Kingdom of Lesotho
Request for a Three-Year Arrangement Extended Fund Facility Arrangement: Staff Report; Staff Supplement; Press Release on the Executive Board Discussion; Statement by the Executive Director for the Kingdom of Lesotho

Lesotho’s fiscal and external balances have deteriorated as a result of the global economic downturn and a surge in spending. Undertaking key fiscal adjustments to restore macroeconomic stability is necessary for raising Lesotho’s growth potential. Executive Directors commend the measures taken in the budget to reduce expenditure. Further strengthening of debt management and accelerating structural reforms is crucial for raising Lesotho’s growth potential. Strengthening the institutional and regulatory framework for banks and non-bank financial institutions (NBFIs) will help to support financial sector health and stability.

Abstract

Lesotho’s fiscal and external balances have deteriorated as a result of the global economic downturn and a surge in spending. Undertaking key fiscal adjustments to restore macroeconomic stability is necessary for raising Lesotho’s growth potential. Executive Directors commend the measures taken in the budget to reduce expenditure. Further strengthening of debt management and accelerating structural reforms is crucial for raising Lesotho’s growth potential. Strengthening the institutional and regulatory framework for banks and non-bank financial institutions (NBFIs) will help to support financial sector health and stability.

I. Background and Recent Developments

1. Lesotho experienced strong macroeconomic performance during 2006–08, supported by favorable external conditions. Real GDP growth averaged 4.5 percent, driven by the construction, textile and mining sectors. Sizeable revenues from the Southern African Customs Union (SACU) resulted in large fiscal and current account surpluses, and boosted gross international reserves. However, gains in reducing poverty and income inequality remained limited, reflecting delays in implementing key structural reforms to generate broad-based growth. In addition, the HIV/AIDS pandemic negatively impacted socio-economic development and continues to threaten the achievement of the MDGs.

uA01fig01

Real GDP Growth

(Annual percent change)

Citation: IMF Staff Country Reports 2010, 225; 10.5089/9781455205745.002.A001

Sources: Lesotho authorities; and Fund staff estimates.

2. Macroeconomic conditions deteriorated sharply in 2009, reflecting the adverse effects of the global economic crisis and a loosening of fiscal policy. Economic growth slowed to 0.9 percent from 4.5 percent in 2008, due to reduced demand for diamond and textile exports, while workers’ remittances fell sharply. On the fiscal front, expenditure rose rapidly in 2009/10 to reach an unprecedented level of 69 percent of GDP. For the first time in five years, the fiscal position shifted into a deficit of 2.7 percent of GDP in 2009/10, compared with surpluses averaging 8.8 percent of GDP during 2006/07–2008/09.

uA01fig02

Fiscal Balance

(Percent of GDP)

Citation: IMF Staff Country Reports 2010, 225; 10.5089/9781455205745.002.A001

Souces: Ministry of Finance and Development Planning ;and Fund staff estimates

3. The external current account balance also shifted into deficit position in 2009. After several years of large surpluses averaging 9.4 percent of GDP during 2006–2008, the current account position shifted into a deficit of 0.3 percent of GDP in 2009, mainly reflecting lower export earnings and worker’s remittances. Nonetheless, capital inflows during 2009 (mainly MCC grants, the SDR allocation and foreign direct investment by Philips Electronics) facilitated a build-up of international reserves to the equivalent of 7.7 months of imports.

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Balance of Payments

(Percent of GDP)

Citation: IMF Staff Country Reports 2010, 225; 10.5089/9781455205745.002.A001

Sources: Lesotho authorities and Fund staff estimates.
uA01fig04

Gross International Reserves

Citation: IMF Staff Country Reports 2010, 225; 10.5089/9781455205745.002.A001

Sources: Central Bank of Lesotho; and Fund staff estimates.

