Public Information Notice: IMF Executive Board Concludes 2006 Article IV Consultation with the Kingdom of Lesotho

October 12, 2006

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The staff report for the Article IV consultation with Lesotho may be made available at a later stage if the authorities consent.

Public Information Notice (PIN) No. 06/112
October 12, 2006

On October 6, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Kingdom of Lesotho.1


Lesotho has made good progress toward macroeconomic stability in recent years. Its fiscal balance has been in surplus since 2003/04, owing mainly to rapidly rising receipts from the South African Customs Union (SACU) and improved domestic revenue collection. Reflecting the sizable SACU inflows and fiscal surpluses, the external current account deficit has narrowed and gross international reserves increased to the equivalent of about five months of imports of goods and nonfactor services by the end of the fiscal year 2005/06. In line with price trends in South Africa, the inflation rate fell in 2003-05 despite rising oil import prices. Market yields on treasury bills have moved downward and the spread relative to South Africa has virtually vanished, due to the strengthened fiscal position. The government used part of the SACU windfalls to retire nonconcessional debt, reducing the net present value of public external debt to levels significantly below the relevant indicative debt sustainability threshold.

However, economic activity has remained sluggish, reflecting the adverse impact of exogenous shocks, and poverty remains widespread. Agricultural production was hit by drought in 2002-05 and excessive rainfall in early 2006, which has also damaged roads and bridges in the rural areas where about 70 percent of the population lives. The manufacturing sector was adversely affected by a substantial real effective appreciation of the loti in 2002-2004 and the removal of textile quotas by industrial countries in early 2005, which led to the loss of about a quarter of jobs in the garment sector. Following a halt of the loti appreciation and the signing of a bilateral agreement that restrains exports from China to the U.S. market, the garments sector saw a modest recovery recently.

In the context of the 2006/07 budget, the authorities have reduced the company income tax rate to attract investment. With SACU revenue projected to reach a record level, total spending is budgeted to increase sharply. A supplementary budget raises expenditure further and largely eliminates the initially targeted budget surplus of 2.7 percent of GDP. While the 2006/07 budget includes a significant increase in expenditures on infrastructure and for reduction of nonconcessional external debt, the wage bill and other recurrent outlays are also projected to increase relative to GDP. The execution rate of capital expenditure, particularly concerning donor-funded projects, was low in the past year.

Lesotho's medium-term outlook is clouded by considerable downside risks, including a further loss of trade preferences for the export sector and a decline in SACU receipts relative to GDP.

Executive Board Assessment

Directors commended the Lesotho authorities for their continued efforts to maintain macroeconomic stability under difficult circumstances. In particular, they noted the marked improvement in the fiscal and external positions in recent years, and welcomed the authorities' prudent use of the large receipts from the Southern African Customs Union (SACU) in the last two years for debt reduction and the accumulation of international reserves.

Directors cautioned, however, that economic growth is still low and that much remains to be done to reduce poverty in view of Lesotho's narrow resource and production base, susceptibility to shocks, and high HIV/AIDS prevalence rates. Directors also identified several downside risks for Lesotho over the medium term, including a further loss of trade preferences and a decline in receipts from the SACU. Against this background, Directors considered that the key policy challenges facing the authorities are to achieve more rapid and broad-based economic growth through an acceleration of structural reforms and to strengthen the medium-term fiscal position. International assistance would continue to be essential for further improving fiscal management and overcoming absorptive capacity constraints.

Directors emphasized the need for a prudent fiscal strategy, in view of the high uncertainty regarding future SACU receipts and the fact that, under the exchange rate parity arrangement, the burden of safeguarding macroeconomic stability falls on fiscal policy and structural reforms. They supported the use of further exceptional SACU receipts for reducing nonconcessional debt and increasing poverty-related spending, but encouraged the authorities to strictly contain the wage bill and other recurrent outlays. Directors also considered that the 2007/08 budget should aim at maintaining fiscal sustainability. They cautioned that pension reform and a new medical aid scheme should be introduced as part of a broader civil service reform that would set personnel-related budgetary expenditures on a sustainable path. Directors also called on the authorities to offset the revenue impact of the company tax cut through sustained improvement in tax administration.

