Abstract
This 2008 Article IV Consultation discusses that Lesotho has made significant progress in macroeconomic performance, but the pace of implementation of key structural reforms has been slow. After a decade of low growth, economic activity surged above historic trends, averaging 6.6 percent during 2006–07, driven by the mining, textile, and construction sectors. However, poverty has seen only a modest decline. Executive Directors have commended the authorities for their prudent macroeconomic management, which has contributed to the recent strong economic performance and a continued build-up of international reserves.
1. Introduction
On behalf of the Lesotho authorities, I would like to thank staff for the candid and productive discussions during the Article IV mission, and the Executive Board and Management for their continued support. The authorities value the advice proffered by the Fund and are in general agreement with the thrust of the reports.
Lesotho has made significant progress in achieving macroeconomic stability over the years. However, Lesotho remains susceptible to external shocks. Growth has been supported by the manufacturing and diamond mining sectors. Prudent use of fiscal surpluses to reduce public debt and build up reserves has enhanced fiscal and external stability. While the current global financial crisis has thus far had limited impact on Lesotho’s banking system, the economy has been affected indirectly through reduced demand for exports, tightened trade credit for the textile industry which has links with Asian financial markets and significantly reduced investment flows for the diamond mining sector.
The authorities remain committed to the implementation of prudent policies to preserve macroeconomic stability and promote sustainable growth.
2. Recent Economic Developments and Macroeconomic Outlook
Lesotho’s economic growth is estimated to have slowed down to 5.1 percent in 2007, from 7.2 percent in 2006, mainly due to a decline in agricultural output as a result of adverse weather conditions. Growth was largely supported by increased production in the mining and manufacturing sectors. The mining sector benefited from additional investment and efficiency gains in diamond mining as well as the favorable outlook on the international prices of precious stones. The manufacturing sector’s contribution emanated mainly from textiles and clothing exports, which were mostly destined to the US. Inflation continued to rise throughout most of the last year, mainly as a result of high fuel and food prices and it reached 12 percent per annum in September 2008. However, it declined to 10.6 percent in December, as the international oil and food prices abated.
Fiscal performance remained strong in 2007/08, with government budgetary operations recording a surplus for the fifth consecutive year. The surplus, estimated at around 10 percent of GDP, was supported by the increased SACU and domestic tax revenues as well as lower expenditures. Surpluses continued to be realized during the first half of 2008/09 fiscal year. The external position also improved, resulting in the accumulation of foreign reserves to about 7 months of import cover by the end of 2007. The improvement in the balance of payments position largely reflected increased SACU receipts as well as a rise in foreign direct investment in manufacturing and mining industries.
Medium term economic prospects seem to be mixed. Growth is expected to benefit from the recovery of the agricultural sector and increased construction activity due to commencement of new public infrastructure projects. Investment projects to be implemented under the Millennium Challenge Corporation (MCC) compact and implementation of Phase II of the Lesotho Highlands Water Project are expected to contribute significantly to growth. Prudent macroeconomic policies are expected to continue to support macroeconomic stability.
Downside risks include the negative impact of unfavorable developments in the external environment and the persistent drought on agriculture. The manufacturing sector is expected to be adversely affected by the reduction in demand in the US economy, as the recession intensifies and credit conditions tighten in Asia, where most of the firms source their financing, while the diamond mining sector could be adversely affected by the falling international prices of rough diamonds. Developments in the global regime for textiles, such as the erosion of trade preferences, would also add strain to Lesotho’s export sector. Inflationary pressures are expected to continue to follow developments in international oil and food prices. The slowdown in the South African economy is also expected to have negative fiscal and external effects on Lesotho’s economy through declining SACU revenues and export demand. The authorities are, however taking necessary measures to help address these challenges.
Government is looking at long term measures such as irrigation to mitigate the problem of persistent droughts.
3. Policies
Fiscal Policy
The authorities remain committed to prudent macroeconomic management and consolidation of macroeconomic stability that has been achieved over the last years. Prudent fiscal policy will continue to be the main tool for macroeconomic management and will be aimed at ensuring sustainable fiscal and external stability. Debt sustainability and external stability has improved significantly over the years, as government used the fiscal surpluses to reduce non-concessional public debt.
Going forward, SACU revenues are expected to decline as a result of the reduction in the common revenue pool cause by the slowdown in the South African economy and the effects of trade liberalization on customs revenues. This poses a significant challenge to fiscal policy given that SACU revenues constitute the bulk of government revenues. In this regard, the authorities will continue their efforts to bolster domestic revenue collections mainly through measures to improve revenue administration. Some expenditure restraint, consistent with the projected fall in SACU revenues while at the same time providing for the infrastructure and social needs of the country, will also be exercised. Fiscal surpluses are expected to continue to be realized, albeit at narrower levels, in the medium term.