4. Monetary policy remained focused on supporting the exchange rate peg and price stability. In December 2009, the Central Bank of Lesotho (CBL) raised its target range for net international reserves from US$500–550 million to US$650–700 million. The 12-month inflation slowed to 4.2 percent at end-December 2009, compared with 10.6 percent at end-December 2008, largely reflecting declining prices for food which represents a large share of the consumer price index basket. With the loti pegged to the rand, inflation and interest rates developments in Lesotho broadly mirror those of South Africa.

uA01fig05

Treasury Bill Rates

(in percent, period average)

Citation: IMF Staff Country Reports 2010, 225; 10.5089/9781455205745.002.A001

Source: International Financial Statistics
uA01fig06

Consumer Price Inflation

(Percent, period average)

Citation: IMF Staff Country Reports 2010, 225; 10.5089/9781455205745.002.A001

Sources: Lesotho Bureau of Statistics; and International Financial Statistics

5. The financial sector weathered the global financial crisis relatively well. Banks are well capitalized, liquid and profitable. However, the sector remains vulnerable from weakly supervised nonbank financial institutions (NBFIs) and the potential for reemergence of Ponzi schemes. The CBL is making progress in strengthening the regulatory framework.

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Capital Adequacy and Non-Performing Loans

(Percent)

Citation: IMF Staff Country Reports 2010, 225; 10.5089/9781455205745.002.A001

Source: Central Bank of Lesotho
uA01fig08

Banking Profitability

(Percent)

Citation: IMF Staff Country Reports 2010, 225; 10.5089/9781455205745.002.A001

Source: Central Bank of Lesotho

II. The Three-Year Arrangement Under the Extended Credit Facility (ECF)

A. Medium-Term Macroeconomic Framework for 2010–13

6. Lesotho faces serious macro-economic challenges over the medium term. SACU revenues are projected to decline by some 23 percent of GDP during 2010/11–2011/12 because of lower imports by South Africa, due to the global economic crisis.1 In the absence of policy adjustment measures, the reduction in SACU revenues would result in an even sharper deterioration in the fiscal deficit (excluding Metolong dam) to an average of about 23 percent of GDP in 2010/11–2011/12.2 Although SACU revenues are projected to recover in line with expected economic expansion in South Africa and the completion of repayments to the Common Revenue Pool, they are expected to stabilize at around 20 percent of GDP in the medium term, well below the average of 37 percent of GDP during 2006/07–2008/09. Moreover, risks remain for further decline in SACU revenues from a change in the revenue-sharing formula, a reduction in the Common External Tariff rates due to trade liberalization, and the creation of a SADC customs union. Strong fiscal adjustment will therefore be required in order to restore fiscal, debt and external sustainability.

7. To address these challenges, the authorities have adopted a medium-term macroeconomic program designed to restore fiscal and external sustainability, achieve sustained broad-based growth for poverty reduction, and strengthen the financial sector. In support of these objectives, the authorities plan to implement measures to: (a) contain public expenditure while protecting the poor and vulnerable groups; (b) strengthen non-SACU revenues; (c) further strengthen public financial management to improve spending efficiency and public service delivery; (d) improve the business climate to facilitate private sector expansion; and (e) strengthen the regulatory framework for the financial sector while enhancing access to financial services, particularly in rural areas (MEFP ¶ 7–15).

Text Table 1:

Lesotho: Medium-Term Key Economic Indicators, 2008-2015

article image
Sources: Lesotho authorities; and IMF staff estimates and projections.

Fiscal data are reported on a fiscal year basis; fiscal year begins in April

Percent of exports of goods and nonfactor services.

8. The proposed medium-term fiscal adjustment path would curtail nonpriority expenditure to achieve a level of expenditure that is consistent with lower SACU revenues. Specific measures will include containing the growth of the wage bill and of goods and services (MEFP ¶ 10–11). These expenditure reductions, together with some recovery in SACU revenues, would result in a narrowing of the fiscal deficit (excluding Metolong) from about 15.3 percent of GDP in 2010/11 to a small surplus by 2015/16. The authorities plan to finance the deficit through a combination of drawdown in deposits at the CBL, budget support grants and new loans from development partners, and by issuing domestic bonds. Given the direct impact of domestic financing on international reserves, the authorities are committed to a cautious drawdown of deposits to protect the credibility of the exchange rate peg.

uA01fig09

Fiscal Balance

(Percent of GDP)

Citation: IMF Staff Country Reports 2010, 225; 10.5089/9781455205745.002.A001

Sources: Ministry of Finance and Development Planning ;and Fund staff estimates
Text Table 2.

