Statement by Peter Ngumbullu, Executive Director for the Kingdom of Lesotho and Joseph Kanu, Advisor to Executive Director September 19, 2005

The Kingdom of Lesotho’s 2005 Article IV Consultation reports that the government’s fiscal position and the external current account have improved markedly. The authorities are preparing an action plan, in collaboration with development partners, to improve the business climate. Critical measures aim to increase labor productivity through training, reduce domestic costs for the private sector by addressing infrastructure bottlenecks, remove regulatory and administrative impediments, improve access to financial services, and promote product and export market diversification.


The Kingdom of Lesotho’s 2005 Article IV Consultation reports that the government’s fiscal position and the external current account have improved markedly. The authorities are preparing an action plan, in collaboration with development partners, to improve the business climate. Critical measures aim to increase labor productivity through training, reduce domestic costs for the private sector by addressing infrastructure bottlenecks, remove regulatory and administrative impediments, improve access to financial services, and promote product and export market diversification.

1. Introduction

On behalf of the Kingdom of Lesotho authorities, we thank Management and staff for their continued involvement and support and for the technical assistance provided. Lesotho’s macroeconomic performance over the years has consistently improved, largely as a result of the authorities’ commitment to ensure that their macroeconomic objectives are achieved. Going forward, the authorities are keen on implementing policies aimed at promoting sustainable economic growth, improving the delivery of public services as well as the investment environment. The authorities have identified several key areas for development in the recently concluded PRSP, to guide the country’s vision and efforts towards achieving the Millennium Development Goals.

2. Recent Economic Developments

Lesotho has continued to record improvements in its overall financial situation, despite a mixed macroeconomic performance and sluggish real economic activity. However, marked improvements have been experienced in the fiscal and external current account positions, with a decline in inflation and a substantial increase in international reserves. Domestic and foreign debts have been contained at manageable levels. The appreciation of the exchange rate, however, has impacted on economic growth, coupled with the phasing out of textile quotas by industrial countries, thereby resulting in declining terms of trade. These adverse developments have been compounded by the cumulative effects of external shocks on manufacturing and the ongoing drought on agricultural output.

The overall fiscal balance has during the past years, shown a surplus reflecting a 6.1 percentage points increase of GDP in SACU receipts arising from the 2002 revision of import data. As Lesotho is a member of the CMA, monetary developments reflected those in South Africa. The fall in the domestic borrowing requirement by government has led to a downward movement of market yield on treasury bills. The interest rate spread also narrowed, while banks’ financial soundness remains strong. In addition, the authorities will submit the draft anti-money laundering legislation to Parliament this year, while implementation of the recommendations of the 2001 FSAP has commenced.

There has been significant reduction in the external current account deficit accompanied by a corresponding increase in net international reserves. This was facilitated by several factors including a boost in exports, the reopening of a diamond mine, rise in SACU receipts and a strong flow of remittances from Lesotho’s migrant workers in South Africa. These effects have been able to offset the adverse impact of a worsening terms of trade. There has also been a marked improvement in debt indicators due to the strengthening of the fiscal situation. However, the share of external public debt to GDP fell to 53 percent in 2005 from 83 percent in 2003, due to exchange rate appreciation thereby resulting in the net present value of debt declining to below 40 percent of GDP.

The authorities have made more efforts towards tackling poverty and the HIV/AIDS pandemic. Important reforms have also been identified in the PRS, while more efforts are being taken towards achievement of the MDGs. The authorities have aligned the budget with the PRS and have taken measures to strengthen institutional and implementation capacity.

3. Medium and Long-Term Outlook, Challenges and Strategy

The authorities are cognisant of the country’s vulnerability to a range of potential and permanent adverse developments over the medium term as well as the cumulative impact of several shocks, that include the erosion of trade preferences and the real effective appreciation of the exchange rate. In this context, they are committed to taking actions to deal with the ongoing challenges facing the country. They will implement measures to address immediate trade shocks, consolidate the gains already achieved in macroeconomic stability, and promote both domestic and external private sector development. A strong export diversification strategy that will generate higher growth and reduce the country’s vulnerability to external shocks will be pursued. Because of the urgency in restoring external competitiveness, the authorities will endeavor to maintain exchange rate parity in view of the benefits arising from the CMA and the intimacy of trade and financial ties with South Africa. Heavy reliance will be placed on structural reforms to ensure achievement of strengthened competitiveness. The authorities will also embark on implementation of the second medium-term scenario as identified by staff to achieve the above objectives.

