Kingdom of Lesotho: Joint World Bank/IMF Debt Sustainability Analysis
Author:
International Monetary Fund
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Publication Date:
21 Apr 2008
eISBN:
9781451823882
Language:
English
Keywords:
ISCR; CR; Lesotho; authority; real GDP; surplus; NPV; debt indicator; creating flow; Lesotho's debt burden; service-to-revenue ratio; concessional debt; Debt sustainability analysis; Fiscal stance; Domestic debt; Africa; Service-to-GDP ratio
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Lesotho has made progress toward macroeconomic stability. After recent economic development, diamond production, garment industry, and good performance in the agriculture and service sectors were recovered. The fiscal position and public debt sustainability indicators have improved. Achievement of these objectives will call for an acceleration of the pace of structural reforms with a focus on promoting private sector development, while ensuring strong medium-term fiscal and external positions. The envisaged programs would be key to relieving constraints on growth and enhancing productivity.

Abstract

Lesotho has made progress toward macroeconomic stability. After recent economic development, diamond production, garment industry, and good performance in the agriculture and service sectors were recovered. The fiscal position and public debt sustainability indicators have improved. Achievement of these objectives will call for an acceleration of the pace of structural reforms with a focus on promoting private sector development, while ensuring strong medium-term fiscal and external positions. The envisaged programs would be key to relieving constraints on growth and enhancing productivity.

This debt sustainability analysis is based on end-2006 data for external and domestic debt provided by the Lesotho authorities, and World Bank and IMF staff estimates for debt outstanding to multilateral creditors. The overall staff assessment is that Lesotho is at a moderate risk of debt distress and remains vulnerable to exchange rate changes and other shocks, although debt appears sustainable in a baseline scenario.

Introduction

This debt sustainability analysis has been prepared jointly by IMF and World Bank staff. It comprises external and domestic debt, and is based on the framework for low-income countries approved by the respective Executive Boards.1 The framework takes into account indicative thresholds for debt burden indicators determined by the quality of the country’s policies and institutions,2 and comprises baseline and alternative scenarios.

Lesotho’s nominal public and publicly guaranteed (PPG) debt declined from 89.1 percent of GDP in 2002 to 51.4 percent of GDP (US $746.0 million) at the end of 2006, reflecting in part, the early repayment of non concessional loans, limited new borrowing, and an exchange rate appreciation between 2003 and 2006. Of the total public sector debt, US $626.3 million was externally owed, with about 89 percent of the total (US $560.0 million) owed to multilateral creditors, mainly IDA and the African Development Fund.3 Government also has domestic debt held by residents in the amount of US $119.4 million. For private sector debt, only obligations toward countries outside the Common Monetary Area are recorded. At end 2006, these obligations were estimated at US $2.3 million.

Lesotho: External and Domestic Nominal Debt Outstanding at end-2006

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The baseline, medium-, and long-term scenario

The baseline scenario is based on a number of macroeconomic projections and financing terms, which are summarized below in Box 1. Compared to the DSA from previous years, the 2007 DSA assumes a higher level of real GDP growth and current account surpluses from 2007 to 2011 (Text Table). Real GDP growth is now forecast to average 5.2 percent up to 2012 with long-term growth remaining at 4.5 percent, compared to average growth rates of 2.1 in the medium-term projected in the last DSA. The last two DSAs assumed growth and current account balances somewhat under the historical average in view of the end of the MFA and the expectation of the expiration of trade preferences under AGOA in 2007.

Comparison of Key Variables in Debt Sustainability Analysis 2005-07

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However, major favorable developments have taken place since then. The positive growth performance, especially strong in 2006 (7.2 percent), was driven by booming diamond production (not fully anticipated in the previous DSAs), a recovery of the garment industry helped in part by the extension of AGOA trade preferences through 2012, and good performance in the agriculture and services sectors. In addition, the Millennium Challenge Corporation (MCC) compact was signed in 2007. The government is expected to receive large grants during the next five years, allowing it to undertake significant capital investment in the development of the country’s health infrastructure and water supply, and is actively promoting private sector development. In particular, the construction of Metolong dam with support of MCC and other donors is expected to increase the potential for the location of “wet industries” such as fabric production, which would allow Lesotho to take fuller advantage of AGOA beyond 2012. These recent developments, which were not previously considered, largely account for the change in growth projections for this year’s DSA.