Lesotho: Medium-Term Fiscal Scenario, 2009/10-2015/16 1/

article image
Sources: Ministry of Finance and Development Planning, and Fund staff estimates and projections.

The fiscal year runs from April 1- March 31.

Overall balance excluding customs revenue (SACU)

9. Reflecting developments in the fiscal position, the external current account deficit is projected to widen to an average of 21.0 percent of GDP during 2010–2012, mainly because of the loss of SACU revenues. Over the medium term, as fiscal consolidation takes hold and there is a recovery of SACU revenues, the current account deficit will narrow from 22 percent of GDP in 2010 to 12 percent of GDP by 2015.3 With the proposed Fund assistance, the level of international reserves is projected to remain above the CBL’s target for supporting the exchange rate peg.

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Balance of Payments

(Percent of GDP)

Citation: IMF Staff Country Reports 2010, 225; 10.5089/9781455205745.002.A001

Sources: Lesotho authorities and Fund staff estimates.
uA01fig11

Gross International Reserves

Citation: IMF Staff Country Reports 2010, 225; 10.5089/9781455205745.002.A001

Sources: Lesotho authorities; and Fund staff estimates.

10. The authorities’ program envisages economic activity to recover gradually over the medium term. Real GDP growth is projected to average 4.3 percent during 2010-13, predicated on substantial increases in public infrastructure investment, including construction of the Metolong dam and the start-up of the second phase of the Lesotho Highlands Water Project (LHWPII) (Box 1), and the expansion of private sector activity, particularly in mining.

uA01fig12

Real GDP Growth

(Annual percent change)

Citation: IMF Staff Country Reports 2010, 225; 10.5089/9781455205745.002.A001

Sources: Lesotho authorities; and Fund staff estimates.

11. Over the medium term, public expenditure and financial management reforms will focus on strengthening budget preparation, execution and accountability. Key measures include introduction and publication of a consolidated medium-term expenditure framework, regular reports on budget performance, introduction of a cash management system, and addressing deficiencies in the Integrated Financial Management Information System (IFMIS). These measures are based on the recommendations made by a March 2010 Fiscal Affairs Department FAD TA mission.

12. Implementing structural reforms remains central to achieving Lesotho’s medium-term goals of sustained broad-based growth for poverty reduction. The authorities’ medium-term program includes measures to reduce infrastructure constraints, strengthen institutional capacity and the legal and regulatory framework, and to enhance property rights and land reform. These measures are considered critical for improving the business climate to facilitate private sector development and economic diversification.

13. The authorities, with support from development partners, intend to strengthen the legal and regulatory framework for the financial sector and deepen financial intermediation over the medium term. These reforms include: strengthening the supervisory role of the CBL; developing the capital market; strengthening the payments and settlement system; establishing credit bureaus; introducing a national identification card system; modernizing commercial courts; and increasing access to financial services, particularly in rural areas.

14. Lesotho remains at moderate risk of debt distress (DSA). After taking into account the new nonconcessional external loan for construction of the Metolong dam, the present value of debt to GDP rises slightly above the key threshold level of 40 percent. Throughout the projection period, however, the debt levels remain at manageable levels as fiscal consolidation takes hold. This underscores the need to restore fiscal sustainability and ensure sound debt management. If the significant amount of remittances to Lesotho, averaging at least 20 percent of GDP over the past several years, are taken into account, the debt ratios decline significantly and would remain below the remittance-modified threshold of 36 percent, thereby reducing markedly Lesotho’s risk of debt distress.

uA01fig13

Public Debt

(Percent of GDP)

Citation: IMF Staff Country Reports 2010, 225; 10.5089/9781455205745.002.A001

Sources: Lesotho authorities; and Fund staff estimates.
uA01fig14

Remittances

(in percent of GDP)

Citation: IMF Staff Country Reports 2010, 225; 10.5089/9781455205745.002.A001

Source: Central Bank of Lesotho and IMF Staff Estimates

15. In recent years, Lesotho’s debt management capacity has improved, supported by technical assistance from some development partners. However, there is scope for further strengthening in light of the increased debt burden and planned issuance of government securities. The authorities plan to strengthen human and institutional capacity in debt management through training and improving the interface between the debt recording system (CS-DRMS) and the IFMIS.

