## 1lsoea2022003 ## Source details **Canonical URL:** [1lsoea2022003](https://www.imf.org/-/media/files/publications/cr/2022/english/1lsoea2022003.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2022/english/1lsoea2022003.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2022/english/1lsoea2022003.pdf.json) --- ### ADDRESSING LESOTHO’S CLIMATE AND ENVIRONMENTAL CHALLENGES - Exposure and impacts - Highly exposed to recurrent natural disasters (droughts, floods, storms); frequency and severity increased significantly in the past decade. - Over two-thirds of the population depend on rain-fed subsistence agriculture. - Share of population directly exposed to natural disasters ranks fourth among SSA countries. - Fiscal and macro-financial impacts of disasters - El Niño–induced drought in FY15/16: US$38 million (LSL584 million, 1.7 percent of GDP). - Floods in FY10/11: US$67 million (LSL462.7 million, 3.2 percent of GDP). - Average annual cost of disaster relief: about US$19.3 million (1 percent of GDP in FY19/20), mostly borne by the government. - Environmental degradation and land - Only 12 percent of the country’s land is arable. - Estimated soil loss: 40 million tons annually (about 2 percent of its topsoil). - About 66 percent of households live on degraded land. - Annual depletion of natural resources estimated at around 4.6 percent of gross national income. - Institutions and policies - DMA established under the Disaster Management Act of 1997. - National Adaptation Programme of Action prepared in 2007. - National Resilience Strategic Framework (NRSF) approved in 2019. - Current interventions: tree planting, land reclamation, wetland and biodiversity protection, conservation programs, horticulture improvements. - Rationale for adaptation and green transition - Lesotho is a low emitter but highly vulnerable; COP26 framed an imperative for less carbon-intensive transition. - Up-front investment in climate-resilient infrastructure yields long-term savings by reducing disaster-relief spending and lowering public debt impact. - Non-infrastructure measures (improved seeds, irrigation, early warning systems, targeted social assistance) often have high benefit-to-cost ratios and can be implemented quickly. - Costs, financing, fiscal implications - Adaptation and mitigation require frontloaded investment; creating fiscal space via revenue mobilization and expenditure restraint is necessary. - Government bears most disaster relief costs; regional risk-pooling/insurance (e.g., African Risk Capacity) could reduce fiscal burden. - Policy recommendations - Maintain fiscal buffers; prioritize Disaster Management Fund resources and strengthen disbursement mechanism. - Consider participation in regional macroeconomic insurance schemes. - Better allocate and target social programs to vulnerable populations. - Implement climate-smart agriculture: drought-tolerant crops, irrigation, sustainable land management. - Promote agricultural and disaster insurance penetration. - Pursue win-win policies: minimize emissions while addressing urban pollution and promoting solar energy and other cost-effective technologies. ### INTERNATIONAL FUNDS, FINANCIAL INCLUSION, AND DIGITAL FINANCE - International support for disaster relief and resilience - International community to expand financial support and technical assistance beyond disaster relief to climate resilience. - Several donor-funded climate projects active (EU, GEF, MCC, UNDP, World Bank); coordination and government cooperation critical. - Financial inclusion progress and challenges - Mobile money: active accounts increased about four and half times since 2015. - By 2021, adults with access to more than one formal financial product increased by 40 percent from 2011. - Only about 10 percent of households who borrow do so from a financial institution. - Deposits to GDP: 30 percent; about half of deposits go to the private sector as credit. - Only about a third of domestic credit goes to businesses. - MSME and household constraints - MSMEs often lack financial statements and business plans; lenders’ use of collateral limited by legal framework. - Difficulty obtaining documentation leads some MSMEs to take consumer loans. - Lenders prefer salaried workers; about half of mortgage loans are to civil servants, who account for only 4 percent of the labor force. - Small MFI sector holds about 5 percent of banking sector assets and lends almost entirely to households. - Financial cooperatives are growing rapidly; regulatory and governance concerns (e.g., Boliba); Financial Cooperatives Bill progress stalled. - Mobile money and digital finance details - Mobile money accounts registered as of year-end 2020: 2.2 million total; 882,000 30-days active (40 percent); 920,000 90-days active (42 percent). - Active accounts equate to around two-thirds of the adult population of 1.4 million. - Two-thirds of Basotho do not use the internet regularly. - Five mobile money issuers; Vodacom market share: 87 percent. - Digital lending in its infancy partly due to lengthy Fintech licensing. - Remittances - Informal remittances estimated to decline from 54 percent in 2016 to 30 percent in 2018 (FinMark Trust). - Policy recommendations for financial inclusion and digital finance - Strengthen digital payments and consumer protection: revise National Payments Act; improve interoperability; monitor anti-competitive practices. - Reduce documentation costs while maintaining protections; utilize national ID for verification (pilot underway). - Consider risk-based, tiered banking agent licensing. - Specific actions: submit National Payments Systems Bill; implement Government Payment Gateway; implement National Switch and common data standards; implement National Identification Act; update Data Protection Act; revise Computer Crime and Cybersecurity Bill; adopt simplified customer due diligence; harmonize Financial Agency requirements; adopt Financial Consumer Protection regulations. - Reduce cross-border remittance costs via regional payment integration and SIRESS usage; coordinate with South African and regional authorities. - Enhance consumer protection and financial literacy; pass Financial Consumer Protection Bill and capacitate Consumer Protection Unit; speed passage of Financial Cooperatives Bill. - Monitor and address over-indebtedness: expand credit bureau coverage; consider integrating Treasury payroll information; monitor lending practices and issue warnings/penalties. - Improve MSME access: improve credit infrastructure; enhance partial credit guarantee scheme; support capital markets; complete collateral property register; broaden Credit Reporting Act coverage; implement Insolvency Act regulations; include businesses in credit bureau; review required documentation for business loans. - Increase project bankability: provide business development training; review partial credit guarantee schemes (LNDC and MSBDCM) to eliminate overlaps and align with best practices. ### FISCAL PRESSURES, PUBLIC SPENDING, AND CONSOLIDATION - Fiscal outlook and recent performance - SACU transfers shrunk by a third in FY21/22; projected short-run rebound but outlook subdued and uncertain. - Absent consolidation, government would have to (i) cut spending abruptly or (ii) accumulate sizeable arrears. - Revenue performance in FY20/21: 5.3 percentage points of GDP higher than projected under the 2020 RCF/RFI. - Current expenditure fell by 3.6 percentage points of GDP relative to RCF/RFI projections. - Result: small overall balance surplus for FY20/21. - FY21/22 budget did not build on gains; sets double-digit deficits over the medium term with no concrete adjustment measures. - Arrears - Domestic arrears stock increased to LSL1.25 billion (3.4 percent of GDP) as of end-November 2021 from LSL720 million (2.1 percent of GDP) at end-March 2021. - Public spending composition and trends - Public spending rose from below 40 percent to beyond 50 percent of GDP over the last 15 years. - Share of compensation and social spending increased, squeezing capital spending and nonwage current spending. - Some current spending misclassified under capital; reclassification begun in FY22/23 budget. - Over past decade, jump of expenditure in percent of GDP increased by 4.3 percent on average (vs. 2 percent for SSA, 1.3 percent for LIDCs). - Wage bill specifics - Wage bill as percent of GDP increased from around 11.7 percent in FY05/06 to 18.4 percent in FY20/21. - Compensation rose from around 60 percent to 70 percent as a share of domestic revenue. - Lesotho has the highest public wage premium among SACU countries and the highest wage bill as percent of GDP while having the smallest number of public servants per thousand population among SACU countries. - Fiscal recommendations and consolidation approach - Move from wage-preserving nominal containment to strategic, growth-friendly, poverty-reducing, efficiency-oriented spending program. - Back consolidation with broad-based domestic revenue mobilization to reduce reliance on SACU transfers. - Assess fiscal costs against results/outcomes; avoid reliance on cash-based warrants that can lead to arrears without robust PFM mechanisms. - Targeted measures - Contain wage bill: - Public employee compensation ~20 percent of GDP or over 70 percent of domestic revenues. - Freezing public wages and sizing public employee complement for 2–3 years could reduce wage bills by 3–5 percentage points of GDP or to below 60 percent of domestic revenues. - Rationalize social spending: - Eliminate ghost OAP beneficiaries; cut tertiary bursary transfers significantly while enhancing poverty-reducing programs; potential reduction of social spending by about 2–3 percentage points of GDP while increasing poverty-reducing spending by 0.5–1 percentage point of GDP. - Improve capital spending efficiency: - Capital spending 12–15 percent of GDP; outcomes poor; enhance project selection and execution. - Combined impact: potential savings of 5–8 percentage points of GDP. - Public compensation reform (structural package) - Over 4–5 years, lower public wage bill by 3–5 percentage points of GDP and reduce from 70 percent to below 60 percent of domestic revenues. - Recommendations: a. Wage freeze with no COLA and no structural notches for 2–3 years; then half “notch” and half “COLA” for 1–2 years. b. Freeze number of public servants: close posts vacant 12+ months; freeze non-essential hiring; redeploy existing workforce; record definitions in Civil Service Establishment Policy; consider winding up Apprenticeship Program if nonessential. c. After freeze, add steps within job grades and explore performance-based compensation. d. Review and adopt new Civil Service Employment Policy. ### SOCIAL SPENDING, TARGETING, AND REPRIORITIZATION - Scale and trends - Social spending increased from 6.4 percent of GDP in FY16/17 to around 8.2 percent of GDP in FY20/21, or around 15 percent of total spending. - Tertiary Bursary Program and Old Age Pension (OAP) are largest shares: 2.64 and 2.39 percent of GDP, respectively (4.81 and 4.35 percent of total spending). - Lesotho’s social spending is twice that of neighbors as a share of GDP. - Composition (FY20/21; Units: LSL Million) - CGP: Amount 57.6; Percent of GDP 0.17; Percent of Total Spending 0.31; Percent of Total Social Spending 2.08; Coverage 22 - School feeding: Amount 187.2; Percent of GDP 0.56; Percent of Total Spending 1.01; Percent of Total Social Spending 6.75; Coverage 100 - Cash-for-work assistance: Amount 98.22; Percent of GDP 0.29; Percent of Total Spending 0.53; Percent of Total Social Spending 3.54; Coverage 20 - Public assistance: Amount 28.8; Percent of GDP 0.09; Percent of Total Spending 0.16; Percent of Total Social Spending 1.04; Coverage 6 - OVC bursary: Amount 73.5; Percent of GDP 0.22; Percent of Total Spending 0.40; Percent of Total Social Spending 2.65; Coverage 11 - Tertiary bursary: Amount 891.42; Percent of GDP 2.64; Percent of Total Spending 4.81; Percent of Total Social Spending 32.12; Coverage 4 - OAP: Amount 806.92; Percent of GDP 2.39; Percent of Total Spending 4.35; Percent of Total Social Spending 29.08; Coverage >100 - Other social spending*: Amount 631.41; Percent of GDP 1.87; Percent of Total Spending 3.40; Percent of Total Social Spending 22.75 - Total social spending: Amount 2775.08; Percent of GDP 8.23; Percent of Total Spending 14.96; Percent of Total Social Spending 100.00 - *Source: Author's calculation based on data from the authorities. - Effectiveness and regressivity - Nearly two-thirds of households benefit from at least one social program; over 80 percent of poor households are beneficiaries. - If social spending perfectly targeted, extreme poverty would be eliminated and the upper bound halved (World Bank 2021). - Tertiary Education Loan Bursary Scheme is regressive: more than 90 percent of beneficiaries non-poor; costs an estimated 1.84 percent of GDP and covers 19,500 beneficiaries. - Recommendations for social reprioritization - Eliminate ghost OAP beneficiaries: World Bank (2021) indicates around 38 percent of ineligible OAP beneficiaries; propose removing 34 percent in T=1 with 4 percent cushion, then assume 6 percent natural growth. - Link GOLSABS with NICR for program integrity. - Reduce tertiary bursary costs over time: start cuts in T+1 (e.g., FY22/23), reduce new intakes, enhance loan recovery, implement means-testing. - Expand poverty-reducing programs: double school feeding and increase public assistance, OVC bursary, and cash-for-work by 50 percent. - Simulation (percent of GDP; base and growth rates from authorities): - CGP: Base 0.16; growth rate 0.30; T+1 0.19; T+2 0.23; T+3 0.28 - School feeding: Base 0.51; growth rate 0.30; T+1 0.61; T+2 0.74; T+3 0.91 - Cash-for-work: Base 0.27; growth rate 0.15; T+1 0.28; T+2 0.31; T+3 0.33 - Public assistance: Base 0.08; growth rate 0.15; T+1 0.08; T+2 0.09; T+3 0.10 - OVC bursaries: Base 0.20; growth rate 0.15; T+1 0.21; T+2 0.23; T+3 0.25 - Total (floor): Base 1.21; growth rate 1.38; T+1 1.60; T+2 1.86 - Tertiary bursary: Base 2.71; growth rate 1.75; T+1 1.15; T+2 0.75 - OAP: Base 2.19; growth rate 0.08; T+1 1.34; T+2 1.36; T+3 1.37 - Other social spending: Base 1.72; growth rate 1.66; T+1 1.65; T+2 1.64 - Total social spending: Base 7.84; T+1 6.13; T+2 5.76; T+3 5.62 - Note: * data from authorities. ** Cleaning up ineligible beneficiaries during T+1, then assuming natural growth of 8 percent. ### CAPITAL EXPENDITURE, ASSET MANAGEMENT, AND INVESTMENT EFFICIENCY - Capital expenditure declined from peak FY11/12 of 20.2 percent of GDP (~one-third of expenditure) to 12.0 percent of GDP (~one-fifth of expenditure) by FY20/21. - Causes: declining revenues, rigid current expenditures, capacity issues in line ministries, uneven project appraisal, legacy current expenditure costs linked to donor-financed capital projects. - Assessment: capital stock relatively high as share of GDP but lower quality vs. peers. - Recommendations - Identify and halt stalled/unproductive capital projects; reclassify misclassified current spending. - Improve project appraisal, prioritization, and execution. - Compile registry of government assets to dispose of unnecessary public nonfinancial assets (e.g., reduce vehicle fleet) to raise funds. ### REVENUE COMPOSITION, VOLATILITY, AND SACU TRANSFERS - Revenue composition and dynamics - Total revenue = external transfers (grants and SACU transfers) + domestic revenues (taxes and non-tax revenues). - Share of external transfers declined from 60 percent in late 2010s to around 50 percent in recent years. - SACU transfers volatile and declining: forecast to shrink by a third in FY21/22 and remain subdued. - Lesotho’s domestic revenue mobilization is among highest in the region. - SACU transfer volatility (2007/08–2021/22) - SACU receipts: Average share of total revenue 43.6%; Average absolute contribution (ppts) 10.0. - Total revenues: Level 100.0; Average absolute contribution (ppts) 10.6. - Non-SACU receipts: Average share 56.4%; Average absolute contribution (ppts) 5.9. - Taxes on income, profits, and capital gains: Average share 21.1%; Average absolute contribution (ppts) 2.4. - Grants from international organisations: Average share 7.2%; Average absolute contribution (ppts) 2.3. - Water royalties - LHDA: Average share 5.0%; Average absolute contribution (ppts) 0.8. - Dividends: Average share 2.2%; Average absolute contribution (ppts) 1.7. - Volatility metrics (standard deviation of absolute contribution to total revenue y/y changes) - SACU transfers: 13.9 (ppts) — over four times greater than next largest (grants: 2.9 (ppts)). - Total revenues: 13.1 (ppts). - Non-SACU receipts: 6.8 (ppts). - Taxes on income, profits, and capital gains: 2.2 (ppts). - Interpretative point - With SACU transfers contributing 10.0 percentage points to revenue growth on average, absent offsets, expenditure would have to change by 10 percent from the previous year to avoid fiscal balance impact from SACU volatility alone. ### FISCAL RULES, DESIGN OPTIONS, AND RECOMMENDATIONS - Existing principles and limits - BSP and DMPF principles include: overall fiscal balance below 3 percent of GDP over medium term; control wage bill; constrain recurrent relative to capital spending; improve PFM; eliminate arrears; expand domestic revenue mobilization; golden rule for borrowing for development expenditure only. - DMPF debt ceilings: total public debt incl. guarantees 60 percent of GDP; public external debt limit 40 percent of GDP; government guarantees limit 5 percent of GDP. - Trigger levels: public debt (excl. guarantees) 50 percent of GDP; public external debt 35 percent of GDP; government guarantees 3 percent of GDP. - Performance and challenges - Since FY09/10 only one principle met each year on average; meeting multiple principles in coming years is very challenging. - Debt sustainability: public debt beyond 60 percent of GDP; present value of public debt projected to approach high-risk thresholds under current policies. - Reserves: Net international reserves would decline below 100 percent (of a DSA benchmark) and gross international reserves below 3.5 months of imports coverage under current policies. - Types of rules (overview) and suitability - Expenditure, revenue, overall balance, structural balance, and debt rules each have pros and cons; structural rules are countercyclical but data intensive; overall balance rules are linked to debt sustainability but can be procyclical given SACU volatility. - Relevance to Lesotho and proposed framework - Key country characteristics to inform rule choice: safeguard peg; SACU volatility; downward rigidity of spending (large wage bill); limited room for capital spending; weak institutional capacity; political instability. - Proposed elements: - Convert DMPF debt ceilings into fiscal rule: total public debt incl. guarantees 60 percent of GDP; public external debt limit 40 percent of GDP; government guarantees limit 5 percent of GDP. - Budget balance rule options: - Option A: Structural balance rule — overall balance excluding SACU transfers and grants as proxy structural balance. Assumptions: SACU ~14–16 percent of GDP; grants ~2–3 percent; a 3 percent overall balance consistent with trend growth. Possible target: overall balance excluding SACU and grants around negative 20 percent of GDP (to be revisited). - Option B: Overall balance rule together with an expenditure rule — limit expenditure growth to less than nominal GDP growth or limit current expenditure to a percent of GDP. - Treat arrears as an adjustor in calculating budget balance. - Numerical targets and cabinet-level measures (recommendations) - Switch wage bill target from percent of GDP to share of domestic revenue; numerical target: reduce and not exceed 60 percent of domestic revenue. - Make capital expenditure target explicit once fiscal position restored (e.g., not to fall below “core” SACU transfers). - Suggested fiscal rule framework: two fiscal rules (debt rule + Option A or B budget rule) set in PFM regulations; cabinet-level targets for government deposits with central bank, wage bill, and capital expenditure. - Roadmap for implementation - a. Develop and enact PFM fiscal rule regulations; set principles/objectives in primary legislation (PFMA Bill) but leave numerical specifics to regulations. - b. Establish monitoring, transparency, and reporting arrangements. - c. Define processes when rules are missed. - d. Ensure political buy-in. - Complementary numerical targets - Wage bill target: not to exceed 60 percent of domestic revenue. - Capital expenditure: explicit target to be set after fiscal position restored. ### MONETARY-FISCAL COORDINATION, THE PEG, AND SDR USE - Context and constraints - Small open economy with currency pegged to South African rand; exchange rate and monetary cycles driven by South Africa. - Under the CMA, all maloti issued by CBL backed by foreign exchange reserves; CBL not prohibited from acquiring domestic assets. - CBL reserve coverage of monetary aggregates (M1 plus) 130 percent as of December 2021. - Government deposits with CBL: 7 percent of GDP as of end 2021. - Effectiveness and coordination trade-offs - Monetary policy less effective; fiscal policy can directly influence aggregate demand under the peg. - Coordination failures can produce inflationary pressures, reserve losses, arrears, or excessive external borrowing. - Scenarios of coordination failure - Scenario 1: Fiscal dominance — drawing down government deposits risks inflation, reserve pressure, or arrears. - Scenario 2: Monetary dominance — central bank limits base money; government forced into external borrowing or aggressive revenue measures. - Scenario 3: Both act autonomously — inconsistent decisions risk loss of confidence, peg pressure, arrears, and stagnation. - Institutional recommendations - Debt office and macro department at MoF set public debt limits based on DSA. - CBL determines reserve level required to safeguard peg and sets ceiling on net credit to government. - Joint determination of affordable fiscal deficit and optimization of spending composition by MoF. - Formalize coordination: reinvigorate inter-Ministerial Macro Working Group; set up debt policy committee; build Macroeconomic Policy and Coordination Department capacity. - SDR allocation (August 23, 2021) - IMF allocated US$650 billion SDRs; Lesotho received about US$95 million. - Options for access: - Direct access: on-lend SDRs to government subject to Article 42 of CBL Act (limits on central bank credit to government); pros/cons include interest costs at SDR rate, exchange risk, increase in external debt. - Indirect access: retain SDR allocation on CBL balance sheet and draw down government deposits; pros/cons include avoiding interest costs and exchange risk but reducing reserves and requiring positive CBL balances. - Reserve target guidance: maintain adequate level e.g., 4 months of import cover. - Boxes and mechanics - Interaction steps: debt limits → central bank ceiling on net claims → MoF reviews spending composition → revenue mobilization → determine domestic financing → joint resource envelope. - SDR impacts: increase GIR and NIR; effect on reserve money depends on exchange regime; either reserve money increases or GIR/M1 or NIR/M1 ratios jump. ### GENDER, PANDEMIC MITIGATION, AND SOCIAL SUPPORT - Disproportionate pandemic impact on women - Of eight pandemic policies, only one explicitly applied a gender lens. - Tourism-sector MSME grant scheme: LSL50 million total; up to LSL20,000 matching grant per company in tourism sector; women make up about 76 percent of workers in accommodation and food services. - Other measures: one-off three-month salary subsidies of LSL800 to 40,000 textile workers; payments of LSL500 for registered informal-sector vendors. - Recommendations to mainstream gender - Operationalize de jure rights and regulations. - Implement social and gender responsive budgeting in PFM reform (NSDP II suggestion). - Key statistics preserved exactly - Women share in accommodation and food services: about 76 percent. - Grant scheme size: LSL50 million. - Matching grant per company: up to LSL20,000. - Salary subsidies: LSL800 to 40,000 workers. - Informal vendor payments: LSL500. - Reserve coverage (“M1 plus”): 130 percent as of December 2021. - Government deposits: 7 percent of GDP as of end 2021. - New arrears: LSL 1.25 billion (3.4 percent of GDP) as of end November 2021. - FY22/23 budget tabled in early March 2022 has large deficits over the next 3 years. ### TAXATION, MINING, TRADE, AND DIVERSIFICATION - Tax system overview - VAT: standard rate 15 percent; accounted for ~38 percent of tax revenues in past decade; VAT generated 7.7 percent of GDP; minimum registration threshold M850,000; VAT C-efficiency 0.56 in 2018. - PIT: two-rate structure 20 percent and 30 percent; non-refundable tax credit M840 per month excludes monthly gross salary ≤ M4,200; PIT contributes nearly a third of domestic tax revenue. - CIT: standard rate 25 percent; reduced rate 10 percent for manufacturing and commercial farming (including textiles). - Nontax revenue: stable at 5–6 percent of GDP; water and diamond royalties ~ three quarters of nontax revenues; diamond royalties ~21 percent of total nontax revenues. - VAT policy note - April 2022 amendment removed zero-rating for mining exports; warns of risks to VAT integrity, cascading, reduced competitiveness, and discouraged investment; alternatives suggested: import VAT deferral mechanism or targeted VAT exemptions during mining development phase. - Mining sector specific issues and recommendations - CIT and loss carry-forward: indefinite carry-forward losses allow mining companies to delay CIT; recommend time-bound loss carry-forward period (longer than ordinary activities). - Royalties: statutory 10 percent (Mines and Minerals Act 2005); FY21/22 budget proposed increase to 15 percent; in practice negotiable and sometimes as low as 4 percent. - Recommendation: strengthen royalty rates rather than introduce export tax; remove immediate expensing of capital expenditure under CIT. - Transfer pricing and capital gains: LRA needs improved expertise and transfer pricing regulations to detect tax avoidance and capital gains avoidance. - Selected mining parameters (Table 2 figures) - Government shareholding: 25% Liqhobong; 30% Letšeng; 20% Lemphane. - Royalty rate: statutory 10%; proposed 15%; in practice lower negotiated rates exist. - Corporate tax: Lesotho 25%; Botswana 22–55%; Namibia 55%. - Withholding tax on dividends: Lesotho 15%; Botswana 7.50%; Namibia 10%. - Trade and export concentration - Imports: 85 percent from South Africa; fabrics and intermediate products from China and Taiwan (~5 percent each). - Lesotho’s share in SACU customs component ~9 percent average last decade. - Exports: >80 percent textiles and diamonds; ~85 percent of exports to Belgium, South Africa, and United States (each roughly 30 percent). - Apparel accounts for ~10 percent of GDP. - Apparel exports declined from $485 million in 2018 to $385 million in 2020. - Letšeng mine: 115,335 carats in 2021 (versus 100,780 in 2020); average price $1,835 per carat in 2021 (4 percent lower than 2020). - Mothae mine expanded processing capacity by 45 percent in 2021. - LHWP: transfers about 900 million cubic meters annually; generates 72-MW hydropower at Muela; annual water royalties averaged LSL950 million over last five fiscal years (2.8 percent of GDP). - Risks and diversification - Export product count fell from ~960 in 2010 to ~700 (SACU average 2,500). - Import-export market concentration: ~30–40 markets vs. SACU average 80 (excluding South Africa). - AGOA expiry risk (2025) and past AGOA shocks noted; US tariff savings from AGOA estimated >$70 million. - Policy direction: diversify products and markets; leverage AfCFTA to access African apparel markets (e.g., Angola, Nigeria, Senegal, Togo). *Source: ADDRESSING LESOTHO’S CLIMATE AND ENVIRONMENTAL CHALLENGES and IMF country report excerpts (1lsoea2022003).