The Selected Issues paper provides an overview of trends, performance export growth, value added, and employment, account of the structure and evolution of Lesotho's textiles during the decade through 2002, and discusses future prospects and key issues. It analyzes the implications of the phasing-out of the African Growth and Opportunity Act and also reviews the HIV/AIDS situation in Lesotho. It discusses the current situation, the measures to enhance financial intermediation, and the Southern African Customs Union Arrangement and its effects on revenues. The paper also includes the summary of tax systems, July 2003, and the exchange trade system.


The Selected Issues paper provides an overview of trends, performance export growth, value added, and employment, account of the structure and evolution of Lesotho's textiles during the decade through 2002, and discusses future prospects and key issues. It analyzes the implications of the phasing-out of the African Growth and Opportunity Act and also reviews the HIV/AIDS situation in Lesotho. It discusses the current situation, the measures to enhance financial intermediation, and the Southern African Customs Union Arrangement and its effects on revenues. The paper also includes the summary of tax systems, July 2003, and the exchange trade system.

III. Measures To Enhance Financial Intermediation in Lesotho21

58. Lesotho is pursuing an agenda of financial sector reform. This paper reviews the current situation and the measures that the authorities have adopted to enhance financial intermediation. There are three main conclusions: (i) stronger measures are needed to improve the institutional environment; (ii) the ongoing capital account liberalization is essential to harmonize Lesotho’s regulations with those of other members of the Common Monetary Area (CMA); and (iii) measures to support rural finance are important.

A. Introduction

59. Financial intermediation is poor in Lesotho. Banks are reluctant to provide credit to local enterprises and consumers. In many parts of the country, banking services are simply not available. Lesotho is in a vicious cycle of poor financial intermediation and a low level of development. While partly a result of the low level of development, poor financial intermediation is itself an impediment to Lesotho’s economic growth because the banking system does not facilitate the flow of resources between lenders and borrowers.

60. Two factors are to blame for this difficult situation. One is weak institutions, particularly weak enforcement of contracts. Anticipating the difficulties in loan recovery, banks avoid making retail loans and concentrate on dealing with the government instead. The second is dominance by South Africa, an economy with a much more sophisticated banking system.

B. Background and Recent Developments

61. The striking fact about Lesotho’s banking sector is the discrepancy between the abundance of cash and the paucity of credit. The banks are highly liquid; their private sector credit-to-deposit ratio is at a very low 28 percent, compared to 81 percent in Swaziland, 113 percent in Namibia, and 157 percent in South Africa.22 At the same time, the demand for banking services remains unmet for many people, especially in the rural areas.

62. The sources of this discrepancy are structural. They can be broadly grouped into two categories: internal and external. Internally, the existing institutional and physical infrastructure is not adequate:23

  • Property rights are often not well-defined because of the uncertainty regarding the legal status and even the location of the assets.24

  • In many cases the credit history for a particular borrower is not available, as the credit bureau is not yet operational. Moreover, the identity of the borrowers is difficult to verify because there is no uniform identification system and a borrower can easily change his or her name to evade the lenders.

  • The existing laws on land ownership make it almost impossible to use land as collateral.

  • Contract enforcement is difficult because the judicial system is slow and inefficient, the commercial court is in its infancy and is not very effective.

  • Married women have few legal rights. A married woman is considered a minor and is, therefore, ineligible for credit without a written permission from her husband.

  • Poor physical infrastructure (lack of electricity and inadequate roads) hampers the extension of banking services to the remote rural areas.

63. The internal impediments to financial intermediation are exacerbated by Lesotho’s small size and its proximity to South Africa. The economy supports a small banking sector consisting of only two independent banks.25 Moreover, both the banks and their potential customers have easy access to the much better developed South African market. Many of the best customers prefer to take their business to South Africa. At the same time, instead of looking for investment opportunities in Lesotho, the banks can always invest their excess liquidity in South African securities.

64. These internal and external impediments leave many of the Basotho, especially the rural poor, without access to formal banking services. To satisfy their demand for credit, many Basotho have to resort to the services provided by the informal sector, represented mostly by the money lenders and the credit societies.26 There are no available estimates of how much money passes through the informal sector, but the anecdotal evidence suggests that the amount is substantial.

65. In recent months, the authorities introduced a series of measures to boost financial intermediation within the country and to facilitate transactions between Lesotho and the rest of the world:

  • To facilitate the extension of credit to the private sector, the government has approved the creation of a credit bureau.

  • In June, Lesotho partially liberalized capital account transactions. Companies and private individuals can now open foreign currency accounts outside the CMA, subject to limits and to approval by the central bank. In addition, all restrictions have been lifted on long-term capital inflows.

  • To make credit more accessible for the rural residents, the Central Bank of Lesotho has established the M 2.5 million Rural Savings and Credit Guarantee Fund. This fund will guarantee 50 percent of the loans extended by the commercial banks to credit societies in the rural areas.