16. Monetary policy will continue to focus on preserving the peg and maintaining price stability. Inflation is expected to stabilize at around 5 percent over the medium term, broadly in line with inflation in South Africa. The CBL intends to maintain an adequate level of international reserves to protect the exchange rate peg.

III. The Economic Program for 2010/11

17. The ECF-supported program would build on the authorities’ Interim National Development Framework, which outlines Lesotho’s medium-term development objectives for growth and poverty reduction (MEFP ¶ 32–35). It would support the authorities’ objectives of fiscal consolidation, external stability and broad-based growth for poverty reduction. The ECF would also help strengthen the country’s international reserves position thereby enhancing the credibility of the exchange rate peg, bolster confidence in the authorities’ policy framework and help to reduce risks.

A. Fiscal Consolidation

18. Fiscal policy will focus on restraining current expenditures while safeguarding social spending on the poor and vulnerable groups. Against the backdrop of the decline in SACU revenues, fiscal adjustment will rely mainly on recurrent expenditure cuts.

The Metolong Dam and the Lesotho Highlands Water Project

The construction of the Metolong dam, supported by the MCC and other development partners and the second phase of Lesotho Highlands Water Project (LHWPII) should support growth over the next several years.

The Metolong dam project is part of the authorities’ effort to ensure long-term reliable water supply for domestic and industrial purposes. The demand for water in Lesotho has outstripped supply due to rapid urbanization, periodic droughts and increased industrial development. The absence of secure water supply to industries has affected investments, especially in the textile sector.

Construction of the Metolong dam follows feasibility studies and economic assessments supported by the European Development Fund, the Arab Bank for Economic Development in Africa (BADEA), the World Bank and the MCC. These studies identified the Metolong dam program as the least-cost long-term solution for securing medium- to long-term water supply. The MCC estimated an economic rate of return of 24 percent and concluded that the project was viable, and that it would improve industrial production capacity, promote investment in the textile sector, and improve employment opportunities and Lesotho’s socio-economic development. Lesotho will also benefit from increased royalties from water transferred to South Africa. The MCC’s cost-benefit analysis indicates that the project would not experience cash flow difficulties.

The estimated cost of the project is about US$413 million and will be financed jointly by Lesotho, the MCC, South Africa, the World Bank, Kuwaiti Fund, OPEC Fund, Saudi Fund and BADEA. Lesotho’s share will be met from a non-concessional loan of €140 million (10 percent of GDP) from the European Investment Bank (EIB) and will be disbursed in rand. The EIB loan is the only one that is non-concessional. Including grants and concessional loans from the MCC, South Africa, the World Bank and the other financiers, the average grant element of the financing package is about 40 percent. The MCC’s grant contribution was approved in September 2008 under the MCC’s compact program to assist Lesotho reduce poverty through sustained economic growth. The grant has to be utilized by 2013 or Lesotho will lose any remaining balance. Construction of the dam has already started and should be completed by 2013.

The Lesotho Highlands Water Project (LHWP) is a bi-national project which involves construction of a system of dams and tunnels to transfer water from Lesotho to South Africa, as well as roads and hydro-electricity generation for use in Lesotho. Following the signing of a treaty in 1986 between the two countries, the project has been implemented in phases. The first phase was completed in 2004, and the authorities expect the second phase (LHWP II) to start in 2012 and to be completed by 2017. Financing for LHWPII is currently estimated at M 12 billion (63 percent of 2012/13 GDP), of which Lesotho will be responsible for sourcing M 4 billion and South Africa the rest. A feasibility study of the project is underway. The authorities are aware of the increased risks to debt sustainability arising from this project, and have committed to seek grants and concessional financing for this and other development projects during the program period (MEFP ¶ 15). Given the uncertainties regarding the financing and timing of the project, staff’s analysis, which are reflected in the DSA results, are based on the worst case scenario in which Lesotho is unable to obtain any additional concessional funding. Even under those circumstances, the remittances-modified debt indicators fall below the modified lower thresholds, implying a manageable debt position (DSA).

