## 1. Public Debt

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---

### Overview and context
- Lesotho’s economy is small and open, with heavy reliance on Southern African Customs Union (SACU) receipts and limited economic diversification, creating fiscal volatility and exposure to external demand shocks.
- Fiscal management has been procyclical and constrained by rigid public expenditures, particularly a large wage bill, and limited access to international financing.
- A fiscal surplus emerged starting from FY23/24, driven by strong SACU receipts and renegotiated water royalty rates under the Treaty with South Africa on the Lesotho Highlands Water Project (LHWP-II).

### Key fiscal targets and institutional arrangements
- Proposed core fiscal-rule elements:
  - Debt ceiling: 60 percent of GDP.
  - Debt anchor: 50 percent of GDP (authorities propose multi-layered anchors at 45, 50, and 55 percent of GDP).
  - Structural deficit target: 3 percent of GDP.
  - Indicative benchmarks: ceiling on total nominal expenditure growth of no more than inflation; limit on the wage bill to 60 percent of total revenues.
  - Establish a Revenue Stabilization Fund (savings fund) anchored on the fiscal rules for stabilization and investment purposes.
  - Establish an independent Fiscal Council to validate macroeconomic assumptions, assess fiscal performance, and publish compliance reports; the Council’s structure comprises five members with at least one member being an external expert, and an outsourced secretariat.

### Recent public debt dynamics and projections
- Public debt declined from 61.5 percent of GDP in FY23/24 to 56.8 percent of GDP in FY24/25 due to accelerated redemption of domestic securities and arrears clearance.
- According to the latest DSA cited, by 2045 Lesotho’s nominal public debt-to-GDP ratio is projected remain close to this ceiling (61 percent), while its PV equivalent would be around 52 percent, close to the DSA’s 55 percent threshold.
- Sustaining a debt level near 60 percent places a premium on strong fiscal management, careful spending prioritization, and prudent debt accumulation strategies.

### Fiscal rules calibration and simulation findings
- Calibration approach:
  - Stochastic simulations incorporating GDP growth, interest rates on public debt, exchange rate fluctuations, terms-of-trade shocks, and external loan disbursements and concessionality.
  - Two complementary approaches: a fiscal reaction function (FRF) estimated on a panel of LIDCs (including Lesotho) and an ad hoc fiscal balance path aligned with the latest macroeconomic framework.
- FRF simulation results:
  - A debt anchor at approximately 47 percent of GDP ensures only a 15 percent probability of exceeding the 60 percent threshold under the simulated shock distribution.
  - Simulations starting from the actual debt level at end-FY24/25 show debt is likely to remain below but close to the 60 percent ceiling over the next six years, with a non-negligible probability of breaching the ceiling under adverse scenarios.

### Policy implications and recommendations emphasized in the text
- Institutionalize fiscal discipline through a legally binding, simple, transparent, and enforceable rules-based framework to mitigate procyclicality and enhance credibility.
- Prioritize savings and strategic investment of recent and future windfalls (SACU receipts and LHWP-II royalties), with the Revenue Stabilization Fund serving both stabilization and investment roles.
- Strengthen public financial management to address low capital spending efficiency and chronic arrears.
- Ensure any new debt aligns with national development priorities, is supported by robust project appraisal, and is accompanied by efforts to strengthen revenue mobilization and expenditure efficiency.
- Use automatic correction mechanisms and pre-specified debt correction thresholds (adjustment plans triggered if debt-to-GDP exceeds 45, 50, or 55 percent, with intensified measures and short-term adjustments once exceeding 60 percent) and include transparent escape clauses for exceptional events with a requirement to return to compliance within three years.
- Sequence rule implementation to accommodate institutional capacity, with room for future revisions as data quality and forecasting tools improve; consider a GDP rebasing and enhancements in macro-fiscal analysis.

### Ad hoc fiscal balance scenario — simulated debt trajectory and implications
- Under the ad hoc fiscal balance scenario, public debt is projected to decline steadily to below 45 percent of GDP by the end of the medium term, provided sustained primary surpluses are realized and borrowing remains aligned with the fiscal path.
- The scenario maintains the observed share of concessional borrowing and assumes a one-to-one relationship between the primary balance and public debt dynamics.
- The likelihood of breaching the 60 percent debt ceiling remains low—less than 10 percent—even under simulated shock scenarios.
- Emphasized needs:
  - Protect the fiscal position against negative shocks.
  - Maintain fiscal buffers to withstand adverse shocks.
  - Preserve fiscal space for growth-enhancing investment and development priorities.

