the top 5 percent of households accounted for 29 percent of production.

The share of crops in agricultural sector value added declined from 41 percent in 1990 to 9 percent in 1992, owing to the drought, before recovering to 4 percent of agricultural value added in 1993 (Table I). Between 1988/89 and 1991/92, the area planted with the three main crops (maize, sorghum, and wheat) fell from 301,900 hectares to 241,200 hectares, a 20 percent decline, while the area harvested dropped by 45 percent (from 279,400 hectares to 153,800 hectares). Value added from crop production declined 65 percent in real terms between 1988 and 1993. Fruits and vegetables proved relatively more resilient, with their share of agricultural value added rising from 7 percent in 1988 to 14 percent in 1993, thanks in part to a diversification into asparagus and other products. Value added from fruit and vegetable production declined only slightly in real terms from 1988 to 1993.

The majority of value added in the agricultural sector in recent years came from livestock, which represented 51 percent of value added in 1988 and 64 percent in 1993. Value added from livestock--mostly cattle, sheep and goats--declined 13 percent in real terms from 1990 to 1993, which again was due to the drought. To relieve environmental damage caused by the overgrazing of livestock on communal lands, a range management program featuring grazing fees was adopted in 1991/92. However, grazing fees were suspended in 1993. Following a series of workshops with farmers and local chiefs, the Government is now developing an alternative program based on local, self-policing associations, which will collect membership fees and develop their own rules for range management.

Producer prices for maize, sorghum, wheat, peas, beans, eggs, and dairy products are set by the Government. These prices reflect those established in South Africa. These prices are set as the border parity equivalent of South African consumer prices.

2. Manufacturing

The manufacturing sector in Lesotho produces mainly agro-industrial items, textiles and garments, leather products, and furniture, as well as electronic goods (such as televisions). Starting from a low base of M 16.2 million value added in 1980, real value added in manufacturing increased to M 67.4 million in 1993, or at 12 percent annually (Table II). Since 1988 real value added in manufacturing has grown at an average annual rate of 8 percent, slightly faster than real GDP. As a result, the share of manufacturing in real GDP increased only from 13 percent in 1988 to 14 percent in 1993. Within the manufacturing sector, the share of value added attributable to textile and clothing production increased from 21 percent in 1987 to nearly 31 percent in 1992, owing to substantial investment activity by Far Eastern firms, seeking Lesotho’s access to markets and its relatively educated and disciplined labor force, and South African firms (Table IV). However, in late 1992, the United States and Canada imposed quotas on imports of selected textile products from Lesotho. As a consequence, production and export growth of garments slowed in 1993. Following bilateral negotiations, the issue was resolved in late 1993. To ease the quota constraint, some garment factories began to expand output of goods not currently subject to quotas. As a result, over the medium term, the current quotas are not expected to constrain textile output significantly.

Through the Lesotho National Development Corporation (LNDC), in particular, the Government has been quite successful in attracting foreign direct private investment, mainly from the Far East, in the manufacturing sector. As a result, exports of garments, textiles, shoes, electronics, and other light manufactures have increased rapidly. The expansion of manufacturing in the late 1980s and early 1990s has provided new employment opportunities. By 1992/93, the garment industry alone was employing about 12,000 workers, compared with total employment of 15,000 in the civil service (excluding teachers). The LNDC’s role of encouraging foreign direct private investment was enhanced in 1992 through the creation of the Investment Promotion Centre (IPC). The IPC identifies potential foreign investors and makes available necessary information regarding services, facilities, and government incentives. The Government’s promotional role has been primarily through tax incentives. Among other activities, LNDC constructs factory shells that are leased to investors at low rates and provides financial assistance to manufacturing firms.

To encourage indigenous entrepreneurship, the Government established the Basotho Enterprise Development Corporation (BEDCO). In the past two years BEDCO has gradually shifted its emphasis from providing facilities and financial assistance for small manufacturing enterprises, especially in furniture and metalcrafting, toward technical assistance to potential entrepreneurs. For example, BEDCO is now assisting would-be Basotho entrepreneurs in the preparation of business plans and loan applications, and is offering business training. However, the Business Advisory and Promotion Services (BAPS) is more advanced in the area of developing local entrepreneurial skills.

3. Construction

Value added from construction has increased rapidly over the last several years, expanding at an annual average rate of 24 percent between 1988 and 1993. As a result, the share of construction in total value added increased from 13 percent in 1988 to 20 percent in 1993. Much of this growth is due to the LHWP, whose construction activity accounted for 7 percent of GDP in 1993. However, non-LHWP construction activity also expanded rapidly, with real value added increasing at an annual average rate of 17 percent between 1988 and 1993. In fact, nearly all of this growth occurred in 1989, 1992, and 1993, with real construction value added increasing only slightly, if at all, in the other years. Non-LHWP construction activity has been spurred both by the continued growth of the manufacturing sector, and its resultant need for factory space, and by the demand for additional housing and related services in Maseru and other urban areas.