The authorities have introduced strong measures to reduce expenditure (as a percent of GDP) on goods and services, subsidies and transfers,4 and to limit the increase in the wage bill (Text Table 3; MEFP ¶ 17). The authorities plan to review expenditure with a view to eliminating noncore functions and nonproductive expenditure over the medium term. The World Bank will be undertaking a Public Expenditure Review as part of the Country Assistance Strategy, and the results of the review could be used at a later stage to strengthen safeguarding of key social spending under the program. To mitigate the impact of the fiscal adjustment measures on the vulnerable, the authorities plan to include in the program a floor on social spending for old age pension, school feeding program and HIV/AIDs interventions (including anti-retroviral therapies) (MEFP Table 1).

Text Table 3:

Summary of Fiscal Measures 2010/11

(in percent of GDP)

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Source: MoFDP, and Fund staff estimates
Table 1.

Lesotho: Selected Economic and Financial Indicators, 2006–2015 1/

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Sources: Lesotho authorities; and IMF staff estimates and projections.

Fiscal data are reported on a fiscal year basis; the fiscal year begins in April.

U.S. dollars.

Based on partner-country data, new trade weights from 2004; a minus sign indicates a depreciation.

Change in percent of broad money at the beginning of the period.

The average effective rate on three-month treasury bills.

Includes changes in inventories and gross fixed capital formation by the Lesotho Highlands Development Authority (LHDA).

For 2008-10, government current expenditure has been reduced by the actual and prospective transfer to the pension fund.

Percent of exports of goods and nonfactor services.

19. The program envisages increases in public investment for infrastructure development in support of the authorities’ pro-growth objectives. Capital expenditure is projected to increase from 16.0 percent of GDP in 2009/10 to 23.6 percent of GDP in 2010/11, reflecting a substantial increase in externally funded capital spending (6.7 percent of GDP) linked to the construction of the Metolong dam. Of this increase about 0.7 percent of GDP is in the form of grants from the MCC and another 3.6 percent of GDP is to be funded through a nonconcessional loan from the EIB. The authorities consider this project, together with the LHWPII, critical for addressing the infrastructure gap in electricity and water supplies and in supporting private sector activities in key export sectors. In addition, Lesotho will benefit from increases in fiscal revenue and foreign exchange inflows generated by increased water supply to South Africa.

20. With non-SACU revenues of about 27 percent of GDP, the scope for significant increases in tax rates is limited, and the main focus will be on implementing measures to improve tax administration. To this end, the 2010/11 budget includes increases in a number of rates, fines and charges, some of which have not been reviewed in over 20 years. Measures will also be implemented to improve tax administration and compliance, and with technical assistance from the US Treasury Department, the Lesotho Revenue Authority (LRA) is strengthening collection of tax arrears, and enhancing intelligence and investigation, as well as auditing functions. The planned profiling of large-tax-payers with a view to increase tax compliance, and the implementation of the Integrated Revenue Management System should help improve the efficiency of tax collection (MEFP ¶ 22).

21. Further strengthening of public expenditure management (PEM) will be critical to enhance the efficiency of public expenditure in light of reduced resources. Significant progress has been made in PEM, and for the first time in several years the 2010/11 budget was formulated on the basis of the expected outturn for 2009/10 rather than on the basis of the previous year’s budget. This should improve budget execution and spending efficiency as resources will be allocated to ministries with the capacity to implement programs and projects. It should also narrow the gap between the budget and outturn which is a key benchmark for assessing public financial management (PFM) and unlocking additional budgetary support from development partners.

22. The authorities have made progress in improving PFM, with technical and financial assistance from development partners, including the Fund. In April 2009, the authorities introduced the IFMIS to improve budget formulation, execution and accountability. However, there are deficiencies related to internal controls, risk exposure and reporting functions, which have impaired the functionality of the system. The teething problems of the new IFMIS have also resulted in a build-up of domestic arrears, which the authorities are in the process of quantifying. The program incorporates a provision for domestic arrears clearance of M 200 million (1.3 percent of GDP) in the first year (MEFP ¶21). A March 2010 FAD technical assistance mission made recommendations for improving the functionality of the IFMIS, and some of these recommendations have been incorporated in the program as structural benchmarks for the first review (MEFP ¶ 20, MEFP Table 2).