The current account balance after recording a surplus of 5.4 percent of GDP in 2006 is forecast to remain strong due to high diamond and garment exports, and continued large South Africa Customs Union (SACU) revenues to 2010. Then it is projected to deteriorate somewhat as SACU revenues revert back to more normal levels. In the baseline scenario, Lesotho starts facing “IDA-hardened” terms in 2010 as a result of the growth in its GNI per capita. Under the Atlas method, Lesotho’s GNI per capita stood at US $1,070 in 2006. Taking into account the lags included in this methodology and the assumptions about growth, Lesotho would no longer be able to borrow at standard IDA terms after 2010.4

Main Assumptions Under the Baseline Scenario

  • Real GDP growth is assumed to increase from 2.8 percent over the last ten years to about 5.2 percent in 2007–12 and then from 2013 to stabilize at 4.5 percent.

  • Inflation (as measured by the implicit GDP deflator) is assumed to move from an average of 4.4 over the last ten years, and then to stabilize slightly above 4 percent as prices converge to that of South Africa’s.

  • Fiscal surpluses are projected to remain strong up to 2012 reflecting large SACU revenues, and are assumed to weaken somewhat in subsequent years when SACU revenues are assumed to decline.

  • Imports and exports of goods and services and transfers are assumed to grow in line with GDP (in US dollar terms). FDI is assumed to grow slightly more rapidly, taking into account the reduction of the corporate income tax rate in 2006 to attract foreign investment.

  • The current account balance (including official transfers) is determined by the above trends, declining gradually from a 4.4 percent of GDP surplus in 2006 to smaller surpluses over the medium term and eventually reaching a deficit as SACU transfers and diamond exports decline. Net income is also assumed to decrease gradually over the long term as remittances from South Africa continue to grow less important over time.

  • Net external public sector financing is assumed to rise to about 2.8 percent of GDP by the end of the current decade and then to stabilize at this level. Foreign grants are assumed to increase to about 4.6 percent of GDP in the medium term, reflecting the MCC compact, and thereafter to decline. After 2010, it is assumed that borrowing from IDA would be at hardened terms. The DSA assumes that new borrowing would be contracted on highly concessional terms during the projection period.

  • Domestic debt is projected to fall in nominal terms gradually over time. Private sector debt is projected to increase only marginally in terms of GDP, to 0.5 percent by 2027.

At end-2006, the NPV of external debt stood at 31.7 percent of GDP (Table 1). Under the baseline scenarios, Lesotho’s external debt indicators remain well below the thresholds throughout the projection period. The NPV of debt-to-GDP ratio, which was fractionally above the threshold in 2006, is expected to gradually decrease to 21 percent in 2017, below the policy-based indicative threshold (40 percent); and the NPV of debt-to-export ratio would also fall gradually to 41 percent by 2017, significantly below the 150 percent threshold. Both ratios will however increase marginally in the later years of the projection period reflecting harder financing terms as Lesotho would no longer have access to borrowing from IDA at standard terms. Borrowing, however, is expected to still be on broadly concessional terms. The highly concessional nature of the existing debt and new borrowing contributes to debt service ratios below the indicative threshold throughout the projection period. The Government undertook to repay early a significant amount of non concessional debt resulting in lower scheduled interest payments and hence a declining effective interest on debt.

Table 1.

Lesotho: External Debt Sustainability Framework, Baseline Scenario, 2005-20271

(Percent of GDP, unless otherwise indicated)

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Source: Staff simulations.

Includes both public and private sector external debt.