IV. Prices, Employment, and Wages

1. Price developments

Price movements in Lesotho are strongly influenced by those in South Africa, because Lesotho is a member of the Common Monetary Area, because many of its imports come from South Africa, because (as noted above) the prices of some of its foodstuffs are set administratively to reflect prices in South Africa, and because the proximity of the two countries means that they share common climatic conditions that may influence food and other prices. During the peak of the drought in 1992/93, the movement in the consumer price indices in Lesotho and South Africa differed significantly because of the much larger weight for food in Lesotho’s consumer price index basket. After a period of relatively rapid inflation in 1985 and 1986, averaging 16.9 percent annually, consumer price inflation slowed somewhat in the late 1980s, averaging 12.6 percent annually between 1988 and 1990 (Table VI). Drought-induced increases in food prices, and large public sector wage increases, led inflation to soar to 17.5 percent in both 1991 and 1992. Improved availability of foodstuffs reduced the average inflation rate for 1993 to 13.9 percent, and inflation is expected to be about 8 percent for 1994.

2. Domestic employment and wages

Unemployment remains a serious problem in Lesotho, with the domestic unemployment rate estimated at approximately 35-40 percent. About 25,000 people enter the labor force annually, but the economy presently has the capacity to absorb only about 6,000 new workers each year.

Total public sector employment increased by only 5 percent from 1990/91 to 1993/94, owing to a civil service rationalization that eliminated temporary workers and to a hiring freeze that began in 1992 and was in place through 1993/94 (Table VII). The civil service is understaffed at the technical and professional levels where the Government has had difficulty in hiring and retaining employees because of competition with parastatals and the private sector and because of more lucrative opportunities outside Lesotho. Understaffing is most severe in the Ministry of Health, where doctors and nurses leave for higher pay and better working conditions in South Africa.

Limited data are available on wages in Lesotho. Minimum wages, which are only indicative, are suggested by tripartite boards comprised of representatives from the Government, employers, and workers. The minimum wages are differentiated according to industry. Although the indicative minimum wage was recently increased, it--like domestic wages generally--remains lower than that prevailing in South Africa: Lesotho’s minimum wage is M 268 a month, or about 25 percent of the wage level of semiskilled labor in South Africa.

3. Migrant workers

Migrant workers’ remittances typically represent about 40 percent of GNP in Lesotho, and thus exceed value added in the primary and secondary sectors combined. For 1992/93, workers’ remittances exceeded value added from the LHWP by a factor of eight. The 1986 labor force survey indicated that about 27 percent of Lesotho’s labor force has worked outside of the country and about one third of households have had at least one member working abroad. Most of these workers are employed in South African gold mines, although a large number work as teachers, physicians, and nurses in South Africa.

Total employment of Basotho miners in South Africa peaked at 150,000 in 1987 and has declined to a current level of less than 120,000. These retrenchments have been caused both by a decline in the price of gold that led to the closing of some marginal mines and by a move among mine owners to more capital-intensive mining techniques. Although gold prices have risen lately, leading to an increase in miners’ wages, there has been only a small increase in re-employment. It would require a sustained gold price of more than US$400 per ounce for some of the marginal mines to reopen and begin hiring again.

In recent years there has been a significant migration of skilled workers from Lesotho--especially doctors, nurses, and teachers--seeking higher wages in South Africa. This outflow has made it difficult for the civil service to staff positions at health facilities and schools and has led the Government to increase wages and to offer other incentives for these jobs. Some of these trained Basotho emigrated to fill positions vacated by South Africans who had left during the period leading to majority rule.

V. Public Finance

1. Institutional framework

Besides the Central Government, the public sector in Lesotho consists of local authorities and 51 public enterprises and financial institutions in which the Government of Lesotho directly or indirectly owns majority shares. The Central Government comprises the office of the King, the Parliament, and ministries and departments. Local authorities comprise the Maseru Municipal Council, district offices, and village development councils, of which the latter two are administered by the Ministry of Interior and Village Chiefs, respectively. The nonfinancial public enterprises are established under specific legislation or the Company’s Act, and some public entities operate as Government Trading Accounts, most of which are under the Ministry of Agriculture. The public financial institutions consist of the Central Bank, two commercial banks (Lesotho Bank and Lesotho Agricultural Development Bank), and three specialized financial institutions (National Insurance Corporation, BEDCO, and LNDC).

The annual budget, prepared by the Ministry of Finance (in the combined Ministry of Finance, Economic Development and Planning) consists of the recurrent budget and the capital budget. The former covers all tax and nontax revenues, spending appropriations to ministries and departments, and statutory obligations (pensions, salaries of the Auditor-General and Judiciary staff, and debt servicing). The capital budget covers foreign grants, foreign loans, Government of Lesotho contributions from the recurrent budget, and budgetary appropriations to line ministries. Until the late 1980s, Lesotho’s development budget captured only actual foreign grants and loans channeled through the budget, to the exclusion of direct donor-financed projects. However, since 1988/89, direct donor-funded development outlays have been incorporated in the budget.