Table 2.

Lesotho: Central Government Operations, 2007/08-2015/16 1/

(In millions of maloti)

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Table 2a.

Lesotho: Central Government Operations, 2007/08-2015/16 1/

(in percent of GDP; unless otherwise indicated)

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Sources: Ministry of Finance and Development Plannning, and Fund staff estimates and projections.

The fiscal year runs from April 1- March 31.

Overall balance excluding customs revenue (SACU)

Domestic balance excludes grants, foreign-financed capital spending, foreign interest payments, and exceptional factors.

On a fiscal year basis.

23. The reduction in revenue has given greater impetus to improving the efficiency and quality of capital expenditure. The Project Appraisal Committee (PAC), which was resuscitated in 2008, vets new capital projects and makes recommendations for inclusion in the budget those projects that meet the medium-term objectives of broad-based growth, poverty reduction and attainment of the MDGs. However, the PAC does not have oversight over ongoing projects. Accordingly, the program includes a structural benchmark for a comprehensive review of all on-going capital projects with the intention of recommending to Cabinet, by end-September 2010, which projects should be retained or eliminated (MEFP ¶18). This is expected to create room for more productive projects in the 2011/12 budget.

B. Structural Reforms to Increase Productivity and External Competitiveness

24. Implementation of the structural reforms agenda is critical for improving the business climate and increasing external competitiveness and productivity. Relatively high unit labor costs and poor investment climate, evidenced by the slippage in ranking in the Doing Business Indicators, have contributed to loss of global and regional competitiveness. This has resulted in a loss of Lesotho’s market share of textile exports to the United States. To reverse this trend, the authorities are implementing reforms aimed at reducing the cost of doing business, enhancing competitiveness and productivity, and adopting new legislation to secure property rights, including the Land Reform Bill which was approved by Parliament in March 2010 and is under discussion by the Senate. These reforms are supported by the MCC through its private sector development program and the World Bank under the private sector competitiveness and diversification program, among other projects. The program includes structural measures to improve the business climate (MEFP¶ 24–26).

uA01fig15

SACU Countries: Cost of Doing Business

(Percent of countries scoring better than the country indicated)

Citation: IMF Staff Country Reports 2010, 225; 10.5089/9781455205745.002.A001

Source: World Bank’s Doing Business, 2006-2010.
uA01fig16

Cost of Doing Business, 2009

(Percent of countries scoring better than Lesotho)

Citation: IMF Staff Country Reports 2010, 225; 10.5089/9781455205745.002.A001

Source: World Bank’s Doing Business, 2010.

25. A recent staff assessment of the real exchange rate concluded that it is moderately overvalued, and this conclusion remains broadly unchanged.5 Given the authorities preference to maintain the peg, there is no scope for external adjustment through a nominal exchange rate depreciation and therefore, restoring current account sustainability will depend on (a) fiscal consolidation; (b) accelerating implementation of structural reforms to increase productivity and reduce unit labor costs; (c) wage restraint to lower cost; and (d) further improvement in infrastructure.

uA01fig17

Nominal and Real Effective Exchange Rates

(2000=100)

Citation: IMF Staff Country Reports 2010, 225; 10.5089/9781455205745.002.A001

Source: INS database

C. Financial Sector Strengthening to Enhance Access to Financial Services and Support Economic Development

26. Enhanced prudential regulations of banks and NBFIs will be a main element of financial sector reform under the program (MEFP ¶28–29). The CBL intends to submit to Parliament, by end-September 2010, the revised Financial Institutions Act (FIA) which incorporates amendments to deal with supervision of NBFIs by the CBL, and unlawful business practices, including Ponzi schemes6. Prudential regulations of savings and credit cooperatives (SACCOs) will also be enhanced by amending the Cooperatives Societies Act to prohibit SACCOs from mobilizing deposits from nonmembers. If cooperatives are allowed to take deposits from nonmembers, they will be supervised by the CBL and will be subject to the same prudential and anti-money laundering requirements established for banks.