Derived as [r - g - ρ(l+g)]/(l+g+ρ+gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and ρ = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Assumes that NPV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the NPV of new debf).

At end-2006 domestic debt contributed only marginally to the baseline scenarios for Lesotho’s public debt ratios (Table 3). Lesotho has a low level of domestic debt, and so public debt indicators are very closely aligned to those of public external debt. Domestic debt, which was at 7.5 percent of GDP at the end of 2006, is expected to be gradually reduced to about 3 percent of GDP by 2017. Domestic debt has been issued by government mostly to provide an impetus to the formation of a money market. The proceeds from the sale of T-bills are held in deposits at the Central Bank of Lesotho; therefore these bills have not represented additions to net debt. The fiscal deficit is projected to remain largely externally financed on concessional terms, and expenditure levels are assumed to be financed from grants and tax revenue.

Table 2.

Lesotho: Sensitivity Analyses for Key Indicators of Public and Publicly Guaranteed External Debt, 2006-27

(Percent)

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Source: Staff projections and simulations.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows. The full presentation of the alternative scenario is in Table 1c.

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (imp an offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

Table 3.

Lesotho: Public Sector Debt Sustainability Framework, Baseline Scenario, 2004-2027

(Percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and Fund staff estimates and projections.

Covers gross debt of the general government.

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues excluding grants.

Debt service is defined as the sum of interest and amortization of medium and long-term debt.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Sensitivity Analysis

External Public debt indicators

Sensitivity tests show that while Lesotho’s debt burden would worsen in the event of an adverse macroeconomic shock or weaker economic performance, it would remain below the indicative thresholds in most cases (Table 2 and Figure 1). In the event of key macroeconomic variables reverting to their pre-2007 levels throughout the projection period, the evolution of debt would be significantly affected. With output and export growth at their historical averages, public debt ratios would fail to improve. The more stringent test of current account balances at historical averages would cause external debt to breach the indicative thresholds.

Figure 1.
Figure 1.
Figure 1.

Lesotho: Indicators of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2007-2027

Citation: IMF Staff Country Reports 2008, 136; 10.5089/9781451823882.002.A003

The debt indicators in the historical scenario (scenario A1) are more elevated than under the baseline scenario, and the threshold of the NPV of debt-to-GDP is breached. The real GDP growth in the ten-year period up to 2006 averaged 2.8 percent, about half that assumed in the projection period. The noninterest current account was also significantly weaker than that projected under the baseline scenario due to the lower level of earlier SACU transfers. These combined effects projected through 2027 would yield significantly worse debt indicators, compared to the baseline scenario.

Borrowing on less favorable terms (scenario A2) would lead to some deterioration of the external debt indicators. The impact however would not be as severe as that under the A1 scenario. Under this scenario, the NPV of debt-to-GDP ratio would reach 25 percent in 2017, still well below the indicative thresholds. Similarly, the NPV of debt-to-exports ratio while higher than under the baseline scenario remains below the indicative threshold.

The bound tests reveal that Lesotho would face the most distress if there were to be a much lower rate of growth and a much lower level of nondebt creating inflows such as FDI in 2007-2008 (scenario B5). Under this scenario, the NPV of debt-to-GDP ratio first increases to 71 percent of GDP in 2009 before falling to 49 percent of GDP in 2017. There are also underlying vulnerabilities with respect to export growth. A shock to exports would lead to higher NPV of debt-to-GDP and NPV of debt-to- exports ratios.

Total Public Debt Indicators

Public debt appears robust in the standard sensitivity tests (Table 4 and Figure 2). The indicators are most sensitive to deviations from the baseline growth path. In the scenario with variables at historical averages ratios initially rise but eventually declines. A similar pattern is observed with more extreme shocks of shorter duration. Although significant pressures would be exerted on total public debt for a number of years, the indicators would remain on trajectories that eventually decline later in the projection period. It should be noted that in the analysis the public debt alternative scenarios are not defined the same way for those of the external debt and are therefore not directly comparable.

