Kingdom of Lesotho: Requests for Disbursement Under the Rapid Credit Facility and Purchase Under the Rapid Financing Instrument—Debt Sustainability Analysis

Requests for Disbursement Under the Rapid Credit Facility and Purchase Under the Rapid Financing Instrument-Press Release; Staff Report; and Statement by the Executive Director for the Kingdom of Lesotho

Abstract

Requests for Disbursement Under the Rapid Credit Facility and Purchase Under the Rapid Financing Instrument-Press Release; Staff Report; and Statement by the Executive Director for the Kingdom of Lesotho

Joint Bank-Fund Debt Sustainability Analysis

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This DSA1 assesses Lesotho’s risk of external and overall debt distress at moderate despite the impact of the COVID shock, but risks to debt sustainability have risen since the last DSA.2 The overall risk of debt distress is also assessed to be moderate. The moderate risk tool suggests limited space to absorb shocks. The results of the DSA highlight the rapid increase in debt levels over the past 3 years, particularly on the domestic side, as well as the impact of the large depreciation of the exchange rate against the US dollar in early 2020 and additional financing needed for COVID mitigation measures. The results also point to the importance of addressing financing shortfalls of the pension fund, building buffers to mitigate external shocks, and maintaining a conservative approach to debt contraction. Recent undersubscription of domestic debt auctions underscores the limited absorption capacity of domestic markets. Controlling current expenditure will be essential to reduce pressure to expand domestic issuance, restore external balances, and mitigate vulnerabilities. Finally, the authorities are encouraged to carefully vet new investment projects to ensure that new borrowing is productive.

Public Debt Coverage

1. Lesotho’s public debt data covers the central government, the central bank, and government-guaranteed debts. Debt coverage is similar to the previous DSA (Text Table 1). While coverage does not include extrabudgetary units such as the Road Fund, the contingent liability of the pension fund, estimated between 10 and 20 percent of GDP, is included in the contingent liability stress test. Increasing participant contributions would gradually reduce the unfunded liabilities. Guaranteed SOE debt is covered by debt data and preliminary estimates on non-guaranteed SOE debt are also included in the analysis. Guaranteed debt related to COVID stimulus measures are also included. Since those estimates are not comprehensive, another 2 percent of GDP is added to the contingent liability stress test. The contingent liability stress test also includes 5 percent of GDP for a financial market shock and 35 percent of the PPP capital stock, which is estimated to be 3.2 percent of GDP (Text Table 2). External debt is defined based on currency-criterion as there is no foreign holdings of local-currency debt. The authorities will begin publishing outstanding debt, including guarantees, of SOEs on the website of the Ministry of Finance in agreement with the World Bank under the Sustainable Development Financing Policy (SDFP).

Text Table 1.

Lesotho: Coverage of Public Sector Debt and Design of the Contingent Liability Stress Test

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Text Table 2.

Lesotho: Summary of Shocks Used for the Contingent Liabilities Stress Test

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The default shock of 2% of GDP will be triggered for countries whose government-guaranteed debt is not fully captured under the country’s public debt definition (1.). If it is already included in the government debt (1.) and risks associated with SoE’s debt not guaranteed by the government is assessed to be negligible, a country team may reduce this to 0%.

Background

2. Lesotho’s total public debt exceeded 50 percent of GDP in FY 2019/20 from 48 percent the previous year (Text Table 3).3 The increase was driven by new external and domestic borrowing, a sharp weakening of the rand to which the maloti is pegged, and revisions to national accounts data. Higher levels of domestic borrowing also reflect efforts by the authorities to finance larger deficits in recent years. External debt accounts for more than three-quarters of total debt and is largely owned to multilateral creditors on a concessional basis. The main creditor is the International Development Association (IDA) followed by the African Development Fund (ADF), the European Investment Bank (EIB), and the IMF. On the bilateral front, the main creditors are China and Kuwait.

Text Table 3.

Lesotho: Stock of Outstanding Debt, 2014/15–2019/20

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Source: Country authorities and staff estimates.Note: Domestic Debt includes arrears and guarantees.

