Kingdom of Lesotho: Selected Issues and Statistical Appendix

This Selected Issues paper on the Kingdom of Lesotho reviews the broad objectives and key institutional features of the Common Monetary Area (CMA) relating to currency arrangements. The CMA Agreement provides for the three small member countries to have access to South African capital and money markets, but only through prescribed investments or approved securities that can be held by financial institutions in South Africa. Lesotho’s exchange rate arrangement under the CMA shares certain characteristics of a currency board.


This Selected Issues paper on the Kingdom of Lesotho reviews the broad objectives and key institutional features of the Common Monetary Area (CMA) relating to currency arrangements. The CMA Agreement provides for the three small member countries to have access to South African capital and money markets, but only through prescribed investments or approved securities that can be held by financial institutions in South Africa. Lesotho’s exchange rate arrangement under the CMA shares certain characteristics of a currency board.

I. The Institutional Arrangements of the Common Monetary Area and Policy Implications for Lesotho

A. Introduction

1. Lesotho, because of its history, geographical location, and membership in various regional institutions, has very close economic and financial ties with South Africa. When Botswana, Lesotho, and Swaziland gained political independence in the 1960s, they were already members of a common customs area—the Southern African Customs Union (SACU)—and also de facto members of a currency union with South Africa.1 The currency union was formally established on December 5, 1974, with the signing of the Rand Monetary Area (RMA) agreement. The RMA was revised in April 1986 to establish the Common Monetary Area (CMA) of Lesotho, Swaziland, and South Africa. Under the terms of the CMA Agreement, the South African rand would continue to be legal tender in Lesotho and Swaziland, which would also have the right to issue their own national currencies.2 When these countries issued their own currencies, they became responsible—albeit to a very limited extent—for their own monetary policy and assumed control of their own financial institutions. Bilateral agreements governed their access to the South African foreign exchange market. In January 1980, Lesotho established its own central bank and issued its national currency, the loti.3 In 1990, Namibia joined the CMA.

Table I.1.

Selected Economic Indicators

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Source: Lesotho authorities and Fund staff estimates.

2. This chapter reviews the broad objectives and key institutional features of the CMA relating to currency arrangements, the movement of funds within the CMA, access to the South African financial markets, gold and foreign exchange transactions, compensation payments, and other provisions. It concludes with a discussion of the main policy implications for Lesotho as a result of its membership in the CMA.

B. Broad Objectives

3. The CMA’s broad objectives are set out in the preamble to the CMA Agreement (Article 2), to which all participating members are signatories. These are to confer the advantages of a common monetary area on its members, provide for the sustained economic development of the CMA as a whole, encourage the advancement of the less developed members, and afford to all parties equitable benefits arising from the maintenance and development of the CMA.

C. Currency Arrangements

4. Under the CMA Agreement, Article 2 gives the three small member countries (Lesotho, Namibia, and Swaziland) the right to issue national currencies, and their bilateral agreements with South Africa define the areas in which their currencies are legal tender. In general, the local currencies issued by the three members are legal tender only in their respective countries. The South African rand, however, is legal tender throughout the CMA area. The national currencies issued by the three small countries are the loti in Lesotho, the lilangeni in Swaziland, and the Namibian dollar.

5. Article 2 of the bilateral agreement between Lesotho and South Africa also requires both countries to permit authorized dealers within their territories to convert, at par, notes issued by the Central Bank of Lesotho (CBL) or the South African Reserve Bank (SARB) without restriction and subject only to normal handling charges. Similar arrangements exist between the other two CMA members and South Africa.

6. The CBL is required (under Article 4 of the Lesotho-South Africa bilateral agreement) to maintain foreign reserves equivalent to the total amount of maloti (the plural of loti) currency that it issues.4 Such reserves may comprise the CBL’s holdings of rand balances, the rand currency the CBL holds in a Special Rand Deposit Account with the SARB, South African government stock (up to 10 percent of total reserves), and its investments with the Corporation for Public Deposit in South Africa.

D. Movement of Funds within CMA

7. Under the terms of the CMA Agreement (Article 3), no restrictions can be imposed on the transfer of funds, whether for current or capital transactions, to or from any member country. The only exceptions result from the member countries’ investment or liquidity requirements prescribed for financial institutions. The small member countries view the investment and liquidity requirements as a measure of savings mobilization for development purposes. The regulations requiring the investment of funds by financial institutions in domestic securities or credits to local businesses or individuals are, in effect, minimum local asset requirements. These regulations are meant to address the concern of the three small, less developed, CMA members that funds generated in their territories and deposited with local financial institutions tended to flow to the more developed capital markets of South Africa.5 Lesotho’s minimum local assets to total deposits ratio, which has been reduced in recent years, is 5 percent at present.