The execution of the budget is carried out by the Budget Controller’s Department. The budget controller issues quarterly warrants authorizing ministries to undertake expenditure commitments. The disbursements for spending within the quarterly authorized limits are made by the Treasury. The Budget controller maintains records and monitors the Government’s budgetary performance on the basis of actual disbursements in respect of the recurrent budget. For development expenditure monitoring is undertaken by the Budget Controller as well as by the Financial Controller’s Department in respect of the direct donor-funded spending.

2. Fiscal developments, 1988/89-1992/93

a. Overview of deficit and financing

During the five-year period 1988/89-1992/93, fiscal operations, in the context of the authorities’ economic and structural program, led to a substantial strengthening of the Government’s finances. The overall budget deficit declined from 9.2 percent of GNP in 1988/89 to 0.3 percent in 1991/92 and shifted into a surplus of 2.2 percent of GNP in 1992/93 (Table IX). The main contributing factors to the continued improvement in fiscal performance were the strong growth in revenue and a curtailment of total expenditure, from 32.7 percent of GNP in 1988/89 to 31.0 percent in 1992/93. Impressive gains in customs and noncustoms receipts contributed to the revenue growth. The increase in customs revenue was due mainly to LWHP-related imports, while the gain in noncustoms revenue was bolstered by reforms of income and sales taxation, in addition to improvements in administration of these taxes, and from increases in license fees and charges.

As the deficit was reduced, the Government was able to repay a substantial amount of domestic bank borrowing. This repayment amounted to 7.7 percent of GNP in 1992/93, as the budget moved into a surplus, and the Government has become a large net creditor to the banking system. Nonbank borrowing showed a declining trend as well, reflecting the drastic reduction in the Government’s need to borrow.

b. Revenue and grants 1/

Lesotho’s strong revenue performance over the five years (1988/89-1992/93) stems partly from the Government’s concerted effort to strengthen the noncustoms revenue bases and partly from the large increases in customs revenues. The strengthening of the noncustoms revenue involved the broadening and revision of the income and sales tax bases and rates, and the improvement of tax administration, as well as the introduction of some revenue-enhancing measures.

Several tax reform measures were taken during 1990/91-1992/93 (as well as in 1993/94) to strengthen noncustoms revenues. In individual taxation, the rate structure was simplified by consolidating the lowest brackets while reducing the rates at both ends of the spectrum; also, the tax net was extended to include expatriate employees and tax administration was tightened vis-à-vis small traders. In company taxation, the base was broadened by eliminating various company tax deductions, revoking the exemption status of several parastatals, rescinding the tax holiday on some undeserving pioneering industries, and implementing a switchover of tax assessment from the preceding year’s to the current year’s profits, effective April 1992. The sales tax was extended to utilities, while the rates were raised on tobacco and alcohol, and the zero-rated status of certain basic goods was removed. The levy rates on petrol and diesel were revised more frequently in order to maintain parity with the retail pump price in South Africa. As a result of these reforms and taking into account the effect of nominal growth in tax bases, noncustoms revenue increased at an annual average rate of 27 percent over the five-year period (1988/89-1992/93). About 40 percent of this growth came from the increase in income tax receipts (mostly from individual taxes, including the self-employed) and another 20 percent came from sales tax receipts. The bulk of the remaining increase was derived from higher nontax revenue (Table X).

The principal source of government revenue in Lesotho is the Southern African Customs Union (SACU), which, on average, contributed about 53 percent of government revenue over this period. The pool of collections of customs and excise duty is divided among the members 2/ according to each member’s proportional share in total imports and production of commodities that bear excise duty. For the smaller members, a minimum of 17 percent of the member’s dutiable base (i.e., its imports plus dutiable production) is assured under the SACU treaty; this minimum base has been in force since 1984/85. Because of lags in the availability of data, this payment, known as the “first estimate,” is made with a two-year lag. To compensate for this lag, an additional payment, known as the “first adjustment,” is received (Table XI). Hence, SACU receipts in any year depend on the value of the dutiable base two years earlier and the difference between the latter and the dutiable base four years earlier. Thus, with rising LHWP-related imports, customs receipts grew by 30 percent a year, increasing from 9.8 percent of GNP in 1988/89 to 15.6 percent in 1992/93.