* ### References ________________________________________________________________________________ 9 ### ADDRESSING LESOTHO’S CLIMATE AND ENVIRONMENTAL CHALLENGES ### A. Exposure, impacts, and structural consequences - Lesotho is highly exposed to recurrent natural disasters, particularly droughts, floods, and storms; frequency and severity have increased significantly in the past decade. - Over two-thirds of the population depend on rain-fed subsistence agriculture; the share of the population directly exposed to natural disasters ranks fourth among sub-Saharan Africa (SSA) countries. - Fiscal and macro-financial impacts of disasters: - Cost of disaster relief for the El Niño–induced drought in FY15/16: US$38 million (LSL584 million, 1.7 percent of GDP). - Cost of disaster relief for the floods in FY10/11: US$67 million (LSL462.7 million, 3.2 percent of GDP). - Average annual cost of disaster relief: about US$19.3 million (1 percent of GDP in FY19/20), mostly borne by the government with limited donor support. - Environmental degradation and land impacts: - Only 12 percent of the country’s land is arable. - Estimated soil loss: 40 million tons annually (about 2 percent of its topsoil). - About 66 percent of households live on degraded land. - The value of annual depletion of natural resources (soil and related habitats) is estimated at around 4.6 percent of gross national income. - Land access and use laws and practices deter long-term investment in irrigation, conservation, and soil improvements; the formal property market is largely undeveloped, contributing to sub-optimal farming practices and lock-in of the rural sector into poverty. ### B. Existing institutions and policies - Institutions and policy milestones: - Disaster Management Authority (DMA) established under the Disaster Management Act of 1997. - National Adaptation Programme of Action prepared in 2007 in compliance with UNFCCC guidelines. - National Resilience Strategic Framework (NRSF) approved by the Cabinet in 2019. - Current interventions include tree planting, land reclamation, protection of wetlands and biodiversity, conservation programs, and some horticulture improvements (new technologies and linkages from farm to market). - Evidence indicates considerably greater effort is needed to mitigate physical and transition risks related to climate and soil degradation. ### C. Rationale for adaptation and green transition - Lesotho is not a significant greenhouse gas emitter but is vulnerable to global warming impacts; COP26 framed an imperative for transitioning to less carbon-intensive economies. - Up-front investment in climate-resilient infrastructure yields long-term savings by reducing disaster-relief spending and lowering the impact of climate shocks on public debt. - Successful country examples cited: - Mozambique’s infrastructure upgrade in the port of Beira. - Kenya’s investment in renewable solar energy. - Non-infrastructure adaptation measures often have high benefit-to-cost ratios and can be implemented more quickly (examples: improved seeds and crop-protection measures, improved irrigation and water retention, early warning systems, and targeted social assistance). ### D. Costs, financing, and fiscal implications - Adaptation and mitigation actions require frontloaded investment and financing, which necessitates creating additional fiscal space through revenue mobilization and expenditure restraint. - Government bears most disaster relief costs; participation in regional risk-pooling or insurance mechanisms could reduce fiscal burden. ### E. Policy recommendations to address climate challenges - Maintain fiscal buffers to provide disaster relief: - Prioritize Disaster Management Fund resources and strengthen its disbursement mechanism to ensure timely distribution. - Consider participation in regional macroeconomic insurance schemes such as the African Risk Capacity. - Ensure better allocation and targeting of social programs to direct limited resources most effectively to vulnerable populations. - Implement climate-smart agriculture and improve access to finance: - Invest in adaptation strategies such as drought-tolerant crops, irrigation infrastructure, and sustainable land management to reduce productivity losses and fight poverty. - Promote penetration of agricultural and disaster insurance to de-risk vulnerable communities and improve their access to finance. - Pursue win-win policies that minimize emissions while addressing urban pollution and promoting solar energy and other cost-effective technologies amid rising fuel and gas prices. *Source: ADDRESSING LESOTHO’S CLIMATE AND ENVIRONMENTAL CHALLENGES (excerpts) — IMF country report content provided.* ### 10. International funds should be mobilized for both disaster relief and building climate ### 10. International funds should be mobilized for both disaster relief and building climate resilience ### International support for disaster relief and climate resilience - The international community can assist the authorities’ efforts by expanding financial support and technical assistance beyond disaster relief to target climate resilience and bolster coping mechanisms. - Currently, there are several donor-funded climate projects being implemented in Lesotho, for example, some donor-funded projects on adaptation and renewable energy (EU, GEF, MCC, UNDP, and World Bank). - Coordination of efforts and the government’s cooperation are critical for their effectiveness. ### Key findings on financial inclusion: progress and challenges - Lesotho is making significant efforts to increase financial inclusion but substantial challenges remain. - The rapid growth of mobile money is an important recent success: active accounts have increased by about four and half times since 2015, improving access for previously excluded parts of the populations, such as the rural poor. - By 2021, adults with access to more than one formal financial product increased by 40 percent from 2011. - The Central Bank of Lesotho (CBL) recently issued pricing directives to alleviate financial transactions costs. - Lesotho underperforms on key dimensions of financial development and inclusion relative to peers. Only about 10 percent of households who borrow do so from a financial institution. - Fewer MSMEs have access to credit in Lesotho than in neighbor SACU member states. - The banking sector is well-capitalized, highly liquid, and largely foreign-owned, but its contribution to private sector credit remains limited: - Deposits to GDP are comparable to peers at 30 percent, but only about half goes to the private sector as credit. - Only about a third of domestic credit goes to businesses, much lower than in peers. - MSMEs face specific constraints: - Often lack adequate financial statements and business plans. - Lenders’ ability to use collateral is limited by the current legal framework. - Difficulty obtaining documentation (business registration, licenses, tax clearance) leads some MSMEs to take more expensive consumer loans. - Weak credit infrastructure and information gaps particularly limit access for rural and non-salaried households. - Households’ access to finance remains limited: - Lenders prefer salaried workers, mainly civil servants, using deduction at source from paychecks to manage risk. - Data suggest about half of all mortgage loans are to civil servants, who account for only 4 percent of the labor force. - Findex 2017 data indicate many rely on family and friends to borrow and a minority who save do so through a financial institution. - Lack of documentation, distance to provider, and high costs are important reasons for not being able to open a bank account. - Agriculture is an important income source and subject to high variability due to periodic droughts; smallholder agricultural insurance has only recently started and surveys suggest high demand. - Microfinance institutions (MFIs) and financial cooperatives limitations and risks: - The small MFI sector holds about 5 percent of the assets of the banking sector and lends almost entirely to households—often salaried workers—raising indebtedness concerns. - Financial cooperatives are growing rapidly, outpacing the supervisory capacity of the central bank. - Some large cooperatives, such as Boliba, remain in regulatory limbo, raising governance concerns. - Progress on the Financial Cooperatives Bill, which would improve MSBDCM’s supervisory powers, has stalled. - Mobile money expansion and usage details: - Usage has increased rapidly, with mobile money accounts more than doubling since 2017. - 2.2 million mobile money accounts were registered as of year-end 2020, of which 882,000 were 30-days active (40 percent) and 920,000 were 90-days active (42 percent). - Active accounts equate to around two-thirds of the adult population of 1.4 million. - Two-thirds of Basotho do not use the internet regularly. - There are five mobile money issuers; Vodacom dominates with an 87 percent market share. - Digital lending is in its infancy partly due to the lengthy licensing process for Fintech companies. - Remittances: - The increasing use of mobile money for domestic remittances has led to a decline in informal services for cross-border remittances. - FinMark Trust estimates informal remittances declined from 54 percent in 2016 to 30 percent in 2018. ### Policy recommendations to increase financial inclusion - Strengthen digital payments and consumer protection: - CBL is revising the National Payments Act and improving the regulatory framework to increase consumer protection and planning upgrades to improve interoperability across service providers. - Monitor whether anti-competitive practices hinder interoperability. - Reduce the cost of meeting documentation requirements while maintaining protections; utilize the national ID for consumer verification (authorities are piloting this). - Consider a risk-based and tiered approach to banking agent licensing. - Specific measures to foster digital financial services: - (i) submit the National Payments Systems Bill to Parliament and implement associated regulations; - (ii) implement the Government Payment Gateway; - (iii) implement the National Switch and the associated common data standards and protocols; - (iv) implement the National Identification Act; - (v) update the Data Protection Act in line with international good practices, and revise and resubmit the draft Computer Crime and Cybersecurity Bill; - (vi) adopt simplified customer due diligence requirements; - (vii) harmonize Financial Agency requirements; and - (viii) adopt Financial Consumer Protection regulations. - Reduce cross-border remittance costs through international coordination: - Greater integration of regional payment systems and expanding usage of existing facilities such as SIRESS to low-value payments. - Coordinate with South African and regional authorities to streamline regulations and increase the number of providers. - Enhance consumer protection and financial literacy: - Passage of the Financial Consumer Protection Bill and capacitating the newly-created Consumer Protection Unit are key first steps. - Speed passage of the Financial Cooperatives Bill to ensure adequate coverage for customers of financial cooperatives. - Monitor and address over-indebtedness: - CBL should expand the coverage of the credit bureau and consider integrating information from Treasury’s payroll system to enhance monitoring of overindebted individuals. - Carefully monitor lending practices and issue warnings and penalties as needed. - Improve MSME access to finance by creating an enabling environment: - Improve credit infrastructure and enhance the partial credit guarantee scheme. - Support development of capital markets. - Complete the collateral property register. - Broaden coverage and scope of the Credit Reporting Act. - Implement the Insolvency Act by developing regulations with detailed provisions for practitioners. - Include businesses in the credit bureau and consider creating credit scores for individuals to facilitate lending to MSMEs. - Review required documentation for business loans to facilitate access while managing risks. - Note: benefits from improving the lending environment will be limited without concurrent pro-growth and stable business environment reforms and elimination of government payment arrears. - Increase project bankability and private-sector-led project selection: - Provide training on business development and preparing financial statements. - Review the two existing partial credit guarantee schemes (LNDC and MSBDCM) to eliminate overlaps and align designs with international best practices, ensuring the private sector leads project selection. ### Fiscal pressures and public spending analysis - Fiscal outlook: - The fiscal outlook remains challenging and absent upfront consolidation the external position will continue to deteriorate. - SACU transfers shrunk by a third in FY21/22 and though they are projected to rebound in the short run, the outlook remains subdued and characterized by uncertainty. - In the absence of consolidation, the government would be forced to either (i) cut spending abruptly or (ii) accumulate sizeable arrears. - Recent fiscal performance: - Revenue performance in FY20/21 was 5.3 percentage points of GDP higher than projected under the 2020 RCF/RFI. - Current expenditure fell by 3.6 percentage points of GDP relative to RCF/RFI projections. - The result was a small overall balance surplus for FY20/21. - FY21/22 budget did not build on these gains, setting out double-digit deficits over the medium term with no concrete adjustment measures. - Domestic payments arrears: - Stock of arrears increased to LSL1.25 billion (3.4 percent of GDP) as of end-November 2021 from LSL720 million (2.1 percent of GDP) at end-March 2021. - Composition and trends in public spending: - Public spending in percent of GDP increased from