27. The program includes reforms to deepen financial intermediation by developing the domestic bond market and increasing access to financial services, particularly in rural areas (MEFP ¶27, 31). The authorities plan to issue longer-dated domestic bonds. This will extend the yield curve for government securities and provide the authorities with an alternative source of budget financing. In addition, the authorities, with the support of development partners, are reforming the Postbank to shore up its capacity to provide microcredit products in rural areas. The Postbank is also introducing Smartcards which will make it easier for pensioners located in rural areas to access funds.

28. The CBL is proceeding with the implementation of the Anti-Money Laundering (AML) Act of 2008 (MEFP ¶30). Draft regulations on the mandate and scope of operations of the Financial Intelligence Unit and for the broader AML regime are being prepared by the CBL and final drafts are expected by end-September 2010.

IV. Program Risks

29. Lesotho’s economic program is subject to several risks arising from: (a) slower than expected regional and global economic recovery which would further dampen demand for exports and reduce foreign direct investments; (b) further decline in SACU revenues, owing to a change in the revenue-sharing formula and the extent of the economic recovery in South Africa; (c) policy slippages, given the need for expenditure restraint which will require political and social consensus; and (d) delays in implementing key structural reforms underpinning growth in the medium term. One mitigating factor to a number of these risks is the authorities’ strong ownership of the program and their commitment to take additional fiscal measures, if warranted, to mitigate risks to the program.

V. Program Monitoring

A. Program Monitoring and Conditionality

30. Program implementation will be monitored through a set of semi-annual quantitative performance criteria (PC) and structural benchmarks (SB) laid out in the authorities’ MEFP, with terms defined in the accompanying Technical Memorandum of Understanding (TMU). Over the three years of the ECF-supported program (2010–13) semi-annual performance criteria will be set on net domestic borrowing of the central government, and net domestic assets and net international reserves of the CBL. For the first year of the program, performance criteria will be set for end-September 2010 and end-March 2011, with the indicative targets for interim end-quarters June and December 2010. There will also be continuous performance criteria on nonaccumulation of government external payment arrears and on the contracting and guaranteeing of new short-term and medium-term nonconcessional external debt.7 Indicative targets will be set on social spending (MEFP ¶16) and on repayment of domestic arrears (MEFP Table 1).

31. The program will set structural benchmarks in three key reform areas for the first year of the program: (i) PFM: to enhance the efficiency and quality of public expenditure; (ii) structural reforms: to improve the investment climate, and boost competitiveness and productivity; and (iii) financial sector reforms: to strengthen prudential regulations to reduce systemic risks to the domestic financial sector, and deepen the financial sector by issuing bonds with a view to promote the development of the domestic money and capital market (MEFP Table 2).

B. Program Financing

32. The new ECF arrangement would be part of a wider effort by Lesotho’s development partners (Text Table 4). Total financing requirements for 2010–13 are projected at US$2,402 million (annual average of 31 percent of GDP). A significant portion of the financing requirement is expected to be covered by SACU transfers, grants and loans from development partners. At the proposed access level for the ECF arrangement, the Fund would account for some 3 percent of envisaged financing by development partners. The financing requirement for 2010 will be financed mainly by SACU transfers, and loans and grants from development partners, including new commitments of US$83 million for budget support from the African Development Bank (AfDB), EU- including from the Vulnerability Flex, and the World Bank. The first year of the ECF-supported program is fully financed. For the period 2011–13, the commitments from the development partners, including the EU and World Bank, should cover the financing requirements over that period (Table 6).

Text Table 4.

Lesotho: External Financing Requirements and Sources, 2010-2013

(in millions of US dollars)

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Sources: Lesotho’s authorities; and IMF staff estimates and projections.

Includes all other net financial flows and errors and omissions.

Includes loans and grants.

Table 3.

Lesotho: Balance of Payments, 2006–2015

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Sources: Central Bank of Lesotho; and IMF staff estimates and projections.

Adjusted for SACU duty receipts.

Lesotho Highlands Water Project.

Lesotho Highlands Development Authority.

Fiinancing Gap refers to the period 2010-2015

The figures for gross official reserves include Lesotho’s SDR allocation of SDR 29.1mn, received August 28, 2009.

Based on current year imports of goods and services