The amount of grants rose at an annual average rate of 17.8 percent in the same period, although they declined from 4.9 percent of GNP to 4.0 percent.

c. Expenditure and net lending

Total expenditure and net lending declined in terms of GNP over the past five years, although recurrent expenditure rose because of the need to raise the level of social services (mainly education and health). The growth in recurrent expenditure, averaging a rate of 19 percent annually, reflected the rise in the wage bill (0.5 percent of GNP) and goods and services and transfers (1.2 percent of GNP). The wage bill rose because of: (i) the cost of integrating teachers in the civil service salary structure in 1991/92 and the surge in hiring teachers and regularizing appointments of essential daily paid employees in 1991/92; and (ii) the impact of large increases in salaries in 1991/92 and 1992/93. As part of the adjustment effort, outlays on goods and services were controlled through a series of measures, including a reduction in the fleet of government vehicles, and cutbacks in departmental fixtures and in military expenditure. However, the rise in outlays on goods and services, and transfers was particularly strong (77 percent) over the last two years (1991/92-1992/93) because of the provisions for the drought-related program, employment-generating projects, and the cost of privatization. Part of the increase in socially oriented expenditure was offset by the decline in domestic interest charges as a result of lower outstanding public domestic debt and lower interest rates. The composition of recurrent expenditure shifted somewhat during 1988/89-1992/93 (Table XII). The share of interest payments in recurrent expenditure declined from 11.3 percent to 8.0 percent while the share of subsidies and pensions rose from 7.3 percent to 11.8 percent, partly reflecting the extension of pensions to married women; the share of the wage bill, however, remained at 44 percent. With respect to capital expenditure, which increased by 9.5 percent annually, below the growth rate of nominal GNP, the share of outlays on physical assets declined from 92 percent of the total to 84 percent, reflecting a shift in expenditure priorities, while the shares of transfers and subventions and net lending doubled, to 5 percent and 11 percent, respectively.

On a functional basis, the share of recurrent expenditure on general public services declined from 32 percent to less than 28 percent during this period, while that on education increased from about 20 percent to 22 percent and outlays on economic services, which are of about the same magnitude as that on education, grew to 21.4 percent (Table XIII). The unallocable category fluctuated sharply with a declining trend, from 18.5 percent of recurrent expenditure to 17.6 percent, while outlays on health and socially oriented services were stable at 11 percent. Capital expenditure showed a considerable shift in priorities in line with the Government’s adjustment policies. Allocations to health and education more than doubled, to 15 percent and 16 percent, respectively. In contrast, allocations to economic services declined from about 77 percent to about 61 percent, largely reflecting shifts away from water and energy, transport and communications, and roads, although the underspending on the latter category also reflected delays in the availability of donor funds and implementional bottlenecks. Allocations to agriculture rose somewhat during this period.

3. Development in 1993/94

The 1993/94 budget had projected total revenue and grants at 34.3 percent of GNP and aimed at containing total expenditure at 32 percent of GNP, with an overall surplus of 2.3 percent of GNP (Table IX). In the event, the overall surplus was estimated at 3.5 percent of GNP largely because of expenditure shortfalls, even though total revenue and grants were also lower than budgeted. As a result, the Government’s net creditor position with the banking system improved substantially, further enhancing Lesotho’s capacity to temporarily cushion any unanticipated change in the fiscal situation.

Total revenue and grants rose by 0.4 percentage points, to 33.5 percent of GNP. Revenue rose by 1.2 percentage points of GNP, to 30.3 percent. This rise was largely derived from the increase in customs revenue, from 15.6 percent of GNP in 1992/93 to 17.9 percent, because of the rising volume of LHWP imports. Despite the Government’s revenue effort toward broadening the noncustoms tax bases, noncustoms revenue rose rather slowly. The new income tax law, which became effective in April 1993, lowered the tax rates and consolidated the individual tax brackets to only three, with the applicable rates ranging from 25 percent to 40 percent, and raised the exemption level on taxable income, while lowering fringe benefits and other deductions; the profit tax rate on resident companies was also lowered from 45 percent to 40 percent. Although the new income tax law was designed to be revenue neutral, it turned out to be revenue reducing relative to the program figure. The shortfall in income tax was partially offset by increases in sales tax receipts, despite the reduction in the sales tax rate to 10 percent from 13 percent. The lower rate provided incentives to traders for the refund of the value-added tax (VAT) for imports from South Africa, which had raised the VAT from 10 percent to 14 percent. The lowering of the sales tax rate in conjunction with the introduction of purchase order vouchers, which are required as proof of transactions, led to improvements in both assessment and collection of sales taxes. The petroleum levy was also increased twice during the year, which resulted in an appreciable gain in receipts. Nontax revenue declined slightly from 4.3 percent of GNP to 4.2 percent, largely because of the inelasticity of rental and property income. Grants declined for the third consecutive year, to 3.2 percent of GNP in 1993/94 from 6.7 percent of GNP in 1990/91. The fall in 1993/94 reflected the cancellation by the United States Agency of International Development (USAID) of the Lesotho Agricultural Policy Support (LAPS) project, and lower disbursements from other bilateral donors and multilateral sources of project aid.