### Structural balance rule: rationale and measurement of SACU revenues
- A structural balance rule is recommended to ensure coherence between debt and deficit targets and to accommodate cyclical adjustments and revenue volatility, especially for SACU receipts.
- Preferred measure of underlying “structural” SACU revenues:
  - the lower quartile of SACU receipts over the past 8 years, chosen from various windows of 4 to 20 years for its relative stability, conservatism, and political defensibility.
  - This choice aims to reduce procyclicality and provide a prudent anchor for structural deficit rules, strengthening medium-term fiscal planning.

### Fiscal rules calibration — scenarios, results, and trade-offs
- Calibration setup:
  - three adjustment paths simulated using the IMF fiscal rules calibration tool;
  - debt ceiling: 60 percent of GDP;
  - long-term trend nominal GDP growth rate: 6.5 percent.
- Three simulated adjustment paths and results:
  - (i) constant balance stabilizing debt at its ceiling over the long term: implies a fiscal deficit of -3.1 percent of GDP every year for five years; debt converges to 50 percent of GDP in about 15 years.
  - (ii) convergence to a 50 percent of GDP debt anchor within five years: requires a fiscal deficit of -1.9 percent of GDP every year for five years.
  - (iii) front-loaded adjustment to reach 50 percent of GDP within five years: entails -0.5 percent of GDP in year 1 → -1.5 percent of GDP in year 2 → -2.5 percent of GDP in years 3–5.
- Feasibility and policy implications:
  - The simulated results suggest that a 3 percent of GDP structural deficit rule is feasible for Lesotho.
  - Using the preferred underlying revenue measure (lower quartile of SACU and grant revenues over the past eight years), baseline projections suggest the structural fiscal balance will remain in surplus over the medium term.
  - Opportunity identified to save revenue windfalls and allocate resources toward retiring costly domestic debt to strengthen fiscal buffers and reduce debt vulnerabilities.
  - Given authorities have not revised future borrowing plans or committed to financing capital spending from domestic resources, prudent priority is to begin repaying costly debt to build fiscal space and resilience.

### Forward-looking scenario analysis — rules, scenarios, and comparative performance
- Simulation design:
  - rule introduced in the first year and simulated over the forecast horizon;
  - four macro scenarios:
    - baseline scenario consistent with the macroframework discussed in the 2025 Article IV Staff Report;
    - low-growth scenario: large and temporary shock to growth in the first year with no permanent effect on long-run real GDP level;
    - boom-and-bust scenario: long period of strong growth followed by a decline with permanent effects on the level of real GDP;
    - contingent liabilities scenario: contingent liabilities amount to 15 percent of GDP in the first year while other macro variables follow the baseline.
  - three operational rules applied under each scenario:
    - structural deficit rule of 3 percent of GDP;
    - spending-to-GDP rule of 55 percent;
    - real spending growth rule capped at 0 percent (indicating nominal spending growth at inflation rate).
- Key comparative findings:
  - Across all four scenarios, the structural balance rule yields the strongest debt reduction path, ensuring a steady and significant decline in the debt-to-GDP ratio over time.
  - The spending growth rule offers moderate debt containment, performing better than no rule but more vulnerable to shocks, especially under the boom-and-bust scenario.
  - The spending-to-GDP rule tends to stabilize debt but is less effective at placing debt on a downward trajectory under adverse or volatile conditions.
  - The no rule scenario results in rising or flat debt paths across simulations, underscoring the importance of adopting fiscal rules.
  - Overall conclusion: rules anchored in fiscal balances provide the strongest safeguard against debt escalation amid growth volatility or contingent fiscal pressures.

### Considerations for a stabilization fund and reserve adequacy
- Recommendation: authorities are strongly encouraged to swiftly operationalize a well-governed stabilization fund, anchored by credible fiscal rules.
- Reserve adequacy and strategy:
  - gross international reserves expected to surpass six months of import coverage in FY25/26—a level deemed appropriate for Lesotho—and staff recommends fiscal surpluses be redirected toward reducing public debt.
  - The IMF Assessment of Reserve Adequacy for Credit Constrained Economies (ARA-CC) framework is used.
  - From simulations, the optimal level of reserves is about 4.5 to 6 months of imports for Lesotho.
  - Placing debt on a declining path to around 45 percent of GDP would still allow reserve accumulation to reach 7.5 months of imports at the end of the forecast horizon.
  - According to the LIC-DSF framework, this adjustment would improve Lesotho’s status from "limited space to absorb shocks" to "some space to absorb shocks."
- Debt repayment sequencing considerations:
  - domestic debt carries a significantly higher interest cost, but gradual repayment of external debt could reduce external debt vulnerabilities; maintaining some domestic issuance supports local securities market development.
  - Concessional rates from Lesotho’s current creditors range from zero to 2.5 percent.
- Stabilization fund design principles:
  - anchor the fund within the broader fiscal rules framework and medium-term fiscal framework (MTFF);
  - enforce fiscal discipline at the budget level with transparent, rule-based deposit and withdrawal mechanisms to avoid ad hoc political pressures;
  - dual objectives—stabilization (counter-cyclical smoothing during revenue volatility) and investment (building long-term fiscal buffers for growth-enhancing capital expenditure);
  - asset allocation: stabilization tranche invested in low-risk, highly liquid instruments; investment tranche pursues higher returns with longer horizon under prudent risk management;
  - strong governance, clear operational guidelines, and regular reporting required to safeguard integrity and effectiveness.