Assumptions

3. The macroeconomic framework reflects the worsened outlook since the previous DSA (Text Table 4). The framework underlying this DSA is the same as that included in the staff report of the 2020 RCF and RFI request which reflects recent global developments. The current macroeconomic framework reflects currently available information. However, updates with respect to economic impact and policy response to the COVID-19 crisis are rapidly evolving and risks are tilted to the downside. Despite the continued expansionary fiscal stance, real GDP growth for the medium term and long has fallen with respect to the previous DSA, due to the COVID-19 crisis and weakened prospects for the main industrial sectors (mining and textile). Inflation projections are slightly lower in line with monetary policy developments in South Africa. A primary fiscal deficit of about 2 percent on average is expected for the medium term as lower SACU revenues and wage pressures prevent additional consolidation, contributing to the increase in public debt. Over the long run, the primary fiscal deficit is unchanged from the previous DSA. On the external sector, the LHWP-II project and lingering weakness in the export sectors from the COVID crisis lead to a current account deficit of around 13 percent of GDP in the medium term. The increase in debt levels with respect to the previous DSA reflects significant financing needs related to the COVID crisis, the higher levels of domestic issuances, and weaker exchange rate dynamics.

Text Table 4.

Lesotho: Macroeconomic Assumptions

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Sources: IMF Country Report No. 19/113 and staffs estimates and projections.

4. External borrowing at concessional terms is expected to decline moderately, while remaining significant. As Lesotho grows and graduates from some concessional borrowing sources and the domestic market develops, concessionality is expected to decline gradually over the long term. However, concessional external borrowing will remain critical for financing large investment projects. In line with the authorities’ medium-term goals, the development of the domestic debt market is assumed to continue.

5. The realism of the macroeconomic framework is supported by several checks, although the unprecedented nature of the current crisis calls for caution in interpretation of these results (Figures 3 and 4). The path for external debt accumulation is steeper with respect to the previous DSA. The current account deficits and a methodological change to the compilation of remittances have been the main driver of unexpected changes in external debt over the past 5 years.4 Over the medium term, the current account deficit is expected to be financed with the support of South African capital transfers, in particular those financing the LHWP-II. More inflows are also anticipated on the back of green energy and other infrastructure projects. Unexpected changes in debt have not been significant over the past five years. GDP growth is expected to be boosted by LHWP-II-related construction. As LHWP-II is not accounted as government capital spending, however, the contribution of government capital to real GDP growth is expected to remain low.5

Figure 1.
Figure 1.

Lesotho: Indicators of Public and Publicly Guaranteed External Debt under Alternative Scenarios, 2020–20301,2

Citation: IMF Staff Country Reports 2020, 228; 10.5089/9781513551845.002.A002

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in or before 2030. The stress test with a one-off breach is also presented (if any), while the one-off breach is deemed away for mechanical signals. When a stress test with a one-off breach happens to be the most exterme shock even after disregarding the one-off breach, only that stress test (with a one-off breach) would be presented.2/ The magnitude of shocks used for the commodity price shock stress test are based on the commodity prices outlook prepared by the IMF research department.
Figure 2.
Figure 2.

Lesotho: Indicators of Public Debt under Alternative Scenarios, 2020–2030

Citation: IMF Staff Country Reports 2020, 228; 10.5089/9781513551845.002.A002

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in or before 2030. The stress test with a one-off breach is also presented (if any), while the one-off breach is deemed away for mechanical signals. When a stress test with a one-off breach happens to be the most exterme shock even after disregarding the one-off breach, only that stress test (with a one-off breach) would be presented.
Figure 3.
Figure 3.

Lesotho: Drivers of Debt Dynamics – Baseline Scenario

Citation: IMF Staff Country Reports 2020, 228; 10.5089/9781513551845.002.A002

1/ Difference between anticipated and actual contributions on debt ratios.2/ Distribution across LICs for which LIC DSAs were produced.3/ Given the relatively low private external debt for average low-income countries, a ppt change in PPG external debt should be largely explained by the drivers of the external debt dynamics equation.
Figure 4.
Figure 4.