The increase in total expenditure and net lending was lower than budgeted largely because of the shortfalls in capital expenditure. About two thirds of the increase in total expenditure was attributable to recurrent expenditure, which fell to 20.2 percent of GNP from 20.6 percent in 1992/93. The slower rise in recurrent expenditure was due to a lower growth of the wage bill because of the hiring freeze that has been in effect since 1992. The declines in subsidies and subventions and transfers were more than offset by the rise in outlays on other goods and services, from 7.4 percent of GNP to 7.7 percent, partly from the continuing provisions for the drought-related relief programs and the rise in maintenance outlays, which had been curtailed over the past several years. Capital spending declined from 10.3 percent of GNP to 9.8 percent because of lower contributions through the capital budget to the hydroelectric component of LHWP, and delays in starting some donor-funded projects, including the World Bank-supported urban reorientation project, owing to the nonavailability of counterpart funds.

Net foreign borrowing remained constant at about 4 percent of GNP, while the Government’s repayment to the banking system reached almost 8 percent of GNP. Nonbank debt was reduced further, owing to the decline in the net issue of treasury bills.

4. Public debt

During 1988/89-1990/91, Lesotho’s domestic debt declined steadily, as the Government reduced its deficit rapidly. By 1991/92, the Government had become a net creditor to the banking system (Table XIV). Nonetheless, the Government has retained a limited amount of debt (mostly treasury bills) to facilitate the Central Bank’s open market operations.

During 1988/89-1993/94, Lesotho’s external debt in terms of maloti has more than doubled, mainly because of continued depreciation of loti against the major currencies. However, in terms of the US dollar, Lesotho’s total external debt showed little change. The share of concessional debt in total external debt, originating mostly from multilateral sources, increased from about 77 percent in 1988/89 to about 84 percent in 1991/92 and increased further to about 91 percent in 1993/94 (Table XXIX).

VI. Monetary and Financial Sector Developments

1. Institutional arrangements

The financial system of Lesotho consists of following four institutions: (a) the Central Bank of Lesotho (CBL), established in 1982; (b) depository institutions, comprising three commercial banks (the government-owned Lesotho Bank, and two long-established private banks, the Barclays Bank and the Standard Chartered Bank), two government-owned specialized banks (the Lesotho Agricultural Development Bank (LADB), and the Lesotho Building Finance Corporation (LBFC), which was merged with the Lesotho bank in 1993), and a network of rural credit unions supported by a central coordinating organization; (c) two development finance institutions, Lesotho National Development Corporation (LNDC), concentrating on larger enterprises, and Basotho Enterprise Development Corporation (BEDCO), focusing on small enterprises; and (d) an insurance sector consisting of the Lesotho National Insurance Company (LNIC), several brokers, and an agent for a South African life insurer.

The CBL is responsible for currency issue, regulation, and supervision of the entire financial system, administration of exchange control, as well as reserve management and monetary policy, and has since 1990 been the sole banker to the Government of Lesotho. Lesotho Bank has the largest market share in the banking sector and is the banker for most of the parastatals. It is also the chief administrator of the Miners’ Deferred Pay Fund (a compulsory savings scheme introduced in 1973 to mobilize miners’ remittances originating from South Africa).

The CBL conducts its monetary management within the overall constraint of its membership in the CMA. 1/ In Lesotho, the South African rand circulates as legal tender alongside its own currency--the loti (plural maloti)--which is pegged at par to the rand. The loti is convertible to the rand and is fully backed by the rand and other convertible currencies held by the CBL. The CMA arrangement also requires the unrestricted transfer of funds between member states, including a uniform exchange system regime vis-à-vis the rest of the world.

2. Monetary developments, policy, and management

a. Monetary developments

Two factors make the quantification of broad money difficult in Lesotho. First, the quantity of rand in circulation is unknown, and second, business entities as well as individuals hold bank accounts across the border in South Africa and may freely use banking facilities there. The monetary statistics therefore underestimate the total stock of broad money in Lesotho. On the basis of the maloti in circulation and bank deposits in Lesotho, the stock of broad money grew at a yearly average rate of 14.6 percent during the period March 1989 to March 1993, with over two thirds of the expansion taking place during the first two years, 1989-91 (Table XV). The fall in aggregate domestic credit, brought about by a sharp decline in net claims on government, contributed to the deceleration of monetary growth during the latter part of the period. During 1992/93 and 1993/94, a fiscal surplus facilitated the rapid net repayments to the banking system by the Government, which resulted in a decline in total net domestic credit, even after allowing for a significant increase in private sector credit. In 1993/94, the stock of broad money grew by nearly 23 percent--from M 818.2 million to M 1,006 million--owing to a rapid buildup of the CBL’s foreign exchange reserves, aided partly by the liquidity impact of a larger-than-anticipated surplus in the overall balance of payments. Consequently, the net foreign assets of the banking system rose sharply from M 822 million at end-1992/93 to M 1,319.6 million at end-1993/94, with most of the increase occurring in the CBL’s reserve holdings.