below 40 percent to beyond 50 percent over the last 15 years. - The share of compensation of public employees and social spending has been increasing, squeezing capital spending and other nonwage current spending. - Some current spending is incorrectly recorded under the capital budget; reclassification of current spending under the capital budget has begun in the FY22/23 budget. - Over the past decade, the jump of expenditure in percent of GDP has increased by 4.3 percent on average, compared to 2 percent for sub-Saharan Africa (SSA), and 1.3 percent for LIDCs. - Public wage bill specifics: - The wage bill as a percent of GDP has increased from around 11.7 percent in FY05/06 to 18.4 percent in FY20/21. - Compensation increased from around 60 percent to 70 percent as a share of domestic revenue. - Lesotho has the highest public wage premium among SACU countries. - Lesotho has the highest wage bill as a percent of GDP while the number of public servants per thousand of population are the smallest among SACU countries, implying the average wage for Basotho public servants would be very high relative to other SACU countries. - Recommended fiscal approach: - Move from a wage-preserving nominal spending containment approach to a strategic, growth-friendly, poverty-reducing, and efficiency-oriented spending program. - Back domestic consolidation with broad-based domestic revenue mobilization efforts that weans the economy off external SACU transfers. - Assess fiscal costs alongside intended results/outcomes, such as social and economic objectives and provision of high-quality public goods and services. - Avoid reliance on cash-based warrants that can restrict spending but also lead to arrears without robust PFM mechanisms and a depoliticized budget. *International Monetary Fund — Kingdom of Lesotho material excerpt* ### 8. Social spending has been increasing over the past five years, from 6.4 percent of GDP in ### 8. Social spending has been increasing over the past five years, from 6.4 percent of GDP in ### Social spending trends and scale - Social spending increased from 6.4 percent of GDP in FY16/17 to around 8.2 percent of GDP in FY20/21, or around 15 percent of total spending. - Budget transfers to Tertiary Bursary Program and Old Age Pension (OAP) account for the largest shares: 2.64 and 2.39 percent of GDP, respectively, or 4.81 and 4.35 percent of total spending, respectively. - Lesotho social spending ranks among the highest within the region and is twice that of its neighbors on social protection spending as a share of GDP. ### Composition and coverage of social protection spending (FY20/21) — Units: LSL Million - CGP: Amount 57.6; Percent of GDP 0.17; Percent of Total Spending 0.31; Percent of Total Social Spending 2.08; Coverage 22 - School feeding: Amount 187.2; Percent of GDP 0.56; Percent of Total Spending 1.01; Percent of Total Social Spending 6.75; Coverage 100 - Cash-for-work assistance: Amount 98.22; Percent of GDP 0.29; Percent of Total Spending 0.53; Percent of Total Social Spending 3.54; Coverage 20 - Public assistance: Amount 28.8; Percent of GDP 0.09; Percent of Total Spending 0.16; Percent of Total Social Spending 1.04; Coverage 6 - OVC bursary: Amount 73.5; Percent of GDP 0.22; Percent of Total Spending 0.40; Percent of Total Social Spending 2.65; Coverage 11 - Tertiary bursary: Amount 891.42; Percent of GDP 2.64; Percent of Total Spending 4.81; Percent of Total Social Spending 32.12; Coverage 4 - OAP: Amount 806.92; Percent of GDP 2.39; Percent of Total Spending 4.35; Percent of Total Social Spending 29.08; Coverage >100 - Other social spending* (Mainly employer social benefits): Amount 631.41; Percent of GDP 1.87; Percent of Total Spending 3.40; Percent of Total Social Spending 22.75 - Total social spending: Amount 2775.08; Percent of GDP 8.23; Percent of Total Spending 14.96; Percent of Total Social Spending 100.00 *Sources: Author's calculation based on the data from the authorities.* ### Capital expenditure and public investment - Capital expenditure declined from a peak in FY11/12 of 20.2 percent of GDP and around a third of expenditure, to 12.0 percent of GDP and around a fifth of expenditure by FY20/21. - Causes: declining overall revenues, rigid current expenditures, capacity issues in line ministries slowing development of ‘bankable’ projects, uneven quality of project appraisal, and legacy current expenditure costs associated with some donor-financed capital projects. - Assessment: capital stock is relatively high as a share of GDP but of lower quality compared to peers; need to identify and minimize stalled projects and misclassified current spending, and improve investment appraisal and execution. ### Revenue composition and dynamics - Total revenue comprises external transfers (grants and SACU transfers) and domestic revenues (taxes and non-tax revenues). - The share of external transfers declined from 60 percent in late 2010s to around 50 percent in recent years. - SACU transfers have been volatile and are declining: forecasted to shrink by a third in FY21/22 and remain subdued thereafter. - Lesotho’s domestic revenue mobilization has performed well; domestic revenue in percent of GDP is among the highest in the region. ### Fiscal balance, debt, and financing risks - Lesotho has experienced chronically large fiscal deficits and a growing debt burden, beyond 60 percent of GDP. - Under current policies, IMF–World Bank Joint Debt Sustainability Analysis (DSA) shows the present value of public debt would rapidly approach thresholds that signal high risk of debt stress. - Net international reserves would decline to below 100 percent (of a specified benchmark in the DSA), and gross international reserves would fall below 3.5 months of imports coverage. - Downward rigidity in spending when SACU transfers fall has increased total spending as a percent of GDP and deteriorated the deficit excluding SACU transfers. ### Policy recommendations — overall approach - Fiscal consolidation is crucial to reduce imbalances, rebuild fiscal space to protect the vulnerable, finance the recovery, and mitigate external shocks. - Given already high revenue ratio (highest among SACU countries), expenditure must bear the brunt of adjustment. - Authorities should contain current spending, scale back unproductive capital spending, and improve efficiency to ensure fiscal sustainability and preserve the exchange rate peg. - The risk of overly ambitious revenue projections and high expenditure jeopardizes fiscal sustainability and resources needed to sustain the exchange rate peg. ### Targeted fiscal measures recommended - Contain the wage bill: - Public employee compensation accounts for around 20 percent of GDP or over 70 percent of domestic revenues. - Freezing the public wage and sizing the public employee complement for 2–3 years can reduce wage bills by 3–5 percentage points of GDP or to below 60 percent of domestic revenues. - Rationalize social spending: - Eliminate ghost OAP beneficiaries and significantly cut budget transfers to tertiary bursary program while enhancing poverty-reducing social programs; could reduce social spending by about 2–3 percentage points of GDP while increasing poverty-reducing spending by 0.5–1 percentage point of GDP. - Improve capital spending efficiency: - Lesotho’s capital spending accounts for 12–15 percent of GDP, higher than neighbors, but outcomes are poor; enhance project selection and there is some room for cutting. - Combined impact: the above measures could save spending by 5–8 percentage points of GDP. ### Public compensation reform package (structural reforms) - Over 4 to 5 years, public wage bill in percent of GDP could be lowered by 3–5 percentage points and from 70 percent to below 60 percent of domestic revenues. - Recommended measures: a. Implement a wage freeze with no cost-of-living-adjustments ("COLA") and no structural wage increases ("notches") for 2 to 3 years and then half “notch” and half “COLA” for 1 to 2 years. b. Freeze the number of public services: close positions vacant for 12 months or more; freeze hiring of non-essential public servants; fill existing posts by re-deploying existing workforce; record definitions in Civil Service Establishment Policy and publish online; consider winding up the Apprenticeship Program if deemed nonessential. c. After 2–3 years of freeze, add steps within job grades and reduce associated pay increases; explore performance-based compensation. d. Review and adopt a new Civil Service Employment Policy to maintain a lean, professional, and efficient civil service. ### Social spending reprioritization and targeting - Eliminate false payments to “ghost” pensioners under OAP: - World Bank study (World Bank 2021) indicates around 38 percent of ineligible OAP beneficiaries. - Proposal: clean up ineligible beneficiaries by removing 34 percent with 4 percent as cushion during year T=1, then assume 6 percent natural growth of the program. - Link GOLSABS with the National Identity and Civil Registry (NICR) via secure data exchange to ensure program integrity. - Reduce tertiary bursary scheme cost over time: - Start cuts in T+1 (e.g., FY22/23) by reducing intake of new students; enhance collection of outstanding student loans and improve targeting via means-testing. - Increase spending on key poverty-reducing programs: - Double school feeding program and increase public assistance, OVC bursary and cash-for-work programs by fifty percent to expand coverage and adequacy. - Simulation results (Table 2, in LSL millions; base and growth rates from authorities): - Poverty-related social programs to be enhanced (Percent of GDP shown in table): - CGP: Base 0.16; growth rate 0.30; T+1 0.19; T+2 0.23; T+3 0.28 - School feeding: Base 0.51; growth rate 0.30; T+1 0.61; T+2 0.74; T+3 0.91 - Cash-for-work assistance: Base 0.27; growth rate 0.15; T+1 0.28; T+2 0.31; T+3 0.33 - Public assistance: Base 0.08; growth rate 0.15; T+1 0.08; T+2 0.09; T+3 0.10 - OVC bursaries: Base 0.20; growth rate 0.15; T+1 0.21; T+2 0.23; T+3 0.25 - Total (floor): Base 1.21; growth rate 1.38; T+1 1.60; T+2 1.86 - Programs to be contained: - Tertiary bursary: Base 2.71; growth rate 1.75; T+1 1.15; T+2 0.75 - OAP: Base 2.19; growth rate 0.08; T+1 1.34; T+2 1.36; T+3 1.37 - Programs to be maintained: - Other social spending: Base 1.72; growth rate 1.66; T+1 1.65; T+2 1.64 - Total social spending (Percent of GDP): Base 7.84; T+1 6.13; T+2 5.76; T+3 5.62 - Note: * data are from the authorities. ** Cleaning up inellible beneficareis druing t+1, and then as s uming natrual growth of 8 percent. ### Capital budget reforms and asset management - Urgent need to strip out misallocated and unproductive capital spending by identifying and eliminating unproductive projects and temporarily halting stalled projects. - Improve investment planning and execution: project appraisal, prioritization, and removal of current expenditure misclassified as capital spending. - Potential savings can be redeployed to build climate-resilient infrastructure. - Compile a registry of government assets to identify and dispose of unnecessary public nonfinancial assets (e.g., reduce government vehicle fleet) to raise funds and reduce costs. ### Growth implications and revenue mobilization - Fiscal consolidation focusing on scaling back less-productive expenditure while prioritizing efficient, well-targeted spending and growth-friendly investment could be growth friendly and mitigate risks to growth. - Domestic revenue mobilization can support adjustment: - Opportunities include (i) introducing excises on alcohol and tobacco; (ii) introducing cashless tax collection systems to improve tax administration efficiency; and (iii) improving compliance by enhancing transparency and audit. - It is vital to maintain the integrity of existing taxes, notably the VAT. *Source: Author's calculation based on the data from the authorities.