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.
1. Introduction
On behalf of the Lesotho authorities, we would like to thank staff for the constructive dialogue during the last Article IV consultations, as well as the Board and management for their continued support. The authorities value the advice provided by the Fund and are in general agreement with the thrust of the staff reports.
The authorities’ commitment to prudent macroeconomic management has contributed to the consolidation of macroeconomic stability. Over the past year, the strong rebound in economic growth is the result of policy measures taken by the authorities that were supported by a favorable external economic climate. Fiscal and external stability was strengthened through prudent use of fiscal surpluses to reduce public indebtedness and to augment reserves. The surplus was mainly driven by the significant increase in SACU receipts as well as growth in exports of textiles and clothing and diamonds. Near term macroeconomic prospects also seem positive. These notwithstanding, macroeconomic management in Lesotho remains challenging due to the country’s continued vulnerability to exogenous shocks. New developments in the textile trade regime could have grave implications for the country’s export sector, while the uncertainty surrounding SACU revenues poses a threat to fiscal stability in the long term.
Achieving the sustainable, broad based economic growth necessary for the improvement of the livelihoods of the majority of the Basotho people, remains a challenge. The authorities are committed to implementing the policies and structural reforms needed to preserve macroeconomic stability and promote sustainable growth and poverty reduction. Private sector development will be a key element of this reform program. Further support from the international community and understanding of the special circumstances of small emerging developing countries like Lesotho, which is likely to face “IDA-hardened” terms in 2010 as its GNI improves, could assist mitigate further challenges to the development agenda.
2. Recent Economic Developments
In 2006, Lesotho’s economic performance was strong and broad based. Further improvements to macroeconomic stability were realized. Real GDP Growth estimated at 7.2 percent in 2006, was supported by the recovery in manufacturing output, a flourishing mining sector and improved performance in the agriculture and services sectors. In the mining sector, increased output was facilitated by increased production in the diamond mines. At the same time, in manufacturing, the negative impact of the expiry of the Multi Fiber Agreement (MFA) on the textile and clothing sector was mitigated by the extension of AGOA by the US, the depreciation of the loti and measures undertaken by Government.
Consumer inflation has been on the rise due to external factors including the general increase in oil and cereal prices. Nevertheless inflation has remained in single digits. Meanwhile, fiscal consolidation remained strong in 2006/07, with government budgetary operations recording a surplus for the fourth consecutive year as a result of strong SACU and domestic revenues, and measures taken to ensure moderate growth in expenditure. The fiscal surplus for the year 2006/07 is estimated at around 16 per cent of GDP.
The balance of payments position remained positive in 2006 with the overall balance in surplus. This facilitated the accumulation of foreign reserves to almost 7 months of import cover. The improvement in the balance of payments position largely reflected the turnaround in the current account balance from a deficit in 2005 to a surplus in 2006.
3. Macroeconomic Outlook and Policies
Macroeconomic prospects remain broadly favorable. Growth is expected to remain strong, supported by the vibrant mining sector and manufacturing, as well as increased construction activity due to scaled up public investments. Investment projects to be implemented under the recently signed Millennium Challenge Corporation (MCC) compact are expected to contribute significantly to growth. Fiscal and external stability will benefit from the expected continuation of large inflows of SACU revenues, in the medium term.
Downside risks include the negative impact of the persistent drought on agriculture and potential unfavorable developments in the external environment. Developments in the global regime for textiles, such as the erosion of trade preferences, would have significant consequences for Lesotho’s export sector. In the short run, garment and mineral exports could also be adversely affected by the slowdown in the US economy. The uncertainty of SACU revenue poses a challenge to fiscal management as these receipts continue to account for the bulk of government revenue; hence, the authorities’ recognition of the need to continue strengthening the domestic revenue effort while containing expenditures. Inflationary pressures are expected to continue to rise in line with oil prices and increases in food prices emanating from drought-induced food shortages, as well as the global cereal shortages created by the increased use of biofuel.
Fiscal Policy
Lesotho’s membership in the Common Monetary Area (CMA) dictates that fiscal policy be the most important tool for macroeconomic management. The core objective of Lesotho’s fiscal strategy is to ensure the maintenance of a sustainable fiscal stance and maintenance of external stability. The authorities’ commitment to prudent fiscal policies and sustained fiscal surpluses has facilitated their success in achieving these objectives. The authorities continue to exercise prudence in the allocation of these surpluses towards improving the country’s debt sustainability and external stability.
In the medium-term, the projected exceptional SACU revenues will help to ensure favorable fiscal outcomes. However, the authorities are cognizant of the fact that, if these revenues decline in the future, sustainability will necessitate a substantial reduction in the share of public expenditure relative to GDP as well as stronger domestic revenue performance. The authorities will therefore endeavor to strengthen their domestic revenue effort through continued implementation of measures to improve revenue administration of the Lesotho Revenue Authority (LRA).