66. Looking ahead, the government plans to submit the new Land Act to parliament. The act will stipulate women’s rights to acquire, hold, and use land. It will also simplify land transactions and make it easier to use land as collateral. In addition, the central bank has outlined the Vision for the Development of a Payments and Settlement System in Lesotho. Over the medium term, the Vision aims to develop a payments system that is reliable, secure, accessible, and cost-effective.

C. Assessment

67. Lesotho has embarked upon a course of reform to improve financial intermediation. The questions are whether the scope of reform is appropriate and what can be expected from the implementation.

68. Empirical evidence suggests that financial development is essential for economic growth. This is true for both industrial and developing countries. A well-developed financial system promotes growth by efficiently allocating the society’s savings and by mitigating the risks.27 This result supports the overall objective of Lesotho’s reform program.

69. The remainder of this subsection is devoted to the analysis of the steps that the government is taking to improve intermediation. These steps are (i) measures to improve the institutional environment, (ii) capital account liberalization, and (iii) support for rural finance.

Measures to improve the institutional environment

70. Lesotho’s economic performance suffers from poorly defined property rights, the inefficient enforcement of contracts, and the lack of accessible information about assets and their owners. These deficiencies severely limit business opportunities because, in such an environment, a person can transact only with people whom he or she personally knows and trusts.

71. Accordingly, to enhance financial intermediation and to improve growth prospects, the government must address these institutional weaknesses. Well-defined property rights, good contract enforcement, and accessible information accelerate economic growth by dramatically expanding the set of potential business partners to encompass, at the limit, the entire society.28

72. The steps being taken are, unfortunately, far from adequate. The credit bureau, an essential provider of information on borrowers, is not yet operational; its establishment has been announced only recently. No action has been taken to introduce a uniform personal identification system for the Basotho.

73. The authorities are well advised to address these issues as soon as possible, since the benefits for the economy could be substantial. Several steps can be suggested:

  • Develop a comprehensive and easily accessible property registry.

  • Make the credit bureau operational.

  • Address the issue of multiple identities.

  • Strengthen the judicial system.

Capital account liberalization

74. Capital account liberalization facilitates transactions between Lesotho and the rest of the world. At the same time, it may subject the economy to excessive volatility and to shocks originating well beyond the country’s borders. In a review of the recent research on this subject, Prasad and others (2003) conclude that financial integration in itself does not lead to economic growth. Echoing that result, Gorinchas and Jeanne (2003) note that, while the direct benefits from financial integration for the developing countries are small, financial integration may promote growth through a positive impact on domestic allocative efficiency.29

75. Capital account liberalization affects domestic allocative efficiency through the entry of efficient foreign banks and the imposition of market discipline on domestic macroeconomic policies (Gorinchas and Jeanne, 2003). These channels are, however, unlikely to be of great significance for the present-day economy of Lesotho. First, there is no room for entry by another bank in the near term, since the existing banks are well capitalized and have difficulty finding good customers for their products. In addition, there are already no restrictions on entry by the banks from South Africa and from other members of the CMA. Second, domestic macroeconomic policies are already constrained by the loti’s peg to the South African rand.

76. Nevertheless, additional circumstances necessitate financial integration between Lesotho and the rest of the world. First, as a member of the CMA, Lesotho should aim to make its policies compatible with those of the other members. As South Africa and other CMA members gradually liberalize their capital accounts, Lesotho cannot lag far behind. Second, capital account liberalization will make it easier for foreign entrepreneurs to conduct business in Lesotho. This is especially true for the vital textiles sector, which is being developed mostly by Taiwanese investors.

77. In sum, capital account liberalization will not produce a windfall. However, it will benefit the economy by raising the productivity of foreign capital already in Lesotho, and by making new investments easier to undertake.

Support for rural finance

78. It does not follow automatically that access to credit for the poor Basotho will improve because the formal domestic financial sector is becoming more efficient. Mosley (1999), in a study of four African countries including Lesotho, argues that availability of credit in the formal sector does not necessarily lead to better access to credit for the rural poor. Notwithstanding the situation in the formal sector, banks are reluctant to lend to these poor because of a lack of collateral and uncertainty about the borrowers’ repayment intentions.

79. In this respect, the recent establishment of the Rural Savings and Credit Guarantee Fund is a welcome development. By encouraging the commercial banks to lend to the credit societies in the countryside, the government and the central bank aim to use the existing credit channels to provide additional resources to the rural Basotho. This strategy capitalizes on the strengths of the credit societies—such as superior local knowledge and high repayment rates—while gradually making them a part of the formal financial system.

80. The proposed rural finance scheme relies upon four pillars: formalization; noncredit assistance; emphasis on savings and investment; and loan guarantees 30:

  • Formalization. To become eligible for funds, credit societies must register with the central bank, must adhere to basic accounting principles, and must open and hold active accounts in the commercial banks.

