Public Information Notice No. 04/6

Public Information Notice: IMF Concludes 2003 Article IV Consultation with Lesotho

February 5, 2004

On January 21, 2004, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Lesotho.¹

Background

Lesotho's economic growth is in a positive trend after a significant slowdown following civil unrest and political turmoil in 1998. Fiscal performance has, however, weakened with increasing budget deficits. The authorities have made significant progress in structural reform, but public expenditure management remains weak due to severe capacity constraints.

Economic growth was favorable in 2002/03, despite adverse weather conditions and the regional food shortage. Economic growth rose to almost 3¾ percent in 2002/03 from 3¼ percent the previous year due mainly to strong clothing exports to the United States under the African Growth Opportunity Act (AGOA). The rapid growth of the textile sector is expected to continue and signals that Lesotho remains competitive in global markets despite the appreciation of the loti against the U.S. dollar during the last two years. Inflation is now restrained after a temporary drought-related peak in 2002.

The overall fiscal deficit (excluding grants) worsened to 8 percent of GDP in 2002/03 from 2¼ percent in 2001/02, as a result of an upward shift in public expenditure and slow growth of customs revenue. Expenditure rose on a wide array of items, including outlays on goods and services – in particular vehicle lease costs – spending on scholarships and pension, and drought-related assistance. With increased domestic financing of government deficits, interest rates came under pressure in 2003.

Lesotho faces daunting medium-term problems: (i) agricultural productivity is falling due to soil degradation; (ii) almost one third of the adult population is HIV positive and fiscal resources to address this and other problems are scarce; (iii) the growth of the textile industry is driven by preferential treatment under AGOA and may not be sustainable as trade preferences by the U.S. are phased out; and (iv) fiscal revenue is projected to decline as a proportion of GDP owing to changes in the Southern African Customs Union (SACU) revenue sharing formula. Lack of adequate infrastructure, inadequate property rights, and insufficient access to bank financing are other impediments to Lesotho's economic prospects.

Some progress has been made in the areas of tax reform and privatization, but the public sector financial management system is weak and continued reforms will be vital to bring government spending in line with its priorities.

Lesotho's Poverty Reduction Strategy Paper (PRSP) is expected to be finalized in early 2004. Nevertheless, the 2003/04 budget was based on the policy priorities agreed upon during the PRSP consultations and discussions of the 2004/05 budget are also based on these priorities.

Executive Board Assessment

Executive Directors noted that economic performance had remained favorable, with moderate growth and declining inflation, despite adverse weather conditions and a regional food shortage. Economic growth rose to almost 4 percent in 2002/03, supported by buoyant growth in textiles exports to the United States under the U.S. African Growth Opportunity Act and related strong construction activity.

Directors endorsed the authorities' medium-term strategy to achieve higher and sustainable economic growth, reduce poverty, and improve social conditions by creating appropriate conditions for private sector development and, in particular, labor-intensive industries. They noted that Lesotho must address daunting medium-term challenges, such as falling agricultural productivity, HIV/AIDS-related and other health problems, potential erosion in trade preferences, inadequate infrastructure and enforcement of property rights, and insufficient access to financial credit. Directors noted the scale of the structural problems and also the drought and food crisis facing the country, and acknowledged that Lesotho would require urgent, substantial external aid to address these issues.

Directors welcomed the authorities' efforts to bring the fiscal deficit under control, with a view to reducing reliance on domestic financing. They supported the improvement in the tax system through the introduction of the value added tax and the establishment of the Lesotho Revenue Authority, while noting that strengthening domestic revenues is essential to offset any loss of revenues from changes in the Southern African Customs Union revenue-sharing arrangement.

Directors commended the reprioritization of government spending to create room for investment in basic health care, education, and other social services, which will be necessary to combat HIV/AIDS, and in physical infrastructure, such as water, electricity, and rail facilities. They stressed that reforms to the public financial management system will be essential to bring spending in line with government priorities, and that reporting of actual outcomes needs to be accurate and timely. To this end, they highlighted the importance of restarting the auditing of public accounts, improving forecasting, budgeting, and accounting within the public sector.

Directors saw a need to continue addressing governance issues, and in this regard supported the establishment of an Anti-Corruption Unit. They welcomed the progress in preparing the PRSP and the integration of its objectives with the budget. They recognized the importance of technical assistance in helping to remove capacity constraints.

Directors agreed that the current peg of the loti to the South African rand has served Lesotho well in view of the country's close economic integration with South Africa. Looking forward, they urged the authorities to pursue sound fiscal and monetary policies, deepen structural reforms to ensure external competitiveness and a sustainable peg, and facilitate a decline in lending rates.

Directors supported the on-going reforms to Lesotho's financial institutions and regulations, noting that these reforms are crucial to increase access to credit for the private sector, particularly for small- and medium-sized businesses. They commended the recent partial capital account liberalization, and underscored that priority should be given to strengthening property rights and the judiciary, and establishing a credit bureau and a rural guarantee fund.

Directors emphasized the need for structural reforms in the agricultural sector to address food and water shortages, and poor agricultural productivity. They commended the progress in privatization, and encouraged the authorities to move ahead with privatization in electricity and the establishment of regulatory agencies for power and telecommunications in 2004.

Directors noted that Lesotho's statistical database is broadly satisfactory for program monitoring purposes, but there are serious deficiencies in the quality and timeliness of core surveillance data. They urged the authorities to strengthen the capacity of the statistical agencies and improve the statistical database.