Figure 2.
Figure 2.

Lesotho: Indicators of Public Debt Under Alternative Scenarios, 2007-2027 1

Citation: IMF Staff Country Reports 2008, 136; 10.5089/9781451823882.002.A003

Source: Staff projections and simulations.1 Most extreme stress test is test that yields highest ratio in 2017.2 Revenue including grants.
Table 4.

Lesotho: Sensitivity Analysis for Key Indicators of Public Debt 2006-2027

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Sources: Country authorities; and Fund staff estimates and projections.

Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of 20 (i.e., the length of the projection period).

Revenues are defined inclusive of grants.

The trajectory of gross debt understates somewhat the decline in Lesotho’s net indebtedness especially in the next few years. This trajectory takes into account the disbursement of loans in the pipeline even in periods when fiscal surpluses would permit a net reduction of debt. It is also assumed that the authorities will stick to the original schedule for the repayment of the highly concessional debt. This implies that the public sector will accumulate some assets over the medium term. Alternatively, the analysis could be said to show that somewhat lower primary surpluses would also be consistent with the reduction in gross debt shown in Figure 2. However, because of limited implementation capacity, the authorities are not expected to significantly increase their level of capital investment making it more likely that they will accumulate assets rather than significantly increase their investment levels.

Conclusion

Lesotho faces a moderate risk of debt distress although in the baseline scenario key debt ratios are below the indicative thresholds for a country with Lesotho’s performance rating. The risk would materialize if variables such as economic growth and the current account deficit were to revert to their historical levels. The results therefore underscore the need for the authorities to continue to pursue prudent debt policies combined with sound macroeconomic policies and structural reforms. Policies should focus on growth enhancing measures and investments, while continuing to seek grants and highly concessional loans in order to mitigate the likelihood of debt distress.

1

See “Staff Guidance Note on the Application of the Joint Fund-Bank Debt Sustainability Framework for Low-Income Countries,” http://www.imf.org/external/np/pp/2007/eng/041607.pdf

2

The World Bank Country Policy and Institutional Assessment (CPIA) has ranked Lesotho for the last three years as a “medium performer” in terms of policy and institutions with a rating of 3.5. The applicable indicative thresholds for debt sustainability, proposed under the framework for low-income countries are: (i) 40 percent for the NPV of debt-to-GDP ratio, (ii) 150 percent for NPV of debt-to-exports ratio; (iii) 250 percent for the NPV of debt-to-fiscal revenues ratio; (iv) 20 percent for the debt service to exports ratio; and (v) 30 percent for the debt service to revenue ratio.

3

The nominal public debt data does not include debt issued by the Lesotho Highlands Development Authority (LHDA). The liabilities of the LDHA are equal to about 10 percent of GDP and are not included since LHDA gets financing from South Africa to cover debt service.

4

In the DSA, IDA-hardened terms are incorporated and substituted for standard IDA terms after 2010, and implies a charge of 0.75 percent, grace period of 10 years and a maturity period of 20 years (including the grace period), compared to the 40-year maturity of standard IDA terms.

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Cover IMF Staff Country Reports
Kingdom of Lesotho: 2007 Article IV Consultation: Staff Report; Staff Supplement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for the Kingdom of Lesotho
Author:
International Monetary Fund
Volume/Issue:
Volume 2008: Issue 136
Publisher:
International Monetary Fund
ISBN:
9781451823882
ISSN:
1934-7685
Pages:
69
DOI:
https://doi.org/10.5089/9781451823882.002
  • Figure 1. Figure 1.
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    Figure 1.

    Lesotho: Indicators of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2007-2027

  • Figure 2.
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    Figure 2.

    Lesotho: Indicators of Public Debt Under Alternative Scenarios, 2007-2027 1

Figure 1.

Lesotho: Indicators of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2007-2027
Figure 1.

Lesotho: Indicators of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2007-2027
Figure 2.

Lesotho: Indicators of Public Debt Under Alternative Scenarios, 2007-2027 1