### Experience from Chile — relevance for Lesotho
- Chile’s 2001 fiscal rule targeted a structural surplus of 1 percent of GDP and anchored policy on estimates of potential output and long-term copper prices provided annually by two independent expert panels.
- Chile accumulated surpluses during booms and drew on savings during shocks, mitigating procyclical fiscal management tied to volatile commodity revenues.
- Outcomes cited:
  - Gross debt declined to as low as 4 percent of GDP in the pre-crisis period.
  - Net debt was contained within a 20 percent anchor.
  - Chile maintained public debt well below its 45 percent of GDP target for much of the pre-pandemic period.
- Lessons for Lesotho:
  - Use of structural balance rules and stabilization mechanisms to manage revenue volatility and maintain debt within sustainable thresholds.
  - Embedding discipline can curb procyclical spending, enhance credibility, and preserve buffers for downturns.

### Lesotho context, macro-structural challenges, and potential gains from reforms
- Public sector footprint and fiscal pressures:
  - Public expenditure to GDP ratio: 53 percent.
  - Public sector wages: 17 percent of GDP (2024 estimates), accounting for 72 percent of tax revenue.
  - GDP per capita fell 14 percent between 2016 and 2023.
  - Over half of the economy’s formal workers are public sector employees; they earn, on average, over four times the median private sector wage.
- Labor market and poverty indicators:
  - Labor force participation: 60 percent (vs. more than 70 percent for sub-Saharan Africa).
  - Unemployment rate: 16 percent in 2024 (versus 6 percent in Sub-Saharan Africa and 5 percent for emerging market and developing economies).
  - Informal employment among those participating in the labor market: nearly 80 percent.
  - Extreme poverty: nearly four in ten people live on less than $2.15 per day.
  - Remittances: over 20 percent of GDP annually.
- Structural transformation and jobs:
  - Textiles sector employment shrunk from a peak of 60,000 workers to around 30,000 currently.
  - Textiles exports to the United States are near 10 percent of GDP and face risks from potential trade policy changes.
  - A reform scenario that increases growth by 1.5 percentage points could be associated with the creation of 4,800 jobs per year using the median elasticity for sub-Saharan Africa; if job-intensity matched levels seen outside the region, the same 1.5 percentage point increase could create 14,000 jobs per year.

### Annex I: Calibration approaches for overall and primary balance (equations preserved)
- Approach 1: Convergence in the Long Term
  - Equation: 푏푏∗ = 휆휆푑푑∗
  - Where 푏푏∗ represents either balance in percent of GDP, 푑푑∗ is a given debt-to-GDP target, and 휆휆 takes the form of −훾훾/(1+훾훾) for an overall balance target, or (푖푖−훾훾)/(1+훾훾) for a primary balance target, where 훾훾 is the nominal GDP growth over the long term and 푖푖 represents the nominal interest rate paid on public debt.
- Approach 2: Convergence by a Given Date
  - Equation: 푏푏∗ = 휆휆(1+휆휆)푁푁−1 [푑푑0(1 +휆휆)푁푁 − 푑푑∗]
  - Calibrates 푏푏∗ so that the debt ratio hits its target 푑푑∗ after 푁푁 years.
- Approach 3: Convergence by a Given Date Following a Transition Period
  - Equation (piecewise): 
    - 푏푏푡 = { 훼훼훼훼 + 푏푏0, where 0 < 훼훼 < 푇푇
             훼훼푇푇 + 푏푏0 = 푏푏푇푇∗, where 푇푇 ≤ 훼훼 ≤ 푁푁 }
  - Where 훼훼 represents the annual constant amount adjusted until it reaches the target 푏푏푇푇∗ after 푇푇 years. If 푏푏푇푇∗ is maintained afterward, this will ensure convergence to the debt target by the end of year 푁푁.