E. Access to the South African Financial Markets

8. The CMA Agreement provides for the three small member countries to have access to the South African capital and money markets, but only through prescribed investments or approved securities that can be held by financial institutions in South Africa. Access to the South African capital market is, however, made subject to a ceiling of 1.5 percent of the required minimum amount that such institutions hold as prescribed investments and approved securities. The terms and timing of such issues are subject to consultation and agreement with the South African government, and the issues have the same rating as South African municipal bonds. So far, Lesotho has not made use of such financing.

9. As regards the short-term money market, there are no regular arrangements for the taking up in South Africa of treasury bills issued by the other CMA member countries. However, the CMA Agreement recognizes the right of the other member countries, in special circumstances, to enter into bilateral negotiations with South Africa to obtain temporary central bank credit.

F. Gold and Foreign Exchange Transactions

10. Although the three small CMA members have the right to authorize foreign transactions of local origin, and are responsible for doing so, the CMA Agreement (Article 5) requires their exchange control regulations to be—in all material aspects—similar to those in effect in South Africa.

11. Under a surrender requirement, gold and foreign exchange receipts accruing to a country’s residents have to be surrendered to an authorized dealer appointed by that country. At the same time, the authorized dealers are required to sell the gold and foreign exchange they purchase to the national central bank, although they may maintain minimum working balances within limits determined by the central bank.

12. The bilateral agreement between Lesotho and South Africa also stipulates that the foreign exchange reserves maintained by the Central Bank of Lesotho and authorized dealers must not exceed 35 percent of Lesotho’s total holdings of such reserves and its rand balances. Thus, the bulk of Lesotho’s gold and foreign exchange are held at the SARB, which is responsible for managing these reserves. The SARB’s reciprocal obligation is to make foreign exchange available for foreign transactions authorized by the other CMA countries.

G. Compensation Payments

13. Since the rand is legal tender in all CMA countries (but the currencies of the three small CMA members are not legal tender in South Africa), South Africa compensates them for forgone seigniorage. Compensation is based on a formula equal to the product of (i) two-thirds of the annual yield on the most recently issued long-term South African government stock, and (ii) the volume of rand estimated to be in circulation in the member country concerned. The ratio of two-thirds was established on the assumption that it approximated the yield of a portfolio of reserve assets comprising both long-term and short-term maturities, assuming that the average yield would be less than the full long-term yield.

H. Other Provisions

14. To facilitate the implementation of the CMA Agreement, the member countries have established a commission in which each of them has one representative (along with some advisors, as needed). The commission holds regular consultations—at least once a year—with the aim of reconciling the interests of member countries on common issues pertaining to monetary and foreign exchange policies. It also convenes at other times at the request of a member country.

15. In April 1989, the CMA Agreement was amended to remove the exchange restrictions arising from the limitation on the conversion of balances upon termination of the agreement or withdrawal of any one party. The members ratified these amendments at end-1989, thus eliminating the restrictions on the making of payments and transfers for current international transactions on the part of Lesotho and Swaziland that arose under the agreement.

16. Article 9 of the CMA Agreement provides for the establishment of a tribunal to arbitrate disputes that might arise between member countries regarding the interpretation or application of the agreement.

I. Policy Implications for Lesotho

17. Lesotho’s exchange rate arrangement under the CMA shares certain characteristics of a currency board—all maloti currency issued by the CBL is backed entirely by the central bank’s foreign exchange reserves. Such an arrangement has the advantage of insulating monetary policy from possible political interference and hence helps enhance the credibility of macroeconomic policies. However, the CMA arrangement for Lesotho is different from a currency board in one important respect: a currency board is typically prohibited by law from acquiring any domestic assets, so all the currency it issues is automatically backed fully by foreign reserves.6 There is no such legal restriction for Lesotho under the CMA. So far, the CBL has been prudent in managing its domestic assets and its net international reserves have exceeded the monetary base.