* ### 6. SACU transfers are the main driver of overall revenue volatility. Grants are also a ### 1lsoea2022003 - 6. SACU transfers are the main driver of overall revenue volatility. Grants are also a ### Revenue volatility: contributions and measures - Over the past 15 years (2007/08 to 2021/22, July 2021 forecast) two measures of variability by source of revenue are presented: - Average absolute contribution to total revenue year-over-year (y/y) change. - SACU receipts: Average share of total revenue 43.6%; Average absolute contribution (ppts) 10.0. - Total revenues: Level 100.0; Average absolute contribution (ppts) 10.6. - Non-SACU receipts: Average share of total revenue 56.4%; Average absolute contribution (ppts) 5.9. - Taxes on income, profits, and capital gains: Average share 21.1%; Average absolute contribution (ppts) 2.4. - General Taxes on Goods and Services: Average share 13.9%; Average absolute contribution (ppts) 1.5. - Grants: From international organisations: Average share 7.2%; Average absolute contribution (ppts) 2.3. - Water Royalities - LHDA: Average share 5.0%; Average absolute contribution (ppts) 0.8. - Rent: Average share 2.3%; Average absolute contribution (ppts) 0.9. - Dividends: Average share 2.2%; Average absolute contribution (ppts) 1.7. - Excise taxes: Average share 1.9%; Average absolute contribution (ppts) 0.6. - Grants: From foreign governments: Average share 1.1%; Average absolute contribution (ppts) 0.6. - Electricity 'Muela: Average share 0.5%; Average absolute contribution (ppts) 0.2. - Other revenues: Average share 1.2; Average absolute contribution n/a. - Standard deviation of the absolute contribution to total revenue y/y changes (volatility of contributions). - The variability (standard deviation) of the contribution of SACU transfers to overall revenue volatility is 13.9 (ppts) and is over four times greater than the revenue item with the second largest variability (grants, standard deviation 2.9 (ppts)). - Total revenues: Standard deviation of growth contribution 13.1 (ppts). - Non-SACU receipts: Standard deviation of growth contribution 6.8 (ppts). - Taxes on income, profits, and capital gains: Standard deviation 2.2 (ppts). - Grants: From international organisations: Standard deviation 2.9 (ppts). - Dividends: Standard deviation 2.4 (ppts). - Other listed items: standard deviations as presented in Table 1. - Key interpretative point: - "SACU transfers contribute to growth four times more than the next largest revenue source (taxes on income, profits, and capital gains). With SACU transfers contributing 10.0 percentage points to revenue growth on average, all else equal, expenditure would have to rise or fall by 10 percent from the previous year to avoid any impact on the fiscal balance due to SACU transfers’ volatility alone." ### Expenditure rigidity, composition, and fiscal outcomes - Wage spending: - Wage spending is the largest component of both current spending (45 percent) and overall spending (30 percent). - Wage spending has been on an increasing trend over time. - Political economy: "Given the politicization of civil service employment, wages tend to be a protected spending item, with unsuccessful efforts to rein them in over time." - Impact on composition: - When revenue constraints bind (for example, due to a dip in SACU revenues), other items—typically capital spending—are cut. - The share of capital spending in total spending has been on a declining trend since FY12/13. - Fiscal balance and debt dynamics: - "With little adjustment in spending, the pattern of the overall fiscal balance is heavily impacted by volatile SACU transfers, with debt drifting upwards over time." - Example: "The overall balance in FY19/20 was still deteriorating while SACU transfers recovered." - Debt levels: "Total public and external debt have been increasing over the past decade, reaching close to 60 percent and 50 percent of GDP, and projected to go beyond them in the next few years, respectively." ### Existing fiscal principles and targets in Lesotho (BSP and DMPF) - Fiscal principles and targets (as specified in the Budget Strategy Paper (BSP) and Debt Management Policy Framework (DMPF)): - (i) Overall budget: "Adopt a Budget that is affordable, sustainable, and yet responsive to the needs of the country over the medium-term." (BSP) - (ii.a) Overall fiscal balance: "Over the medium-term, bring the overall fiscal deficit to below 3 percent of GDP consistent with long-term GDP growth." (BSP) - (ii.b) Wage bill: "The Government’s expenditure on wage bill should not be seen growing as a percentage of Gross Domestic Product (GDP) and must be reduced over the medium term alongside measures to streamline the civil service." (BSP) - (ii.c) Ratio of recurrent to capital spending: "Consistently constraining the Government’s recurrent expenditure not to grow more than development expenditure." (BSP) - (iii) Public financial management: "Improve monitoring, transparency, and accountability mechanisms to ensure expenditure efficiency." (BSP) - (iv) Arrears: "Prioritize the elimination and curtailment of accumulation of arrears." (BSP) - (v) Domestic revenue mobilization: "Expand domestic revenue mobilization to reduce reliance on volatile and shrinking transfers from SACU." (BSP) - (vi) Golden rule: "Over the medium term, the Government’s borrowings shall be used only for the purpose of financing development expenditure and not for recurrent expenditure." (BSP) - Safeguard the peg: "Adopt a Budget that is affordable, sustainable, and yet responsive to the needs of the country over the medium-term." (BSP) - Debt limit (DMPF): "The ceilings on total public debt, including guarantees, will be 60 percent of GDP and public external debt will be limited to 40 percent of GDP. Government guarantees will be subjected to an overall limit of 5 percent of GDP." - Trigger levels to initiate fiscal adjustment when breached: - Public debt (excluding guarantees): 50 percent of GDP. - Public external debt: 35 percent of GDP. - Government guarantees: 3 percent of GDP. - Performance and challenges: - "Since FY09/10, only one of these principles have been met each year (Table 3). Under the authorities’ current forward-looking medium-term fiscal framework, it would be very challenging to meet any of these principles in the coming three years." - On the wage bill rule (ii.b): - Between FY09/10 to FY20/21, the rule would have been met five times and missed seven times. - In the FY22/23 Budget, it will be met once and missed twice over FY21/22-FY24/25. - Critique: Expressing the rule in terms of GDP could be pro-cyclical and undermine fiscal sustainability. - On the recurrent vs. capital spending rule (ii.c): - Between FY09/10 and FY20/21, principle adhered to six times and missed six times. - Over FY21/22–FY24/25, the principle will be met twice and missed once. - The extent of misses has led to capital expenditure falling sharply as a share of total expenditure in some years. - On the golden rule (vi): - "This principle has been met comfortably in every year between FY09/10 and FY20/21, given the large SACU transfers. But it is projected to be met over the period FY21/22–FY24/25." - On the deficit rule (ii.a) and debt sustainability: - Lesotho is committed (as a member of the SADC) to a public debt convergence criterion of 60 percent of GDP. - "The latest IMF WEO forecast for the next five years points to nominal growth recovering to around 5 percent a year, which is consistent with 3 percent of deficit. On this basis, a deficit limit of 3 percent of GDP is consistent with stabilizing public debt at 60 percent of GDP over the medium term (since 3/60=0.05)." - Caveat: "However, the size and volatility of SACU transfers presents problems for a simple overall balance-based fiscal rule (see Section E)." - Legal and institutional notes: - DMPF sets debt ceilings and trigger levels; older legislated limits still in force from the 1967 Loans & Guarantees Act and subsequent Amendments place a high limit on debt by stating it must not exceed the past three years’ recurrent revenues. - BSP does not set out escape clauses or how quickly deviations should be addressed; draft PFM Bill incorporates a section on deviations from targets. ### Types of fiscal rules and applicability to Lesotho - Overview of rule types (definitions, examples, pros and cons) as presented: - Expenditure rules: - Definition: Limit total, primary, or current spending by ceiling on growth or percent of GDP. - Examples: Namibia: public expenditure levels below 33 percent of GDP; Peru: real growth of current expenditure ceiling of 4 percent. - Pros: Clear operational guidance; steer size of government; allows economic stabilization; relatively easy to communicate and monitor. - Cons: Not directly linked to debt sustainability; could lead to unintended shifts in spending composition; may not constrain revenue side. - Revenue rules: - Definition: Set ceilings or floors on revenues or determine use of windfall revenues. - Examples: Kenya: maintain revenues at 21-22 percent of GDP; France: determine ex ante allocation of higher-than-expected tax revenues. - Pros: Can improve revenue performance; steer government size; clear operational guidance; easy to communicate and monitor. - Cons: Not directly linked to debt sustainability; can be pro-cyclical; do not account for automatic revenue stabilizers. - Overall balance rules: - Definition: Constrain the size of the deficit and thereby control the evolution of the debt ratio. - Examples: Indonesia, Israel: overall deficit ceiling of 3 percent of GDP. - Pros: Clear operational guidance; allow for economic stabilization; easy to communicate and monitor; closely linked to debt sustainability. - Cons: Could be procyclical; headline balance affected by developments outside government control. - Structural balance rule (including over-the-cycle and golden-rule variants): - Definition: Account for the business cycle and set structural budget balance targets. - Examples: Sweden: surplus of 1 percent of GDP over the cycle. - Pros: Countercyclical; linked to debt sustainability. - Cons: Require estimation of structural balance; need significant data and knowhow; harder to communicate and monitor. - Variants and notes: - Over-the-cycle balance rule: average target over the cycle; stronger stabilization but requires precise dating of the cycle. - Investment-based "golden rule": overall balance net of capital expenditure; allows borrowing for investment only; risks from weak public investment management and creative accounting. - Pay-as-you-go rules: procedural offsets for deficit-raising measures; not counted as numerical fiscal rules in IMF dataset. - Debt rules: - Definition: Set explicit limit or target for public debt in percent of GDP. - Examples: Liberia, Poland: debt ceiling of 60 percent of GDP; Kosovo: debt ceiling of 40 percent of GDP. - Pros: Directly linked to debt sustainability; easy to communicate and monitor. - Cons: Limited short-term operational guidance; can be met via temporary measures; can be procyclical; debt affected by external developments. - Relevance to Lesotho: - Structural/cyclically-adjusted rules may be more suitable for countries subject to large external shocks (such as SACU transfer volatility), but require significant data and capacity. - Overall balance-based rules face challenges given SACU volatility and spending rigidities. *Source: IMF staff analysis and data as presented in the supplied chapter content.* ### 17. During the past two decades, a growing number of countries across the world have ### 1lsoea2022003 - 17. During the past two decades, a growing number of countries across the world have ### Global adoption trends and scope - As of end-2021, about 105 economies have adopted at least one fiscal rule, 11 countries more than the last update in 2015 and 96 countries more than 1985, the beginning of the database period (Davoodi and others 2022). - Advanced countries were frontrunners on the adoption of fiscal rules, but they are increasingly common in emerging market and developing economies especially since the late 2000s. - As of end 2021, the number of EMDEs with fiscal rules were more than double the number of advanced economies. - The expansion in rules came in waves, often after large shocks and with the inclusion of supranational rules. - The fiscal rule dataset contains 106 economies comprising four main types of fiscal rules: expenditure rules, revenue rules, budget balance rules, and debt rules. - The fiscal council dataset covers more than 50 fiscal councils on a de-jure basis and describes their mandates, structure, and operational independence. ### Average number and regional patterns - Countries had an average of about three fiscal rules in 2021 up from about 2 in the early 2000s. - The increase in the average number of rules has been more pronounced in Europe, where many countries adopted national rules along with supranational rules in the European Union. - Use of multiple rules was motivated by the need to achieve multiple fiscal objectives and constrain different budget aggregates, but multiple rules increase complexity and can make compliance harder to explain and monitor. ### Common combinations and rule types - About 60 percent of countries with fiscal rules have a debt rule combined with operational limits on annual budget aggregates. - Out of the 105 economies with fiscal rules in 2021: - One-third had a debt rule together with a deficit limit and an expenditure ceiling. - Another quarter had a debt rule combined with a budget balance rule. - Expenditure rules are increasingly common, often set as a ceiling on annual expenditure growth. - Revenue rules have been less used; when used they are often: - Set as a ceiling on revenue-to-GDP ratio in advanced countries (Belgium, Denmark) to avoid further tax hikes. - Set as a floor in low-income countries (such as the WAEMU) to encourage greater revenue mobilization. - Differences across income groups: - About three-quarters of advanced economies have expenditure rules. - Less than a third of emerging markets and developing economies have expenditure rules (examples: Brazil, Mongolia, Paraguay). - Over 80 percent of EMDEs have adopted debt rules. - About 10 percent of national debt rules use an anchor concept rather than a hard ceiling (Finland, Australia, United Kingdom). - Most debt rules are expressed in percent of GDP; for low income developing countries some debt rules are set in net present value terms. - Budget balance rules accounting for business cycles are more predominant in advanced economies (Czech Republic, Estonia) than in emerging markets (Chile, Colombia). ### Institutional framework, legal basis, and enforcement - Fiscal rules are increasingly supported by institutional arrangements to improve flexibility, enforcement, and monitoring. - Fiscal rules can be supported by fiscal responsibility laws (FRLs) and independent bodies (e.g., fiscal councils). - In 2000, only 30 percent of countries established fiscal rules in the legislation; by 2021 more than 60 countries have fiscal rules featured at or above statutory levels. - As of 2021, over 40 percent of fiscal rules were supported by fiscal responsibility laws, doubled from a decade ago. - The desirable legislative support depends on country-specific circumstances: higher-level legislation tends to confer stability but does not guarantee effectiveness if enforcement mechanisms are weak. - Escape clauses: - Should include (i) a very limited range of factors that allow such escape clauses to be triggered in legislation, (ii) clear guidelines on interpretation and determination of events (including voting rules), and (iii) specification on the path back to the rule and treatment of accumulated deviations. - Formal escape clause provisions exist for budget balance (and debt rules) in Brazil, Colombia, Germany, Mauritius, Mexico, Jamaica, Panama, Peru, Romania, Slovakia, Spain, and Switzerland. - Typical triggers: recession or significant growth slowdown; other