Lesotho: Realism Tools

Citation: IMF Staff Country Reports 2020, 228; 10.5089/9781513551845.002.A002

Country Classification and Determination of Scenario Stress Tests

6. Lesotho has a medium debt carrying capacity (Text Table 5). Debt carrying capacity is determined by a composite indicator (CI) that includes the World Bank’s Country Policy and Institutional Assessment score, global economic growth, Lesotho’s real growth rate, import coverage of reserves, and remittances. The composite indicator for the October 2019 WEO and the World Bank’s CPIA 2018 CPIA score yields a medium CI rating (3.02), as in the previous vintage.

Text Table 5.

Lesotho: Debt Carrying Capacity

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7. Lesotho does not trigger other tailored stress tests. Apart from the contingent liability tailored shock described above, Lesotho’s economic characteristics do not trigger any of the tailored stress tests on natural disasters, commodity prices, and/or market financing risk module.

External Debt Sustainability Analysis

8. All external debt sustainability indicators remain below their corresponding thresholds in the baseline scenario (Tables 1 and 2, and Figure 1). The present value (PV) of PPG external debt-to-GDP is expected to reach close to the 40 percent threshold in FY 2020/21, about 10 percentage points higher than the 2019 DSA. Afterwards, it is expected to slowly decline as domestic borrowing expands and financing needs decline. The higher levels of external borrowing mainly reflect additional financing needs to address the COVID crisis, as well as the recent exchange rate depreciation. For example, the World Bank is discussing a Development Policy Operation in addition to a COVID health project. Lesotho is also participating in the debt services suspension initiative (DSSI) supported by the G-20 and Paris Club, which will save roughly $6 million in debt service this year.6 This debt suspension is reflected in the macro framework and the DSA. All other indicators of external debt sustainability remain well below the thresholds.

Table 1.

Lesotho: External Debt Sustainability Framework, Baseline Scenario, 2019–2040

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.1/ Includes both public and private sector external debt2/ Derived as [r – g – ρ(1+g)]/(1+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.3/ 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.4/ Current-year interest payments divided by previous period debt stock.5/ Defined as grants, concessional loans, and debt relief.6/ Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).7/ Assumes that PVof private sector debt is equivalent to its face value.8/ Historical averages are generally derived over the past 10 years, subject to data availability, whereas projections averages are over the first year of projection and the next 10 years.
Table 2.

Lesotho: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2020–2030

(In percent)

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Sources: Country authorities; and staff estimates and projections.

A bold value indicates a breach of the threshold.

Variables include real GDP growth, GDP deflator (in U.S. dollar terms), non-interest cur rent account in per cent of GDP, and non-debt creating flows.

Includes official and private transfers and FDI.

9. Stress tests show that Lesotho’s external debt vulnerabilities could emerge in the event of a realization of an export or contingent liabilities shock (Tables 3 and 4, and Figure 1). The PV threshold of PPG external debt-to-GDP would be breached if an export shock was realized and financed with external debt. In this scenario, servicing the current account deficit would increase the PV of debt-to-GDP by close to 20 percentage points with respect to the baseline by 2030. The threshold would also be breached in the event of growth shock, primary balance shock, and contingent liabilities shock. The PV of debt-to-exports and debt service to exports breach the indicative threshold under the export shock scenario as well. All other stress scenarios remain under the thresholds for these indictors.

Table 3.

Lesotho: Public Sector Debt Sustainability Framework, Baseline Scenario, 2019–2040

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.1/ Coverage of debt: The central government, central bank, government-guaranteed debt . Definition of external debt is Currency-based.2/ The underlying PV of external debt-to-GDP ratio under the public DSA differs from the external DSA with the size of differences depending on exchange rates projections.3/ Debt service is defined as the sum of interest and amortization of medium and long-term, and short-term debt.4/ 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 and other debt creating/reducing flows.5/ Defined as a primary deficit minus a change in the public debt-to-GDP ratio ((-): a primary surplus), which would stabilize the debt ratio only in the year in question.6/ Historical averages are generally derived over the past 10 years, subject to data availability, whereas projections averages are over the first year of projection and the next 10 years.
Table 4.

Lesotho: Sensitivity Analysis for Key Indicators of Public Debt, 2020–2030

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Sources: Country authorities; and staff estimates and projections.