  • Noncredit assistance. Selected nongovernmental organizations will train the credit societies in the areas of accounting and fund management.

  • Emphasis on savings and investment. Credit societies must save; their savings accounts in the commercial banks will be used as collateral. The funds received from the commercial banks should be used for investment purposes and not for consumption.

  • Loan guarantees. To reduce the risk faced by the commercial banks, the Rural Savings and Credit Guarantee Fund will cover 50 percent of the potential losses; the rest will be covered by the credit societies and by the commercial banks themselves (20 percent and 30 percent, respectively).

81. How do the proposed features bode for the success of the rural finance scheme? While the scheme itself has barely started, several points can be made, based on the experience of other countries:

  • First, reliance on credit societies, the institution that is already functioning and well understood by the Basotho, is a sound policy. In contrast, if the new banking practices run counter to the existing customs, they would be unlikely to succeed because personal relationships are the basis for credit extension in the rural areas.31

  • Second, an inclusion of noncredit assistance is a welcome feature. McKernan (2002) shows that noncredit assistance (such as vocational training and information sharing among members) is important in raising the living standards of the borrowers.

  • Third, loan guarantees, introduced with proper safeguards and with risk shared by all the parties involved, are important in attracting the commercial banks. The banks are not familiar with the rural market, where the return may be high, but so is the risk. Moreover, the banks do not need to penetrate the rural market to prosper. Therefore, an additional incentive to attract the banks to the rural areas is necessary.

  • Fourth, while encouraging the borrowers to save and invest seems like a laudable idea, the results of such a policy are not obvious. In an environment where investment opportunities are few, the best way for the borrowers to increase their well-being may be to channel the money to other uses (for example, to on-lend the money in the informal market).32 The requirement to save in such an environment becomes simply an additional cost that must be incurred by the borrowers to secure the access to credit (Masanjala, 2002). Therefore, the policy to promote business opportunities in the rural areas—by extending the road network and access to electricity, for example—would greatly complement the emphasis on savings and investment.

  • Finally, rural finance is not a panacea for rural poverty. The experience of other countries suggests that credit extended by the rural finance institutions, while helping the poor, does not reach “the poorest of the poor.” 33 The credit societies are not charities, and the “the poorest of the poor,” with their low and highly variable income, are a bad credit risk. Therefore, the rural finance scheme must be accompanied by programs that target the most vulnerable segments of society.

D. Conclusion

82. The authorities recognize the value of sound financial intermediation for economic growth and the necessity for action. The reforms being introduced include measures to improve the institutional environment, gradually liberalize the capital account, and support rural finance.

83. This paper has reviewed the progress to date. More vigorous measures to improve the institutional environment are needed, such as developing a comprehensive and easily accessible property registry, making the credit bureau operational, addressing the issue of multiple identities, and strengthening the judicial system. Capital account liberalization is necessary to harmonize Lesotho’s regulations with those of other members of the CMA and to facilitate foreign investment. The initiative to support rural finance is also beneficial because access to credit for the rural Basotho is unlikely to improve on its own.


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Prepared by Dmitriy Gershenson.


All data for September 2003. For Lesotho, the data are provided by the authorities. For other countries, the data are from IMF (2003).


For a detailed review of structural impediments to financial intermediation, see Vumbukani and Patel (2002).


For example, many buildings cannot be precisely identified because they are built on unnumbered sites.


The NED Bank and Standard Bank. The third bank, Lesotho Bank (1999), is jointly owned by the Standard Bank and the government of Lesotho. The ratio of total banking sector assets to GDP is low at slightly above one-third.


Only a fraction of the money lenders are licensed by the central bank. Credit societies are informal associations that finance consumption expenditure, for example during the festive season, and funeral expenses. The activities of credit societies are not regulated.


For a review of recent findings on this subject, see Levine (2003).


The importance of property rights, the legal enforcement of contracts, and the availability of information is discussed by Soto (2001).


In the same vein, Edison and others (2002) indicate that the evidence on whether capital account liberalization promotes growth is mixed. Nsouli, Rached, and Funke (2003) argue that to promote growth, capital account liberalization must be accompanied by the reform of domestic financial markets.


As described in Central Bank of Lesotho (2001 and no date).


The available evidence suggests that simply transplanting unfamiliar banking practices from one region to another may be counterproductive. For example, Pickering and Mushnski (2001) note that peer pressure—a crucial component of rural lending in Asia and other regions—was not effective among the Lakota Indians in the United States because of the Lakota’s deep-rooted aversion to intervene in other people’s affairs.


Fujita (2002), based on a study of credit flows in two Bangladeshi villages, argues that the poorer farmers use the available funds to lend to the richer farmers.


Amin, Rais and Topa (2003) note this phenomenon in their study of the credit extended by the Grameen Bank in rural Bangladesh.