Significant progress is being made in strengthening public financial management (PFM). PFM reforms which were initiated in 2005 include the review of procurement regulations, introduction of the medium term expenditure framework (MTEF) and the introduction of the Integrated Financial Management Information System (IFMIS). Implementation of the new procurement regulations began in 2007 and the process of implementing IFMIS is at an advanced stage. The IFMIS system is already in place and will start operating during the coming budget year (2009/10). The IFMIS is expected to enhance all the accounting aspects of the budget process, including commitment control and generation of reports for budget monitoring.
The authorities are also putting measures in place to improve budgeting in order to improve the effectiveness of the budget as an instrument to achieve the national development objectives and to enhance the efficiency of resource allocation among ministries. In this connection the MTEF, which had been introduced on a pilot basis, has now been rolled out to all government ministries and its functionality is now being expanded. New Public Financial Management and Accountability and Audit bills have been drafted to underpin the PFM reforms and are currently undergoing review.
Public service effectiveness will be addressed under the Public Sector Improvement and Reform Program (PSIRP), which is undergoing some design. It is intended to cover civil service reform and decentralization of public services.
Lesotho’s public and publicly guaranteed debt is sustainable, although there is a moderate risk of debt distress. To safeguard debt sustainability, the authorities will continue to reduce the amount of commercial debt outstanding and to the extent possible, limit borrowing to concessional terms.
Monetary Policy and Financial Sector Issues
Lesotho’s CMA membership, which provides for the loti to be pegged at par to the rand and for free movement of capital within the CMA, has supported price stability. Monetary policy in Lesotho continues to be aimed at maintaining a strong external reserve position to support the exchange rate parity with the South African rand as well as to meet the country’s external obligations. This has been supported by prudent fiscal policies.
The current global financial crisis has thus far had limited impact on Lesotho’s banking system. The banking sector remains strong, with banks being profitable, well-capitalized, and liquid with relatively moderate and well provisioned non-performing loans (NPLs). Downside risks posed by the relatively high concentration of the banks’ portfolios on a few borrowers are mitigated by the full collateralization of most of the loans to the top twenty borrowers.
Financial intermediation has continued to be limited as banks remain risk averse and as a result access to financial services is lacking for the bulk of the population. The authorities are making efforts to increase access to financial services, with the support of the MCC and under the International Fund for Agricultural Development (IFAD) rural financial intermediation program (RUFIP). These include the strengthening of the institutional and operational framework of the Lesotho Postbank, and the development of the microfinance sector. The improvement of financial intermediation would also be facilitated by the creation of the credit reference bureau, development of a national identity system, an Automatic Clearing House and modernization of the commercial court. The ongoing review of legislation for the non-bank financial institutions (NBFIs), under RUFIP, is expected to usher a sound regulatory framework for NBFIs, which pose a challenge to the ability of the authorities to supervise and regulate as they are not covered by the current financial institutions laws.
The new Anti-Money Laundering legislation has been approved by Parliament and preparations are underway to develop regulations and to establish a Financial Intelligence Unit.
Growth Policies
The Government’s key priority remains that of promoting sustainable economic growth to reduce poverty and move towards achieving the MDGs. The authorities have developed a draft Growth Strategy Paper (GSP), which identifies opportunities and binding constraints on growth. Going forward, the authorities plan to devote significant resources in the medium term fiscal framework and the annual budgets, as well as the Government’s reform initiatives with the priorities identified in the GSP.
To address the constraints on growth, the authorities are, with the support of the World Bank and the MCC, undertaking reforms to improve the investment climate and international competitiveness. Effective implementation of the MCC’s private sector development component and the World Bank’s ongoing Private Sector Competitiveness and Economic Diversification Program would help reduce the cost of doing business in Lesotho. These would include addressing the legal and regulatory constraints, improving private sector access to credit and piloting economic diversification initiatives in tourism and agribusiness.
A trade and investment facilitation centre has already been established to serve as a one stop shop for potential investors and to reduce regulatory impediments and facilitate investment. A modernized Companies Bill is under preparation to support these business reforms.
4. Conclusion
In conclusion, I wish to reaffirm the authorities’ commitment to the prudent macroeconomic management which has facilitated the achievement of macroeconomic stability. Promotion of growth and poverty reduction also remain high in their policy agenda. They are confident that, with the continued support of the Fund and the international community, they will make meaningful progress toward achieving their developmental goals.