triggers include natural disaster and banking system bailout (country-specific). - Formal enforcement examples: - Automatic corrections of ex post deviations (correction mechanisms) can raise credibility when specified clearly and anchored in legislation; political will remains decisive. ### Examples of correction mechanisms (summarized) - Switzerland and Germany: structural budget balance “debt brakes” with notional accounts and thresholds (Germany thresholds: 1.0 percent of GDP per ordinary law and 1.5 percent per constitution; Switzerland threshold: 6 percent of expenditure). Differences include treatment of projection errors and correction timing. - Poland and Slovakia: 60 percent debt-to-GDP ceiling with intermediate triggers (Slovakia: 50 percent—clarification and measures; 53 percent—cabinet package to trim debt and freeze wages; 55 percent—expenditures cut automatically by 3 percent and expenditure freeze for next year except EU co-financing; 57 percent—cabinet submits a balanced budget). - United States: sequesters as automatic spending cuts (one-time adjustment in 2013 example) with downside bias against capital spending. - Kenya: Minister of Finance must submit a compliance report to National Assembly explaining deviations, remedial measures, and proposed policy decisions affecting objectives. ### Lessons learned from international experience - An adequate public finance management (PFM) framework and political buy-in matter. - A good fiscal rule needs to strike an appropriate balance between simplicity, flexibility, and enforceability. - Rules should cover a broad range of government fiscal activities to reduce scope for allocating spending to uncovered arrears or playing accounting tricks. - Rules should incentivize building fiscal buffers during upturns and allow adequate fiscal support during downturns (ensure countercyclicality). - A good fiscal rule needs to be calibrated in line with sustainability and stabilization objectives (e.g., deficits consistent with stable or falling debt/GDP ratio). - Combining two or more fiscal rules can help address trade-offs (example: debt rule combined with expenditure rule links to debt sustainability and assists operational decisions, allows some countercyclicality, and targets size of government). ### Designing a fiscal rule framework for Lesotho — key country characteristics to consider - The following key characteristics should inform rule choice: - The importance of safeguarding the exchange rate peg; - The volatility of SACU transfers; - The downward rigidity of spending: current spending is driven by a large public sector wage bill; - Insufficient room for capital spending, which is very large and inefficient relative to SACU peers; - Weak institutional capacity; and - Political instability. - These factors suggest a rule that is (i) countercyclical, and (ii) easy to operate, (iii) easy to enforce. ### Proposed elements for Lesotho’s fiscal rules - Authorities consider including requirements to set fiscal principles, objectives, and numerical targets in primary legislation via the pending Public Financial Management and Accountability (PFMA) Bill, with definitions left to regulations or the BSP. - It is advisable not to define objectives and targets in primary legislation given the political environment, to avoid undermining credibility and incentivizing off-budget activities or creative accounting. - Build on existing Cabinet-approved targets with modest changes. Key proposals include: - Debt rule(s) to safeguard the exchange rate peg: - Convert debt ceilings under the debt management framework into a fiscal rule. - Ceilings proposed: - Total public debt, including guarantees, set at 60 percent of GDP; - Public external debt limited to 40 percent of GDP; - Government guarantees subject to an overall limit of 5 percent of GDP. - These should be set out in PFM regulations. - Budget balance rule options (two options examined): - Option A: Implement a structural balance rule, but acknowledging difficulty estimating structural balance for Lesotho. As an alternative, use overall balance excluding SACU transfers and external grants as a proxy for structural balance. - Assumptions: (i) SACU transfers and grants expected to remain at around 14–16 and 2–3 percent of GDP, respectively; and (ii) a 3 percent overall balance is consistent with trend growth. - Under these assumptions, a target overall balance excluding SACU and grants of around negative 20 percent of GDP could be a possible target. - This target would need revisiting as more information on SACU transfers becomes available. - Option B: Implement an overall balance rule together with an expenditure rule. - Rationale: SACU transfers are very volatile and when combined with rigid, steadily increasing spending the overall balance will be volatile and growing over time. - An expenditure rule that limits expenditure growth to less than nominal GDP growth or limits (current) expenditure to a certain percentage of GDP would address upward momentum in deficits. - Introduce a formal target for limiting domestic arrears to make the overall balance rule effective: - Arrears can be treated as an adjustor in calculating the budget balance (budget balance adjusted upward/downward by the amount of increase/decrease of arrears). - Additional analysis is required to determine the most useful budget balance rule and to calibrate appropriate numerical targets consistent with trend growth. *Source: 1lsoea2022003 - 17. During the past two decades, a growing number of countries across the world have* ### 32. The above two rules could be complemented by two numerical targets to improve the ### The above two rules could be complemented by two numerical targets to improve the quality of the spending. ### Fiscal rule recommendations and numerical targets - Complement two qualitative rules with two cabinet-level numerical targets (e.g., set in the BSP). - Switch the wage bill target: - Move from a share of GDP to a share of domestic revenue. - Rationale: avoid possible pro-cyclicality of a GDP-based target and allow addressing the target through domestic revenue mobilization as well as wage restraint. - Observed trend: over the past the decade, wage bill in domestic revenue has been increasing (Figure 11). - Numerical target: gradually reduce to and then not to exceed 60 percent of domestic revenue. - Make the existing capital expenditure target explicit once fiscal position has been restored. ### Suggested Fiscal Rule Framework (summary of Table 5) - Introduce fiscal rule requirement - Establish requirements to set fiscal principles, objectives, and numerical targets. - Setting body: Parliament, primary legislation (PFMA). - Two fiscal rules - Debt rule - Ceilings on total public debt, including guarantees, will be 60 percent of GDP. - Public external debt will be limited to 40 percent of GDP. - Government guarantees will be subjected to an overall limit of [5] percent of GDP. - Setting body: Parliament, e.g., PFM regulations. - Option A: Structural balance rule (overall balance excluding SACU transfers and grants) - Reduce the structural fiscal balance (overall fiscal deficit excluding SACU revenue and grants) until it has increased above [–20] percent of GDP consistent with long-term growth trend. - This target would have to be revisited at certain intervals as more information is available on the path of SACU transfers. - Arrears should be treated as an adjustor to the efficacy of this rule. - Setting body: Parliament, e.g., PFM regulations. - Option B: Overall balance rule - Overall deficit below 3 percent of GDP plus total spending below a certain percent of GDP (to be calibrated). - Setting body: Parliament, e.g., PFM regulations. - Fiscal Targets (Cabinet, e.g., BSP) - Government deposits with the central bank - Ensure the level of government deposits with the central bank target for NIR. - Wage bill - Reduce the wage bill progressively until it has fallen to 60 percent of domestic revenues. - Capital expenditure - Once the fiscal position has been restored, consider setting an explicit target for capital or development expenditure (e.g., not to fall below “core” SACU transfers). ### Rationale and context - Given Lesotho’s fiscal situation and characteristics of various fiscal rules, the SIP recommends: - Two fiscal rules supplemented by two numerical targets to rationalize the composition of expenditures. - Once the fiscal position has been restored, reassess the case for using a stabilization fund to manage volatility in SACU revenues. ### Roadmap to introduce the fiscal rules (next steps) - a. Develop and enact PFM fiscal rule regulations that characterize the fiscal rules. - Include requirements to set fiscal principles, objectives, and numerical targets in primary legislation (notably, the new PFMA Bill) but leave the specification of those principles, objectives, and targets to PFM regulations. - Rationale: In an unstable political environment, missing targets that are specified in laws risk undermining credibility, incentivize off-budget activities, and encourage creative accounting to meet the letter but not the spirit of the law. - Calibrate the precise numerical fiscal targets which are consistent with preserving debt sustainability and to safeguard the peg. - b. Establish mechanisms to ensure fiscal policies are set consistent with fiscal rules. - Set up monitoring, transparency, and reporting arrangements to ensure fiscal outcomes are in line with fiscal rules. - c. Define what should happen when rules are missed. - d. Ensure political buy-in. *KINGDOM OF LESOTHO — INTERNATIONAL MONETARY FUND* ### 11. More policies to ameliorate the disproportionate impact of the pandemic on women ### 11. More policies to ameliorate the disproportionate impact of the pandemic on women ### Disproportionate impact and current measures - Out of eight policies instituted by the authorities to combat the effects of the pandemic, only one has attempted to view implications through a gender lens. - Government pledge: launch a grant scheme of LSL50 million for micro-, small and medium-sized enterprises (MSMEs) with less than 50 employees, providing up to LSL20,000 matching grant to companies in the tourism sector, including hotels, restaurants, transport, and food sectors. - The tourism-sector grant measure indirectly addresses women's economic security, as women make up about 76 percent of workers in the accommodation and food services. - Other implemented measures that implicitly support women’s livelihoods: - one-off three-month salary subsidies of LSL800 to 40,000 workers in the textiles industry; - payments of LSL500 for registered informal-sector vendors. ### Policy recommendations to mainstream gender - Bring a gender lens to pandemic mitigation measures to address the disproportionate impact on women. - Reinforce efforts to mainstream gender issues by: - operationalizing de jure rights and regulations; - implementing social and gender responsive budgeting in Public Financial Management Reform, as suggested in the NSDP II. ### Context: public finance and macro policy coordination (relevant constraints) - Lesotho is a small open economy with its currency pegged to the South African rand, requiring close coordination between the Ministry of Finance (fiscal) and the Central Bank of Lesotho (monetary). - Exchange rate and monetary policy cycles in Lesotho are driven entirely by South African monetary and exchange rate policies; fiscal policy has been used as a spending brake when SACU transfers dip. - The government has established some principles to guide the conduct of fiscal policy (documented in the budget strategy paper) but they are unenforced; public expenditure has typically been more discretionary than rules-based. - The FY22/23 budget tabled in Parliament in early March 2022 has large deficits over the next 3 years, with limited concrete adjustment measures nor financing plans. As a result, arrears are being accumulated. ### Monetary regime, buffers, and limits - Under the CMA, all maloti currency issued by the CBL is backed entirely by the central bank’s foreign exchange reserves; however, unlike a classical currency board, Lesotho is not legally prohibited from acquiring domestic assets. - The CBL maintains high reserve coverage of monetary aggregates to enhance buffers and allow some domestic liquidity control. Even when applying a wider measure of short-term bank liabilities (“M1 plus”), coverage has remained comfortably above 100 percent (130 percent as of December 2021). - The peg eliminates a key lever for demand management but provides a nominal anchor and constraint on spending; limits to fiscal expansion can arise from weakening confidence in the peg and risks of current account deficits, inflation, and currency crises. ### Fiscal vs. monetary effectiveness under the peg - Monetary policy is less effective: the central bank does not have independent control of its money supply; money supply expands/contracts with central bank purchases/sales of foreign exchange and interest rates largely mirror those in South Africa. - Fiscal policy can directly influence aggregate demand and is particularly effective under the peg because changes in the fiscal stance do not affect the interest rate or the exchange rate. - The degree of capital mobility and the size of the nontradable goods sector alter policy effectiveness: - Less-than-perfect capital mobility reduces the effectiveness of fiscal policy and increases the effectiveness of monetary policy. - Presence of nontradable goods reduces fiscal effectiveness and increases monetary effectiveness. ### Scenarios illustrating coordination failures (interaction of fiscal and monetary/exchange rate policies) - Financing identity summarized as: FFD_t = (B_t − B_{t−1}) + (M_t − M_{t−1}) + (A_t − A_{t−1}), where FFD_t is the fiscal deficit; B_t government borrowing; M_t central bank’s net claims on government; A_t arrears. - Scenario 1: The