Directors encouraged the authorities to continue their efforts to improve public financial management. They welcomed the wider application of the medium-term fiscal framework and other steps to improve budget planning and execution. While supporting the objective of improving public service delivery at the local level, Directors encouraged the authorities to take prompt action to ensure that the implementation is broadly budget-neutral. They underscored the importance of increasing the execution rate of capital expenditure to support economic growth and increase aid absorption.

Directors stressed that, to achieve higher growth and diversify the production base, the authorities need to press ahead with structural reforms aimed at improving Lesotho's attractiveness as a location for private investment. In this context, Directors considered that the exchange rate peg under the Common Monetary Area has generally served Lesotho well, but noted that the real appreciation of the loti in recent years heightens the need for sustained actions to reduce structural impediments and enhance the economy's flexibility and competitiveness. They therefore urged the authorities to implement without delay the reforms to remove red tape and other regulatory impediments, and increase competitiveness by enhancing labor productivity, infrastructure, and institutions. The launching of the Trade and Investment Facilitation Center was seen as an important step in this direction. Directors also supported the Central Bank of Lesotho's efforts to improve private sector access to bank credit and to strengthen the regulatory framework for the nonbank financial sector.

Directors agreed that Lesotho will continue to need international support in order to make progress toward the MDGs and address pressing social challenges, including combating HIV/AIDS prevalence. They stressed the need to mobilize additional donor support for the strengthened implementation of Lesotho's Poverty Reduction Strategy. Directors saw scope to further improve the quality and timeliness of Lesotho's statistics for enhancing policy analysis and surveillance.

Lesotho: Selected Economic Indicators, 2002/03-2006/07 1


2002/03 2003/04 2004/05 2005/06 2006/07
     Est. Proj.

  (Annual percent change, unless otherwise indicated)

Real Economy


Real GDP growth (percent)

3.6 3.2 2.6 1.3 2.5

Nominal GDP (millions of maloti)

7,541 8,249 8,930 9,405 10,141

Inflation (percent)

12.2 6.4 4.7 3.6 4.5
  (Percent of GDP)

National Accounts


Gross domestic investment

43.0 43.9 34.4 28.1 30.0

Gross national savings

25.0 33.1 31.3 26.2 25.3

Central Government


Revenue and grants

44.2 43.9 51.0 48.8 55.6


40.2 41.7 48.4 47.7 52.8

Total grants

3.9 2.2 2.5 1.0 2.8

Total expenditure and net lending

48.5 43.1 42.1 44.8 54.8

Overall balance (excluding grants)

-8.3 -1.4 6.3 2.9 -2.1

Overall balance (including grants)

-4.4 0.8 8.8 3.9 0.8
  (Annual percent change, unless otherwise indicated)

Money and Credit


Net domestic assets 2

73.4 16.5 -27.9 -0.2 -8.4

Money and quasi-money (M2)

2.7 5.3 6.2 4.7 6.7
  (Percent of GDP)

External Sector


Current account balance (excluding grants)

-34.6 -25.7 -21.9 -22.3 -28.4

Current account balance (including grants)

-18.0 -10.8 -3.0 -1.8 -4.7

External debt 3

81.8 61.4 49.8 47.2 47.1

External debt-service ratio 4

11.8 9.2 7.3 10.9 1.9

Gross official reserves (millions of US dollars)

408.4 436.9 507.7 564.0 626.2

Gross official reserves (months of imports)

4.3 3.7 4.4 4.9 4.8

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


1 Fiscal year beginning in April.

2 Change in percent of M2 at the beginning of the period.

3 Government only. The appreciation of the loti significantly affected the debt-to-GDP ratio in 2003/04.

4 In percent of exports of goods and services.

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.


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