b. Credit developments

The trend in total domestic credit has reflected the objectives of Lesotho’s adjustment programs. Prior to the adoption of these programs, in the early and mid-1980s, total domestic credit had expanded rapidly, fueled by bank financing of large government budget deficits and growth in private sector activity. After 1990, the trend was reversed and total domestic credit fell from M 502.8 million at end-March 1990 to M 154.5 million at end-March 1993, and then to a negative M 116.2 million in March 1994. This was consistent with the fiscal stance of the authorities’ adjustment program. The aggregate movements, however, conceal the different directions of movement of the two components of domestic credit. Whereas net claims on government have declined sharply and become negative in recent years (reflecting a rapid decline in the budget deficit and the subsequent surplus that allowed net repayments of government debt to the banking system), private sector credit was programmed to grow to support the economic recovery (Tables XV, XVII, XVIII, and XX). The credit ceiling that has been put on commercial banks, as part of the CBL’s monetary goal, has not been binding during the 1993/94 fiscal year.

Table XX shows the sectoral composition of commercial bank credit to the private sector. In the early 1990s, most of the credit expansion went to sectors other than agriculture. However, with the recovery of the economy from the severe drought that hit Southern Africa during 1990-92, agricultural credit demand picked up in 1993/94, although a significant part of agricultural activity is either self-financed or financed by nonbank informal rural lenders. The steady growth in credit to the manufacturing sector during the period 1989-94 is attributable to the rapid growth of that sector in recent years. More recently, the sudden spurt of credit demand in the second half of 1993 reflects the recent expansion of exports of garments, textiles, electronics, and other light manufactures. The period after June 1993 also witnessed increased construction activity and a consequent rapid growth of credit to the construction sector. Another notable feature of credit developments in 1993/94 is the sharp decline in credit to the trade and hotel industry, because of continued depressed activity in these sectors. There was some increase in other service sectors, owing to the economic recovery in South Africa and in Lesotho.

Overall credit to the private sector has grown steadily over the period 1989-94 to accommodate the economic expansion brought about by the Fund supported program and the LHWP. During most of this period, the Government has been a net creditor to the banking system. As a result, the credit deposit ratio, which had reached about 76 percent in December 1989, was only 57.7 percent in March 1994 (Table XIX). Because of the Minimum Local Asset Requirement (MLAR) put in place in 1981--which requires banks to maintain domestic assets amounting to a minimum 85 percent of their total assets (implying that foreign assets may comprise only up to a maximum of 15 percent of banks assets)--banks have progressively accumulated large deposits at the CBL (Table XVII).

c. Interest rate policy

Owing to Lesotho’s membership in the CMA and the close interdependence of the country’s banking system with that of South Africa, the scope for independent interest rate policy in Lesotho is very limited. In general, the CBL’s interest rate policy mirrors developments in South Africa and actions of the South African Reserve Bank.

At present, the CBL officially sets the discount rate, the minimum (passbook) savings rate, and the rates it pays on commercial bank deposits at the CBL. Tables XXII and XXIII show movements of interest rates in Lesotho vis-à-vis South Africa. Interest rates began to drop in late 1993 after a downward adjustment of the CBL discount rate, from 15 percent in September 1993 to 13.5 percent in December 1993, a move that followed similar changes in South African Reserve Bank policy. The treasury bill auction rates likewise declined steadily from 11.1 percent in March 1993 to 9.9 percent in March 1994. Following the trends in the market, the prime overdraft rate in South Africa and prime rate in Lesotho began to decline in March 1993. By December 1993 both rates had dropped by a percentage point, to 15.25 percent and 14 percent, respectively. Similarly, consistent with trends in South Africa, savings and time deposit rates in Lesotho moved downward by 1 percentage point by December 1993. With the drop in the inflation rate in 1993/94, all deposit rates in Lesotho are now positive in real terms.

d. Bank liquidity

The CBL has not changed the statutory cash reserve or liquid asset ratios for the commercial banks in the recent past. The cash reserve ratio has remained unchanged at 3 percent for the Miners’ Deferred Pay Fund (MDPF), 5 percent for call money and time deposits, and 9 percent for demand deposits. The minimum liquid asset ratio, on the other hand, has remained unchanged at 30 percent for short-term deposit liabilities, 20 percent for medium-term liabilities, and 5 percent for long-term liabilities.