Ministry of Finance and the fiscus dominate. - Fiscal authority sets the fiscal deficit without consulting the central bank. - Government deposits (7 percent of GDP as of end 2021) can be drawn down; if this exceeds demand for real base money at target price level, increased inflationary pressures, pressures on international reserves and the exchange rate, or arrears would arise. - Directing institutions (e.g., Pension Fund) to finance the deficit or withholding payments can cause financial repression and accumulation of arrears. - Scenario 2: The central bank and exchange rate policies dominate. - Monetary authority determines base money independently; the capacity to borrow and raise revenues constrains the fiscal deficit. - Government may be forced into excessive external borrowing (high risk of external debt distress) or aggressive domestic revenue mobilization that weights on incomes and activity; risk of reducing fiscal deficit in ways that jeopardize growth and social protection. - Scenario 3: Both the central bank and Ministry of Finance act autonomously and do not coordinate. - Inconsistent decisions create an unstable equilibrium; one authority becomes subordinated or conflict persists. - Prolonged policy inconsistency leads to loss in confidence, risk to the exchange rate, delays to reforms, stagnating growth, high financing costs, arrears, and pressure on the exchange rate. ### Historical lessons on exchange rate crises from coordination failures - 1992/93 UK Exchange Rate Mechanism Crisis: inconsistency between domestic policy needs and interest rates required to defend the peg. - 1994/95 Mexico Peso Crisis: expansionary fiscal and monetary policies inconsistent with a pegged exchange rate rule contributed to the collapse of the peg. - 1997/98 East Asian Financial Crisis: overreliance on foreign savings, mounting current account deficits, short-maturity foreign borrowing, rapid credit growth, and weak oversight left pegs unsustainable and triggered crises when confidence evaporated. ### Key statistics and figures (preserved exactly as in source) - Women make up about 76 percent of workers in the accommodation and food services. - Grant scheme size: LSL50 million. - Matching grant per company (tourism sector): up to LSL20,000. - One-off three-month salary subsidies: LSL800 to 40,000 workers in the textiles industry. - Payments for registered informal-sector vendors: LSL500. - Reserve coverage (“M1 plus”): 130 percent as of December 2021. - Government deposits: 7 percent of GDP as of end 2021. - Reported new arrears: LSL 1.25 billion (3.4 percent of GDP) accumulated as of end November 2021. - The FY22/23 budget tabled in Parliament in early March 2022 has large deficits over the next 3 years. *Source: 1lsoea2022003 - 11. More policies to ameliorate the disproportionate impact of the pandemic on women* ### 19. Hong Kong SAR offers a successful case of policy coordination that helped support ### 19. Hong Kong SAR offers a successful case of policy coordination that helped support the peg in the midst of the East Asian Financial Crisis ### Hong Kong SAR: successful defense of the peg - Hong Kong SAR faced several large speculative attacks but eventually weathered these attacks and successfully defended the peg mainly for the following reasons: - (i) Hong Kong SAR had very strong fiscal stance, which had remained in surplus for decades. - (ii) Hong Kong SAR adopted decisively critical structural reforms (e.g., cutting wages) to restore its competitiveness quickly. ### A macro policy framework in the context of Lesotho - Lesotho is characterized as a small economy with perfect capital mobility and a small (informal) nontradables sector under a peg regime. - Key trade-offs and synergies among macro objectives (preserving debt sustainability, safeguarding the peg, maintaining investor confidence, protecting financial stability, maintaining fiscal sustainability, and achieving high growth): - Preserving debt sustainability, safeguarding the peg, maintaining investor confidence, and protecting financial stability: - Debt sustainability requires limits to borrowing, which implies either: - (i) greater use of government deposits and lower reserves, undermining confidence in the ability to defend the peg; or - (ii) accumulating greater arrears, inducing NPLs, and undercutting financial stability. - Enhancing the peg or enhancing financial stability will have similar trade-offs. - Preserving fiscal sustainability versus achieving high growth: - High growth through investment requires a larger fiscal deficit when current spending is sticky, which will undercut fiscal sustainability. - Enhancing fiscal sustainability by cutting spending can harm growth. ### Policy coordination: roles and institutional arrangements - Policy coordination can depoliticize macroeconomic policies while preserving the independence and accountability of the Central Bank of Lesotho (CBL). - Key fiscal and monetary policy roles recommended: - a. Debt limits: The debt office and the macro department at the Ministry of Finance should determine how much debt the government can take on, informed by estimates of debt sustainability. - b. Reserve levels: CBL should determine the reserve level required to safeguard the peg; CBL can consult with the Ministry of Finance. The reserve requirement will determine the floor on net claims on government (NCG). - c. Fiscal deficit: Safeguarding the peg and preserving debt sustainability should determine the affordable fiscal deficit. - d. Spending composition: The government optimizes the composition of spending within the fiscal deficit envelope informed by the CBL to achieve macro policy objectives—sustainable and inclusive growth. - Institutional formalization suggestions: - Reinvigorate existing channels such as the inter-Ministerial Macro Working Group. - Set up a debt policy committee under the Debt Department of the Ministry of Finance with members from both the MoF and CBL to integrate knowledge on external financing needs and financial markets. - Develop capacity within the Macroeconomic Policy and Coordination Department of the Ministry of Finance for debt sustainability analysis. ### Interaction at multiple layers for effective coordination - Recommended layered interaction to ensure communication, data dissemination, modelling, and informed decision-making: - Principals’ meeting: - High-level platform involving top officials from the MoF, the CBL, and other Ministries, Departments, and Agencies (MDAs); meet regularly to discuss strategic policy issues and responses to recent macro developments. - Directors’ meeting: - Include Macro Director, Budget Controller from the MOF; director of research, director of market operation from CBL; head of the debt office; meet regularly to implement principals’ agreements. Senior policymakers from relevant MDAs can be included as needed. - Technical task forces and working groups: - Technical staff (e.g., the existing Macroeconomic Working Group) provide forecasting and technical inputs on growth, inflation, revenue, reserves, etc. ### Example of policy coordination: the 2021 SDR allocation - SDR allocation details: - On August 23, 2021, the IMF allocated US$650 billion of Special Drawing Rights (SDR) to member countries in proportion to their quota shares in the IMF. - About US$275 billion is going to emerging and developing countries, of which low-income countries will receive about US$21 billion – equivalent to as much as 6 percent of GDP in some cases. - Lesotho received about US$ 95 million of new SDR allocation. - The IMF does not impose restrictions on the use of SDR allocation. - Two approaches for government access to SDR allocation: - a. Direct access: - On-lend the SDR allocation to the government, subject to Article 42 of the Central Bank of Lesotho Act, which specifies: - (i) the total credit of central bank to the government shall not exceed 5 percent of the Government’s actual revenue in the previous year’s budget; - (ii) any advance from CBL to the Government should be repaid within 93 days from the end of the Government’s financial year to which it relates, and where any such advance remains unpaid after the due date, the power of the Bank to make further advances in any subsequent financial year shall not be exercised unless the amounts due in respect of outstanding advances have been repaid. - Pros and cons noted: direct debt to the government (accountability) but incurs interest costs at SDR rate (holdings < allocation), exchange risk, direct increase in external debt, and repayment timing constraints. - b. Indirect access: - Retain SDR allocation on the CBL balance sheet and draw down government deposits at the CBL, effectively accessing the SDR allocation indirectly. - Mechanism: SDR allocation increases NIR (above current target), creating space for government to draw down part of its deposits with the CB; given perfect capital mobility and a high degree of leakage, the drawdown in deposits will lead to a reduction in reserves. - Pros and cons noted: creates space for drawing down deposits, saves interest costs at SDR rate, avoids exchange rate risk, but hides the actual debt burden and requires positive balances at the CBL. - Policy coordination imperative for SDR use: - Without coordination, the cheaper indirect option may not be available; unilateral drawdowns risk endangering the peg. - Withdrawals must be determined within the context of safeguarding the peg, preserving debt sustainability, and maintaining external stability, as indicated by reserve targets (e.g., maintaining an adequate level of 4 months of import cover). ### Boxes: interactions and monetary mechanics - Box 1: Interactions between debt, spending, and reserves (summarized steps) - a. Debt limits from debt sustainability analysis suggest a path for the debt stabilizing primary balance. - b. Parallel roles: - Central bank sets a ceiling on net credit to government (change in government deposits) to safeguard the peg by maintaining NIR and GIR coverage. - Ministry of Finance reviews spending composition (current vs. capital) based on priorities. - c. Revenue mobilization estimated by the Ministry of Finance and Lesotho Revenue Authority. - d. Potential domestic financing determined by the central bank in coordination with the Ministry’s Debt Department. - e. (a)–(d) jointly determine total potential financing sources and the resource envelope for public expenditure, preserving fiscal space for shocks. - Box 2: Impact of SDR allocation on monetary aggregates - A. SDR allocations and BOP: - “Holdings of SDRs”: Increase long-term debt liabilities (other investment inflows) under the Financial Account by the amount of SDR allocation. - “Allocations of SDRs”: Increase gross international reserves (GIR) under official reserve assets by the amount of the SDR allocation below the line of the BOP. - B. SDR allocations and monetary sector: - Foreign Assets under Net Foreign Assets (NFA) increase by the SDR allocation in local currency; foreign liabilities under NFA also increase by the same amount; net foreign assets unchanged; SDR holdings directly increase GIR; Net interactional reserves (NIR) will also increase provided short-term foreign exchange debt liabilities are not subtracted from GIR. - C. Impact on base money depends on exchange rate regime: - Under a peg/currency board, reserve money is usually driven by GIR and NIR; with increased GIR and NIR, reserve money should increase accordingly (assuming no leakages). - Alternatively, monetary authority can break the GIR/NIR–money supply link, implying a jump in the GIR/M1 or NIR/M1 ratios. - Therefore one of the following should be observed: (i) a jump in money supply (reserve money), or (ii) a jump of GIR/M1 ratio or NIR/M1 ratio. ### Conclusions and policy recommendations - Macro policy coordination matters for Lesotho given its small open-economy features, large foreign-owned banking sector, and pegged exchange arrangement. - The peg anchors macro policy and inflation, but limited nominal exchange rate adjustment scope requires fiscal policy and structural reforms to play the key role in external adjustment. - Risks of uncoordinated policy: government spending and cash management plans can conflict with (i) minimum international reserves needed to safeguard the peg, (ii) borrowing needed to preserve debt sustainability, and (iii) minimizing arrears. - Recommended augmentations and formalizations: - (i) The Ministry of Finance should determine public debt limits based on prudent debt sustainability analysis. - (ii) The CBL should determine a ceiling on NCG that secures the peg. - (i) and (ii) jointly determine the fiscal deficit, whose composition can be optimized by the Ministry of Finance to achieve sustainable and inclusive growth. *International Monetary Fund — Kingdom of Lesotho chapter content.