In an effort to strengthen public expenditure management and enhance the effectiveness of public services the authorities have launched a public sector improvement and reform program (PSIRP). Progress made under the PSIRP includes strengthening of budget planning and execution, public procurement reform and the introduction of the medium term fiscal framework. The principles underpinning the authorities’ fiscal strategy are to: maintain the real value of public expenditure by ensuring that the main categories of discretionary ministerial expenditure increase by at least the annual rate of inflation; ensure that the current increase in SACU revenues (and, hence, the ratio of revenue to GDP) does not give rise to an unsustainable level of aggregate public expenditure and that the public sector does not expand aggregate demand excessively; ensure that a primary surplus of revenue (including grants) over expenditure (excluding interest) is achieved; minimize the amount of commercial debt outstanding and to ensure that aggregate debt ratios do not exceed sustainability indicators; maintain a surplus of current revenue over current expenditure; and secure additional external finance on concessional terms. This should ensure that the overall medium term fiscal framework remains within sustainable limits.
Monetary Policy and Financial Sector Issues
Price stability in Lesotho has been facilitated by the country’s membership in the CMA, which provides for the loti to be pegged at par to the rand and for free movement of capital within the CMA. Monetary policy in Lesotho continues to be aimed at maintaining a strong external reserve position that is adequate to support the exchange rate parity with the South African rand as well as to meet the country’s external obligations. The viability of this arrangement has also been supported by prudent fiscal policies.
The banking sector remains strong, with banks being profitable, well-capitalized and liquid and with relatively moderate and well provisioned non-performing loans (NPLs). Downside risks to the banking sector are posed by the relatively high and increasing concentration on the asset side of the banks’ balance sheets, and a rising trend in NPLs. However, these risks are mitigated by the fact that most of the loans to the top twenty borrowers are fully collateralized. The authorities continue to implement measures geared towards strengthening prudential supervision including the review of the legal and regulatory framework as well as their own supervisory practices and procedures.
Financial intermediation continues to be limited as banks remain risk averse. The low access of financial services to the population has encouraged the rapid growth of credit cooperatives. These often engage in financial intermediation with non-members, and pose a challenge to the ability of the authorities to supervise and regulate them as they are not covered by the current financial institutions laws. The extent of their operations is not well known, and the quality of regulatory oversight is limited under existing arrangements. The authorities are currently making efforts to strengthen this sector as well as to regulate and supervise it. Technical assistance from the International Fund for Agricultural Development (IFAD) is expected to assist in this regard.
The strengthening of the Lesotho Postbank, which currently does not extend credit, and the development of the microfinance sector, which are also to benefit from IFAD assistance, is expected to increase access to financial services. Other efforts geared towards the improvement of financial intermediation include the creation of the credit reference bureau and reform of the commercial court. These measures will be supported by the World Bank and MCC funded private sector development projects.
The operation of unlicensed financial entities, which have attracted sizable deposits from the public by promising very high rates of return and accumulated large and growing liabilities that could become very difficult to meet, poses a challenge to the authorities. These entities also face significant rollover risks thus presenting substantial risks to depositors. Measures to deal with these institutions and to minimize any adverse impact are already at an advanced stage. The authorities have requested Fund advice and initiated a public education campaign to raise public awareness of the dangers of such schemes and to discourage more people from engaging in them.
The authorities have also submitted an Anti-Money Laundering Bill to parliament for enactment.
Growth Policies
The authorities continue to place emphasis on the need for pro-growth policies aimed at achieving sustainable broad-based growth that is required to reduce poverty, improve the living standard of Basotho and more generally ensure progress towards achieving the MDGs.
The authorities are currently developing a Growth Strategy Paper (GSP). The GSP will identify both opportunities and binding constraints to growth. The PRS will be compatible with the GSP and together they will serve as a roadmap that guides work in support of the long term goals presented in Vision 2020. The GSP would be linked to the budget, therefore helping inform the formulation of medium term fiscal plans and institutional reform initiatives, which in turn should guide annual budgets as well as the Medium Term Expenditure Framework.
Private sector development is the key ingredient to growth and poverty reduction. Hence, the authorities’ plans to promote private sector led growth through measures aimed at improving the investment climate and incentives as well as enhancing international competitiveness. Measures already taken in this regard include the reduction of company tax rates during the 2006/07 fiscal year, and the establishment of the trade and investment facilitation centre to serve as a one stop shop for potential investors and to reduce regulatory impediments and facilitate investment.
Efforts to improve the investment climate will be reinforced by the World Bank supported Private Sector Competitiveness Program as well as the private sector development component of the compact signed with the MCC earlier this year. Key reforms would include removing regulatory constraints posed by registration, licensing, immigration and tax processes and improving private sector access to credit through the establishment of a comprehensive property registry, development of a national identification system, reform of the judiciary and administration of justice as well as the simplification of land transfer procedures. To facilitate access to credit, parliament passed a Married Persons Act in 2007, which allows for married women to access bank credit without their husbands’ permission. The authorities are also taking measures to improve labor productivity and economic infrastructure, as well as to diversify the economy and markets in order to reduce the country’s vulnerability to shocks.
4. Conclusion
In conclusion, we would like to reiterate the authorities’ commitment to macroeconomic stability and the promotion of high and sustainable economic growth. They appreciate the continued support of the Fund and the international community in general in addressing the enormous challenges that they face. This support is particularly important for the country, if it is to reduce poverty and make headway towards achieving the MDGs. Further support from the international community to small emerging developing countries like Lesotho, which is likely to face “IDA-hardened” terms in 2010 as its GNI improves, could assist mitigate further challenges to the development agenda.