18. The peg of the loti to the rand, the parallel circulation of the loti and the rand, currency convertibility, and regional capital mobility imply that Lesotho (like the other small CMA countries) does not have any independent control of its money supply. The demand for maloti depends importantly on the public’s confidence in the exchange rate parity given the extensive financial linkages between Lesotho and South Africa. Lesotho’s monetary base basically expands (or contracts) in line with central bank purchases (or sales) of foreign exchange. Spreads on government paper between Lesotho and South Africa have been small (below 40 basis points as of end-March 2005). Given the small size of its economy relative to that of South Africa, interest rate movements in Lesotho largely mirror those in South Africa, except for a spread that reflects country risk.

19. As suggested in the literature on optimal currency areas, the net gains for a country from joining a monetary union depend importantly on its economic characteristics, including its vulnerability to economic shocks and the degree of factor mobility within the monetary union.7 Lesotho is the poorest of the CMA countries, with much narrower production and export bases (especially compared with South Africa’s). It has experienced large negative terms of trade shocks since 2001/02, as the exchange rate appreciation vis-à-vis the U.S. dollar and the removal of textile quotas had a relatively strong downward effect on Lesotho’s terms of trade, given the large share in total exports of garments destined to the U.S. market.8 In contrast, the terms of trade have been improving in South Africa and have remained broadly unchanged in Swaziland. The economies of these countries are also more diversified than that of Lesotho. On factor mobility, although there are virtually no restrictions on capital movements between South Africa and Lesotho, employment in South Africa requires a work permit. Moreover, given the lack of skills and training, most of Lesotho’s workers would have difficulty finding a job in South Africa. In the past, opportunities for unskilled and semi-skilled Lesotho workers to get employed in South Africa were greater, particularly in the mining sector. These opportunities have been reduced in part due to the ongoing restructuring of the mining sector in South Africa. This suggests that the benefits of the CMA may have weakened from what they were originally. Moreover, for Lesotho to attract significant new investment flows (such as foreign direct investment), it must first remove various structural obstacles (including low labor productivity, regulatory and administrative impediments to private investment, bottlenecks in infrastructure, and an underdeveloped financial sector).

Figure I.1.
Figure I.1.

Common Monetary Area: Terms of Trade Index 1999-2004 (2000=100)

Citation: IMF Staff Country Reports 2005, 438; 10.5089/9781451823837.002.A001

Source: Lesotho Aurthorities; and IMF staff estimates.

20. Furthermore, with the exchange rate peg and lack of monetary independence, Lesotho will have to rely heavily on fiscal adjustment to cope with shocks. Efforts should continue to be made to restructure and realign expenditure priorities in line with the country’s poverty reduction strategy and to contain the public sector wage bill in the context of public sector reform. However, with progress in the ongoing trade liberalization discussions between the SACU and its trading partners, Lesotho is likely to receive lower SACU (tariff) revenues. This means that this fiscal transfer mechanism would become less important for Lesotho.

21. Under these circumstances, Lesotho’s adjustment effort will need to focus on strengthening competitiveness, mainly through the conduct of prudent fiscal policy and domestic structural reforms. The latter should focus on overcoming labor market and wage rigidities by encouraging the parties in wage negotiations to take into account productivity and terms of trade developments. It would also be important to boost labor productivity through an industry-led, demand-driven skills development program, with the private sector and donors sharing the cost. Legal and regulatory reforms would have to be implemented to develop the financial sector and remove obstacles to private sector development.


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The SACU was established in 1910, with membership comprising South Africa, Botswana, Namibia, Lesotho, and Swaziland. In 1921, after the establishment of the South African Reserve Bank, the South African pound became the sole medium of exchange and legal tender in South Africa, Bechuanaland (now Botswana), Lesotho, Namibia, and Swaziland.


Botswana, however, withdrew from the RMA in 1975, mainly because it was not willing to surrender its ability to formulate and implement monetary policy and wished to have the option of adjusting the exchange rate, if necessary, in response to shocks affecting its economy (see Collings, et al (1978) and Guma (1985)).


See Foulo (2003).


The aggregate amount of Maloti currency issued is measured at any given time by the average of such currency in circulation during the immediately preceding 14 days.


To some extent, such flows are facilitated by the fact that Lesotho’s banking system comprises four banks, three of which are South African. At the same time, however, foreign direct investment (stock) from South Africa is sizable, equivalent to about one-fifth of Lesotho’s GDP.


See Humpage and McIntire.


See Mundell (1961), McKinnon (1979), and Cobham and Robson (1994).


See Chapter II, “Competitiveness and Export Performance in Lesotho,” for more details.