Fiscal Policy

The burden of safeguarding macroeconomic stability under the exchange rate parity arrangement will fall on fiscal policy. In view of this, the authorities will address the envisaged weakening of the fiscal position in the immediate and medium term. The authorities are aware of the potential for the country’s underlying revenue performance to deteriorate with weaker economic growth. The increase in civil service wages would result in an expected 5 percent increase in individual income tax threshold and increased expenditures. As a result, the authorities will maintain an overall balance consistent with macroeconomic stability, which will include repayment of two high interest rate loans to reduce the burden on future debt service. In the event that any domestic financing of fiscal deficits in excess of grants and concessional loans could weaken the external current account and worsen the reserve position, efforts will be made to minimize loss of foreign exchange reserves. The authorities will also limit fiscal deficits over the medium term to 2-3 percent of GDP and will undertake a periodic review of this position based on realistic assessments of the country’s prospects for mobilizing grants and concessional loans. This includes the potential for any domestic financing that will be raised in the case that demand for expenditure increases. In addition, the authorities will implement other measures that will include strengthening revenue mobilization, while pursuing reforms in the allocation mechanism of the development component of SACU in view of the concerns raised by the poorest members.

External Sector Policies and the Monetary framework

The current exchange rate parity has facilitated regional trade and progress is expected to be made towards achieving fiscal and monetary discipline as well as reduce inflationary pressures. Because of the weakening of external competitiveness due to large adverse exogenous exchange rate movements that were not offset by wage adjustments, the authorities, in association with other CMA partners will also take action to modify the common exchange rate arrangements to promote long-term growth in smaller member countries. They will also implement sound macroeconomic policies that would include prudent fiscal restraints and structural reforms that will enhance competitiveness. In addition, the authorities will continue to maintain an open trade and exchange system, in view of the fact that trade policies are largely dictated through the SACU arrangements.

As the exchange rate is at par with the South African rand, there is currently no space for the authorities in determining monetary policy. This implies a virtual absence of exchange controls on capital movements within CMA. Given this development, the authorities are determined to have an indicative monetary policy framework for the current period that will target international reserves which are currently at about four months of imports. This would include projections for money demand, while taking into account projected declines in real GDP and inflation. The authorities are fully aware of the benefits of such a mechanism in determining the limits to be observed especially with regards to net domestic assets and net creditor position of government in the banking system. More prudence will be undertaken to lower the NPV of external debt below the 40 percent of GDP threshold, currently an appropriate indicative threshold for the debt to GDP ratio.

Structural Reforms

The authorities will continue to implement measures that will increase labor productivity and contain domestic cost pressures. In view of the current high unemployment in the manufacturing sector, they will ensure that parties involved in wage negotiations are encouraged to take into account productivity and terms of trade movements. They will also continue to exercise constraints on any increases in public sector wages to avoid spill-over effects in the economy. In order to stimulate production and eliminate further declines in employment, the authorities will provide subsidies to the textile sector, that will be properly designed to protect against any downside risks. Such action will be weighed against the expected benefits in investment flows, output and employment. The investment climate will be improved to further attract foreign investment and will entail accelerating reforms that will eliminate legal and regulatory impediments towards private sector development, including improvements in infrastructure facilities and completion of the privatization of the Lesotho Electricity Corporation (LEC).

The authorities will also strengthen institutional framework for the development, execution, monitoring, and evaluation of new programs for scaling up poverty reduction expenditures. They will continue to pursue public-private partnerships, aimed at improving infrastructure and public service delivery in health and education sectors.

Financial Sector Issues

The authorities will implement measures that will lead to improvements in the financial sector, especially with regards to enabling competition and private sector access to bank credit. They will develop a three-tier banking system that will consist of foreign-owned banks, local cooperatives and small banks, and microfinance institutions. Measures will also be taken to strengthen banking regulation, amend the Matrimonial and Land Acts, and remove obstacles to bank lending as well as ensure a proper and well functioning payments system that will involve revision of the current legislation and facilitate electronic transfer payments.

4. The PRS Process

The authorities are fully aware that the PRS is an important step toward sustained growth and poverty reduction in the country as well as meeting the MDGs. The process has been conducted through broad based consultations with key stakeholders and civil society. The authorities have fully outlined their priorities with a program of actions that has facilitated preparation of a set of cost matrices and performance indicators. The key limitations and risks to the PRS relate to its operationalization, possible further shocks to the economy and governance. Given the goals and objectives identified in the PRS, the authorities are ready and committed to transfer this into actual work plans. They will also exercise expenditure restraints as dictated by the fiscal framework, especially in non-priority areas that have been identified. There will be improvements in monitoring and evaluation which will help to identify existing capacity constraints in the public sector.

While ensuring that these challenges are overcome and risks mitigated, the authorities will give priority to developing and implementing a comprehensive medium-term macroeconomic framework and an action plan for sustained growth to address external vulnerability and competitiveness concerns. In addition, the authorities will address the designation of an action plan to improve the allocation of resources and public expenditure management, including civil service reform and address the HIV/AIDS pandemic more vigorously.

5. Conclusion

The authorities have taken appropriate measures to ensure achievement of macroeconomic objectives. Given this development, the authorities have expressed strong interest in continued Fund involvement and support through capacity building and technical assistance. They are requesting Fund assistance and involvement in crucial areas of fiscal and public resource management, financial sector reform and prudential supervision, as well as the designing of an appropriate macroeconomic framework. They have also shown interest in securing the necessary assistance in drafting an appropriate law for electronic banking, review of the study conducted to determine an adequate level of foreign reserves and provision of field training to personnel in financial programming.