* ### 9. To combat the high poverty and inequality, Lesotho spends more than twice the SSA ### 9. To combat the high poverty and inequality, Lesotho spends more than twice the SSA ### Social spending: overview and coverage - Lesotho spends more than twice the SSA African average on social programs. - Over half of social spending is geared toward education; the rest goes toward food and pension transfers. - Nearly two-thirds of households in Lesotho benefit from at least one social program. - Over 80 percent of poor households are beneficiaries. - If Lesotho’s social spending was perfectly targeted, extreme poverty would be eliminated and the upper bound would be halved (World Bank 2021). ### Targeting, impact, and fiscal incidence - Most social programs are well-targeted and progressive, with most benefits going toward the poorest households. - Using fiscal incidence analysis: - The Old Age Pension has the biggest impact on poverty. - The School Feeding Program covers the highest number of poor households and has significant impact. - The Child Grant and Public Assistance programs are progressive but transfers are too small to significantly reduce poverty. - Overall social spending effects: - Reduces the poverty rate by 3.4 ppts at the upper bound line. - Reduces the poverty rate by 6.5 ppts at the extreme line. - Reduces the Gini coefficient by 4.1 percentage points (World Bank 2021). ### Regressive programs and education outcomes - The Tertiary Education Loan Bursary Scheme is the costliest program and is regressive: - More than 90 percent of beneficiaries are classified as non-poor (World Bank 2021). - Program increases inequality and has minimal direct impact on poverty. - The bursary costs an estimated 1.84 percent of GDP and covers 19,500 beneficiaries. - Education costs and outcomes: - Government offers universal primary education; secondary education is expensive, with 65 percent of the costs falling on households (World Bank 2017). - Only 4 percent of secondary-age students receive the Orphan and Vulnerable Children Program (OVC) grants. - FY17/18 household budget survey indicates just 10 percent of the adult population has completed secondary education, with close to half of dropouts indicating cost as the main reason for quitting secondary school. ### Box 1 — Summary of Social Programs (costs and coverage; cost and beneficiary data refer to FY17/18) - Cash-for-Work Assistance Program (Ministry of Forestry, Range, and Soil Conversation): - Total spending: 0.3 percent of GDP. - Coverage: 98,000 beneficiaries (approximately 20 percent of the target group). - Public Assistance Program (PAP) (Ministry of Social Development): - Total budget: roughly 0.24 percent of GDP. - Coverage: approximately 12,700 beneficiaries (around 6 percent of the target group). - Orphan and Vulnerable Children Program (OVC): - Covers roughly 21,000 beneficiaries (around 11 percent of the target group). - Cost: 0.2 percent of GDP. - Tertiary Education Loan Bursary Scheme (National Manpower Development Secretariat, Ministry of Development Planning): - Cost: estimated 1.84 percent of GDP. - Coverage: 19,500 beneficiaries. - Eligibility by academic merit; low recovery rates mean it functions de facto as a grant. - Child Grant Program (CGP) (Ministry of Social Development): - Cost: 0.2 percent of GDP. - Coverage: 27,000 households (around 22 percent of the target group). - Transfers disbursed quarterly based on number of children. - School Feeding Program (Ministry of Education and Training): - Coverage: roughly 295,000 beneficiaries (100 percent of the target group). - Aim: provide 1–2 meals per day to early childhood and primary school students. - Cost: about 0.5 percent of GDP. - Old Age Pension (OAP) (Ministry of Finance): - Established in 2004; universal, non-contributory for adults over 70 not receiving a civil service pension. - Annual benefits roughly 50 percent of per capita GDP. - Coverage: approximately 84,000 people. - Cost: 2.0 percent of GDP. - World Bank (2021) reports significant number of “ghost” OAP pensioners, implying coverage over 100 percent. ### Policy recommendations for social spending - Redirect resources to the most successful, well-targeted programs. - Specific measures: - Avoid expanding the Public Assistance program as currently designed: transfers are too small and coverage too low to significantly reduce poverty. - Increase the School Feeding program by 50 percent — projected to reduce poverty by 1¼ percent. - Augment Old Age Pension only after reducing incidence of “ghost pensioners.” - To mitigate additional costs, combine expansions of well-targeted programs with reductions in budget transfers to the regressive tertiary education loan bursary program, introduce means-testing, and pursue loan recovery. --- ### Overview of taxation in Lesotho - Lesotho possesses core components of a modern tax system but needs improvement in domestic revenue mobilization, especially after COVID-19 and SACU revenue volatility. - Revenue composition: - VAT provides the bulk of revenues. - Personal income tax (PIT) and corporate income tax (CIT) follow. - Excise taxes are a small but nonnegligible portion with potential. - VAT: - Since introduction in 2003, VAT has accounted for approximately 38 percent of tax revenues in the past decade. - VAT generated 7.7 percent of GDP (Figure 6 reference). - Standard VAT rate is 15 percent. - VAT features: minimum registration threshold on annual taxable turnover of M850,000; destination-based system with exports zero-rated. - VAT C-efficiency is 0.56 in 2018. - Reduced rates, exemptions, and zero-ratings apply; government intends to gradually eliminate rate differentials and unify the VAT rate. - Recent April 2022 amendment removed zero-rating for exports of the mining sector—analysis warns this risks undermining VAT integrity, causing cascading, reducing competitiveness, and discouraging investment in capital assets. - Suggested alternatives: import VAT deferral mechanism or targeted VAT exemptions during mining development phase. - PIT: - Levied under the Income Tax Act 1993 at progressive rates: - Employment income subject to a two-rate structure of 20 percent and 30 percent. - Low income earners with monthly gross salary equal to or less than M4,200 are excluded by a non-refundable tax credit of M840 per month. - Fringe benefits taxed at 40 percent; resident contractors withholding 5 percent; non-resident contractors withholding 10 percent. - PIT contributes nearly a third of total domestic tax revenue; PIT revenues are 2.5 times CIT revenues on average over the past decade. - Sharp jump in marginal rates: bottom rate 20 percent, double the regional average of 10 percent. - CIT: - Standard CIT rate is 25 percent. - Reduced rate of 10 percent applied to manufacturing companies and commercial farming, including textile manufacturing. - Reduced rate may distort activity and erode the tax base; concerns exist that foreign-owned textile firms could relocate if preferential rate removed. - Nontax revenue: - Stable at 5 to 6 percent of GDP. - Water and diamond royalties account for about three quarters of total nontax revenues. - Royalties on diamond exports constitute roughly 21 percent of total nontax revenues. - COVID-19 tax relief measures (2020): - Remitted PIT payable by individuals engaged in the public transport business during lockdown. - Deferred CIT payments in 2020 with varying deferral schedules and repayment instalment plans differentiated by taxpayer size. - Deferred VAT and PAYE payments for businesses closed during national lockdown for April, May, June; payable from July 2020 to March 2021 in 9 equal monthly instalments. - MSME taxation and formalization: - Presumptive tax system exists for retail and transport sectors; transport tax based on vehicle size. - LRA proposed a turnover-based tax to be phased in, starting with transport. - Business Licensing and Registration Act, 2019 effective November 17, 2020, aims to automate registration and licensing, enable online license application and payments, streamline procedures, and limit processing to five business days. - Mining sector tax challenges: - Revenue sources: government equity interest, royalties, corporate income tax, withholding tax on dividends. - Capital structures with loans from parent companies have enabled profit shifting and undermined CIT revenues. - Some policy changes (e.g., VAT zero-rating removal for mining exports) may reflect attempts to address international corporate income tax avoidance but carry broader VAT integrity risks. *Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1lsoea2022003.pdf* ### 14. There remains considerable potential to improve the revenue-raising capacity of the ### 1lsoea2022003 - 14. There remains considerable potential to improve the revenue-raising capacity of the ### Mining sector: revenue-raising potential and tax design issues - Corporate income tax (CIT) and loss carry-forward - Diamond mining companies are subject to the standard CIT rate of 25 percent. - Under the current CIT regime, indefinite carry-forward losses allow mining companies to only start paying CIT when enough profits are generated to cover perpetual losses. - Recommendation: adopt a time-bound loss carry-forward period. The period could be longer than for ordinary economic activities given the capital-intensive nature of mining, allowing a longer investment recovery period. - Royalties and export taxation - Statutory royalty rate is 10 percent according to the Mines and Minerals Act 2005; the government had proposed in the FY21/22 budget to increase it to 15 percent. - In practice royalty rates are negotiable and some mines operate under reduced rates as low as 4 percent. - There is no sector-specific profits tax. Introducing an export tax would for all practical purposes be equivalent to increasing the royalty rate. - Recommendation: review and strengthen royalty rates rather than introduce an export tax; remove the immediate expensing of capital expenditure under the CIT (noted as less common in the mining sector). - Transfer pricing, capital gains, and tax administration - The Lesotho Revenue Authority (LRA) needs improved tax expertise and regulations on transfer pricing. - Such measures would help detect tax avoidance behaviors, including mining companies changing ownership without paying tax on capital gains. ### Mining sector: government participation and comparative tax parameters (selected figures from Table 2) - Government shareholding (equity interest) — Lesotho: - 25% Liqhobong Mine - 30% Letšeng Mine - 20% Lemphane Mine - Royalty rate: statutory 10%; increased to 15% in recent proposal; in practice companies can negotiate lower rates. - Corporate tax: standard 25% (Lesotho) versus 22-55% (Botswana) and 55% (Namibia). - Withholding tax on dividends: 15% (Lesotho), 7.50% (Botswana), 10% (Namibia). - Taxation on downstream processing: Lesotho shows "-" (no sector-specific profits tax). ### Trade overview: import and export concentration and partners - Imports - 85 percent of goods imports come from South Africa, including most agricultural products (one-third of the total). - Intermediate products, particularly fabrics, are sourced from China and Taiwan (around 5 percent of the total each). - Lesotho’s share was about 9 percent on average over the last decade in the SACU revenue-sharing formula (customs component based on share of intra-SACU imports). - Exports - Over 80 percent of exports comprise textiles and diamonds. - About 85 percent of exports go to three countries—Belgium, South Africa, and the United States. - Top export markets have been relatively stable, with roughly 30 percent shipped to Belgium, South Africa, and United States each. - Apparel accounts for about 10 percent of GDP. - Product composition changes: apparel over 40 percent of exports in 2019; diamonds just under 40 percent in 2019 (compared to 26 percent in 2010). ### Export performance: sector specifics and recent developments - Apparel - Growth driven historically by AGOA and low labor costs; almost all exports to the U.S. (around 80–90 percent) fall under HS Chapters 61 and 62 (70 percent of total apparel exports). - The textile, apparel and footwear manufacturing industry employs an estimated 45,000 workers (mostly female). - Apparel exports declined from $485 million in 2018 to $385 million in 2020. - A 14 percent minimum wage hike in the textile sector, and the anticipated expiration of AGOA in 2025, are expected to erode competitiveness. - Diamonds - Letšeng mine recovered 115,335 carats in 2021 (versus 100,780 in 2020). - Average price at Letšeng was $1,835 per carat in 2021, which was 4 percent lower than in 2020. - Mothae mine expanded processing capacity by 45 percent in 2021 and pursued cutting and polishing partnerships to move up the value chain. - After closures in 2020, three mines reopened in 2021: Letšeng, Mothae, and Kao. Firestone Diamonds’ Liqhobong remained inactive in 2021 due to debt restructuring negotiations. - Two locally owned mines, Thaba-Telle and Qaqa, have been awarded diamond mining leases but are not yet operational. - Water exports and LHWP - Lesotho Highlands Water Project (LHWP) transfers about 900 million cubic meters of water annually and generates 72-megawatt (MW) hydropower at the Muela Power Station. - Annual royalties from water transfers have averaged LSL950 million over the last five fiscal years, or 2.8 percent of GDP. - Phase II of the project faces delays exacerbated by the pandemic and adverse weather. ### Risks, competitiveness, and diversification needs - Concentration and diversification - Lesotho exports about 700 products (HS6), down from about 960 in 2010; SACU average is 2,500 products. - Imports number about 3,000 goods. - Export- and import-market concentration: about 30-40 markets or source countries (significantly lower than SACU average of 80, excluding South Africa). - Over 85 percent of Lesotho’s imports come from South Africa. - External risks - Loss of AGOA benefits has had severe impacts historically (example: Eswatini’s apparel exports to the US fell from $57 million in apparel in 2014 to $2.7 million and $1 million in 2015 and 2016 respectively). - US tariff rates on apparel range from 15 to 32 percent; estimated tariff savings from AGOA exceed $70 million. - The anticipated loss of preferential access will increase pressure on the apparel sector in an increasingly competitive global market. - Policy direction for resilience - Diversification into new products and trading partners and upgrading the quality of existing products would reduce vulnerability to external shocks, provide opportunities to raise productivity, and move labor into higher-productivity activities. - The AfCFTA provides opportunities to diversify export markets, particularly for apparel toward African countries that are net importers of apparel (e.g., Angola, Nigeria, Senegal, and Togo). *Source: IMF staff compilation from the provided chapter content.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1lsoea2022003.pdf_