3. Financial intermediation for development

a. Miners’ Deferred Pay Fund

The MDPF is a compulsory savings scheme (and repatriation of part of the earnings to Lesotho) for Basotho (contractual) miners in South Africa. Under the scheme, which was introduced in 1973, South African mining companies transfer 30 percent (reduced from 60 percent in 1990) of the basic pay of Basotho miners to a special fund at the Lesotho Bank, which earns an interest rate equal to the savings deposit rate. The account is used to support each miner’s family in Lesotho. As a result, there is a rapid turnover in this account. For example, at end-March 1994, outstanding deposits under the MDPF stood at M 48.5 million. Under “normal” circumstances the miners can access the Fund directly only at the termination of their employment contract (usually 12-18 months).

b. Export Financing Scheme

The Export Financing Scheme (EFS), established by the CBL in 1988 to encourage nontraditional exports, acts as a credit guarantee facility for manufacturers and traders engaged in export activities. It provides collateral by way of pre- and post-shipment export credit on concessional terms (usually 2 percentage points below the prime interest rate) from the participating commercial banks. In the event of failure by the exporters to repay, the loss is largely covered by the CBL. There is also a refinancing facility available at the CBL and its operation is backed by the Export Development Fund. Between the start of EFS in 1988 and the end of 1993, M 193 million was disbursed through the commercial banks.

VII. External Sector

l. Overall developments

Lesotho’s currency, the loti (plural maloti), is freely convertible and pegged at par to the South African rand. Lesotho’s external sector is heavily influenced by developments in the region and notably those in South Africa. The balance of payments position is mainly determined by the remittances from Basotho workers employed in South Africa, particularly in the mining sector, and by variations in nonduty SACU receipts. In addition, the bulk of Lesotho’s external trade takes place with South Africa, with about 80 percent of imports originating from, and about 40 percent of exports going to, South Africa. Since 1988, developments in Lesotho’s balance of payments have also been strongly influenced by the launching of the LHWP, designed mainly to exploit the country’s surplus water for export to South Africa. The implementation of the LHWP has led to a surge in project-related imports of goods and services, which are financed from external sources. Upon completion of the first phase of the project in 1997, the LHWP will provide an important additional source of foreign exchange earnings for Lesotho in the form of royalties for water exported to South Africa. There will also be foreign exchange savings through domestic production of electricity. At present, practically all electricity needs are met through imports from South Africa.

Lesotho’s balance of payments has improved substantially since 1988/89. Addressing the acute balance of payments problem was a major reason for adopting an adjustment program. As a consequence, the overall balance of payments has recorded rising surpluses that have boosted reserves to about M 1,006 million (US$291.7 million), or the equivalent of 19.6 weeks of non-LHWP imports at end-March 1994, compared with 4.2 weeks at end-March 1990 (Table XXIV). The current account deficit (including unrequited transfers but excluding LHWP-related transactions) fell from 9.6 percent of GNP in 1988/89 to 2.6 percent of GNP in 1992/93, and improved further to 1.9 percent of GNP in 1993/94. These favorable trends reflect to a large extent the impact of measures taken during the ongoing adjustment program, although Lesotho’s external position has also benefited from growing SACU revenues and LHWP-related transactions.

2. Merchandise trade

a. Exports

Lesotho’s exports surged by nearly 39 percent in 1992/93 and by 11 percent in 1993/94 (Table XXIV and XXVII), on account of the continued expansion of the export-oriented manufacturing sector. As a result, manufactured exports, namely clothing, electronics, and footwear, now account for more than 80 percent of total exports, and their growth has more than offset the reduction in traditional exports--mohair, wool, and diamonds--the prices of which have remained weak during the past decade.

The remarkable performance of manufactured exports has been made possible by Lesotho’s successful effort to attract investment from the Far East and South Africa, as well as Lesotho’s access to the European Union, United States, and Canadian markets. Lesotho’s association in the Lomé Convention has facilitated its access to the European Union market. The U.S. market remains Lesotho’s most important outlet, although it was temporarily closed when the United States (and Canada) placed quotas on textile imports from Lesotho in 1992/93. Exports have also benefited from the broad range of tax and financing incentives provided by the Government to private investors.

The direction of Lesotho’s merchandise exports has continued to change, as exports to North America and the European Union have increased further (Table XXVIII). Although South Africa remains the most important export market, the share of Lesotho’s exports to SACU and CMA member countries (principally South Africa) declined from 60 percent in 1990 to about 40 percent in 1993. During the same period, the share of exports to North America rose from about 19 percent to about 33 percent, while the share of exports to the European Union also increased slightly, from about 20 percent to 22 percent.

b. Imports

The annual growth rates of non-LHWP merchandise imports were on the order of 10 percent during 1991/92-1993/94 (Table XXIV), reflecting mainly tight monetary and fiscal policies and the slow rise in workers’ remittances. The composition of non-LHWP imports is largely dominated by consumer goods, namely foodstuffs and miscellaneous manufactures. Tentative estimates indicate that in recent years there has been an increase in the share of investment goods imports (other than LHWP), reflecting the implementation of projects in the public sector investment program. Imports associated with the LHWP accounted for 11-15 percent of total merchandise imports during the last three fiscal years.