A bold value indicates a breach of the benchmark.

Variables include real GDP growth, GDP deflator and primary deficit in percent of GDP.

Includes official and private transfers and FDI.

Overall Risk of Public Debt Distress

10. All public debt sustainability indicators remain below their corresponding thresholds in the baseline scenario (Table 2 and Figure 2). The PV of public debt-to-GDP is expected to reach close to 50 percent in FY 2021/22, below the 55 percent threshold, before falling below 40 percent in the long run.

11. Lesotho’s public debt is vulnerable to a potential growth shock. (Table 4 and Figure 2). The PV threshold of public debt-to-GDP will breach in the event of a shock to growth, whereby real GDP growth is set to its historical average minus one standard deviation for the second and third year after the projections begin. Under this stress test, the PV of debt-to-GDP would rise to around 80 percent by 2030. The historical scenario, whereby real GDP growth, primary balance-to-GDP ratio, GDP deflator, non-interest current account, and net FDI flows are set to their historical averages, would also breach the indicative threshold. The 55 percent threshold would also be breached under the contingent liability and export shock scenarios.

12. The mechanical signal for the overall risk of public debt distress is moderate. The moderate signal comes from three of the external debt indicators and the public debt indicator breaching the threshold under the stress scenario.

Risk Rating and Vulnerabilities

13. Lesotho’s risk of external and public debt distress remains moderate, with limited space to absorb shocks (Figure 5). Notwithstanding the crisis, external and public debt and debt service indicators for the baseline remain below their respective thresholds, but shocks to contingent liabilities, growth, and exports lead to breaches. Moreover, given that the debt burden has risen significantly in recent years, the DSA results highlight the importance of a conservative debt management strategy focused on concessional sources wherever possible. Domestic debt issuance should be expanded cautiously and in line with the market’s absorption capacity. The government will also need to address the pension fund’s financing gap to ensure the sustainability of public sector financing. Ensuring sustainability in the post-COVID world will require strong efforts to control recurrent expenditure, particularly on the wage bill.

Figure 5.
Figure 5.

Lesotho: Qualification of the Moderate Category, 2020–2030 1/

Citation: IMF Staff Country Reports 2020, 228; 10.5089/9781513551845.002.A002

Sources: Country authorities; and staff estimates and projections.1/ For the PV debt/GDP and PV debt/exports thresholds, x is 20 percent and y is 40 percent. For debt service/Exports and debt service/revenue thresholds, x is 12 percent and y is 35 percent.

Authorities’ Views

The authorities concurred with the DSA and the “moderate” risk rating, with limited space to borrow. In the context of additional financing needs amidst the COVID crisis, they acknowledged the need for additional external borrowing in the short term. However, they also noted that prudent debt management must continue in the medium term, in particular by pursuing financing with a significant grant element and that stronger capacity in the Cash Management Unit would support the forecasting of financing needs. Steps to curb the wage bill and other recurrent expenditures will also be needed to ensure debt sustainability. Finally, the authorities highlighted upcoming improvements to debt transparency in accordance with their participation in the World Bank’s SDFP.

1

This DSA updates the previous Joint DSA from April 2019 (IMF Country Report No. 19/113). This DSA follows the Guidance Note on the Bank-Fund Debt Sustainability Framework for Low-Income Countries (December 26, 2017).

2

Lesotho’s debt carrying capacity is assessed to be medium based on the composite indicator of 3.02 as described in this DSA.

3

The fiscal year runs from April 1 to March 31.

4

The authorities recently updated compensation of employee inflows in the primary income account. The revision increased inflows by roughly M2.5 billion per year (about 8 percent of GDP).

5

The LHWP-II-related capital transfers also account for much of the large residuals in the external debt table (Table 2) in the medium term.

6

The initiative provides a time-bound suspension of official bilateral debt service payments to IDA-eligible and least developed countries.

Kingdom of Lesotho: Requests for Disbursement Under the Rapid Credit Facility and Purchase Under the Rapid Financing Instrument-Press Release; Staff Report; and Statement by the Executive Director for the Kingdom of Lesotho
Author: International Monetary Fund. African Dept.