With regard to the origin of imports, South Africa continues to be the major source of Lesotho’s merchandise imports, and imports from the SACU member countries (principally South Africa) accounted, on average, for about 90 percent of all imports during the period 1989-93 (Table XXVIII). However, South Africa’s share in Lesotho’s total imports is declining over time. Imports (mainly semiprocessed inputs for manufacturing) from Asia about tripled during the same period, establishing the Far East as the second largest source of Lesotho’s imports.

3. Service and transfers

Remittances from Basotho mine workers in South Africa constitute the major source of Lesotho’s foreign exchange receipts. The growth in workers’ remittances is a function of the number of Basotho mine workers in South Africa and changes in the average wage level. During 1991/92-1993/94, workers’ remittances increased marginally in real terms, as annual declines in the number of mine workers were only slightly more than compensated by wage increases. An improvement in gold prices in 1993 halted retrenchments and led to some new hiring at year-end. In any case, the average number of Basotho miners in the South African mining sector at the end of 1993 stood at 117,900, up from 117,000 early in the year (Table XXVI).

Over the period, larger deficits were recorded in the other services account (excluding workers’ remittances), attributable mainly to the increase in imports of services, including transportation, associated with the implementation of the LHWP (Table XXV). Reflecting the Government’s policy of limiting nonconcessional foreign borrowing, interest payments remained fairly constant in U.S. dollar terms, while outflows of dividends and profits were somewhat compensated by higher earnings from official reserves, which increased sharply over the period 1991/92-1993/94.

Unrequited transfers, consisting largely of official grants and nonduty SACU receipts, also increased sharply in 1992/93 and 1993/94. The U.S. dollar value of SACU nonduty receipts, which are based on the level of all merchandise imports, has increased almost threefold since 1988/89, owing largely to the steady rise in imports associated with the LHWP.

4. Capital account

Net long-term capital flows increased steadily over the five years through 1993/94 and were dominated by disbursements related to Phase 1A of the LHWP project (Table XXIV). Phase 1A has two components: a water transfer component for export of water to South Africa (by far the larger part of Phase 1A), and the smaller electricity component to generate power for Lesotho and for export. The costs of both components of Phase 1A are financed through external borrowing by the Lesotho Highlands Development Authority, on behalf of the Government of Lesotho. However, the Government of South Africa will service and repay the debt related to the water component (in lieu of full payment to Lesotho for its water exports); in addition, beginning in 1996/97 South Africa will make regular royalty payments to Lesotho. Other official disbursements (excluding LHWP), which are relatively small, also rose during the period under review, and were mainly directed toward the financing of the public investment program. Long-term private foreign investment continued to flow at a steady level. Short-term capital, largely comprising changes in the net foreign assets of the commercial banks, recorded a sharp outflow during 1992/93 as banks sought to hold foreign assets in order to earn a return, while domestic credit demand remained depressed because of the drought. However, in 1993/94 the short-term capital outflow decreased, as domestic credit demand picked up.

5. External debt and debt service payments

The external public debt (excluding LHWP) has risen at a moderate pace in the past five years, increasing from M 690.6 million (US$270.0 million) in 1988/89 to about M 1,542 million (US$531.1 million) in 1993/94 (Table XXIX). In maloti terms, the increase appears large on account of the continued depreciation of the loti against the U.S. dollar. During this period, in the context of the Government’s adjustment effort, the external debt profile improved substantially, as a result of the repayment of some nonconcessional loans and the Government’s cautious approach to new borrowing. The share of concessional debt rose from about 77 percent in 1988/89 to about 91 percent in 1993/94, on account of both the increase in concessional bilateral loans and the cessation of nonconcessional borrowing. This factor, coupled with the steady rise in exports of goods and services over the years, lowered debt service payments. The debt service as a percentage of exports of goods and services declined from 4.1 percent in 1988/89 to 3.3 percent in 1993/94, while external debt as a percentage of GNP remained stable at about 36-40 percent during the period.

6. Exchange rate developments

Changes in the nominal exchange rate of the loti reflect developments in the exchange market for the South African rand, to which the loti is convertible and pegged at par. As a result, over the five-year period 1988/89-1993/94, the loti depreciated nominally by 25 percent against the U.S. dollar, reflecting sporadic plunges in the value of the rand, which often reflected political uncertainty in South Africa. However, the nominal effective exchange rate of the loti--measured against a trade-weighted currency basket, of which the rand accounts for 95 percent--has been much more stable, having depreciated only by about 1.2 percent during the same period. Lesotho’s trade-weighted real effective exchange rate is heavily influenced by the weight of the rand and by the fact that price developments in Lesotho tend to reflect those in South Africa.

A detailed description of Lesotho’s exchange and trade system and the changes that took place in the system in 1993/94 is provided in Appendix I.