_Source: Authorities’ data and IMF staff calculations; content extracted from the provided chapter/section._

### 1. Public Debt ___________________________________________________________________________ 4

### 1. Public Debt

### Overview and context
- Lesotho’s economy is small and open, with heavy reliance on Southern African Customs Union (SACU) receipts and limited economic diversification, creating fiscal volatility and exposure to external demand shocks.
- Fiscal management has been procyclical and constrained by rigid public expenditures, particularly a large wage bill, and limited access to international financing.
- A fiscal surplus emerged starting from FY23/24, driven by strong SACU receipts and renegotiated water royalty rates under the Treaty with South Africa on the Lesotho Highlands Water Project (LHWP-II).

### Key fiscal targets and institutional arrangements
- Proposed core fiscal-rule elements:
  - Debt ceiling: 60 percent of GDP.
  - Debt anchor: 50 percent of GDP (authorities propose multi-layered anchors at 45, 50, and 55 percent of GDP).
  - Structural deficit target: 3 percent of GDP.
  - Indicative benchmarks: ceiling on total nominal expenditure growth of no more than inflation; limit on the wage bill to 60 percent of total revenues.
  - Establish a Revenue Stabilization Fund (savings fund) anchored on the fiscal rules for stabilization and investment purposes.
  - Establish an independent Fiscal Council to validate macroeconomic assumptions, assess fiscal performance, and publish compliance reports; the Council’s structure comprises five members with at least one member being an external expert, and an outsourced secretariat.

### Recent public debt dynamics and projections
- Public debt declined from 61.5 percent of GDP in FY23/24 to 56.8 percent of GDP in FY24/25 due to accelerated redemption of domestic securities and arrears clearance.
- According to the latest DSA cited, by 2045 Lesotho’s nominal public debt-to-GDP ratio is projected remain close to this ceiling (61 percent), while its PV equivalent would be around 52 percent, close to the DSA’s 55 percent threshold.
- The framework recognizes that sustaining a debt level near 60 percent places a premium on strong fiscal management, careful spending prioritization, and prudent debt accumulation strategies.

### Fiscal rules calibration and simulation findings
- Calibration approach:
  - Stochastic simulations incorporating GDP growth, interest rates on public debt, exchange rate fluctuations, terms-of-trade shocks, and external loan disbursements and concessionality.
  - Two complementary approaches: a fiscal reaction function (FRF) estimated on a panel of LIDCs (including Lesotho) and an ad hoc fiscal balance path aligned with the latest macroeconomic framework.
- FRF simulation results:
  - A debt anchor at approximately 47 percent of GDP ensures only a 15 percent probability of exceeding the 60 percent threshold under the simulated shock distribution, indicating more prudent resilience lies at the lower end of the authorities’ suggested anchor range.
  - Simulations starting from the actual debt level at end-FY24/25 show debt is likely to remain below but close to the 60 percent ceiling over the next six years, with a non-negligible probability of breaching the ceiling under adverse scenarios.

### Policy implications and recommendations emphasized in the text
- Institutionalize fiscal discipline through a legally binding, simple, transparent, and enforceable rules-based framework to mitigate procyclicality and enhance credibility.
- Prioritize savings and strategic investment of recent and future windfalls (SACU receipts and LHWP-II royalties), with the Revenue Stabilization Fund serving both stabilization and investment roles.
- Strengthen public financial management to address low capital spending efficiency and chronic arrears.
- Ensure any new debt aligns with national development priorities, is supported by robust project appraisal, and is accompanied by efforts to strengthen revenue mobilization and expenditure efficiency.
- Use automatic correction mechanisms and pre-specified debt correction thresholds (adjustment plans triggered if debt-to-GDP exceeds 45, 50, or 55 percent, with intensified measures and short-term adjustments once exceeding 60 percent) and include transparent escape clauses for exceptional events with a requirement to return to compliance within three years.
- Sequence rule implementation to accommodate institutional capacity, with room for future revisions as data quality and forecasting tools improve; consider a GDP rebasing and enhancements in macro-fiscal analysis.

_Source: Authorities’ data and IMF staff calculations._

### 17.      Under the second approach—the ad hoc fiscal balance scenario, debt is projected to

### 1lsoea2025002-source-pdf - 17. Under the second approach—the ad hoc fiscal balance scenario, debt is projected to

### Ad hoc fiscal balance scenario — simulated debt trajectory and implications
- Under the ad hoc fiscal balance scenario, public debt is projected to decline steadily to below 45 percent of GDP by the end of the medium term, provided sustained primary surpluses are realized and borrowing remains aligned with the fiscal path.
- The scenario simulates debt dynamics under the baseline projections of real GDP growth, real interest rates, and primary balances, maintaining the observed share of concessional borrowing and assuming a one-to-one relationship between the primary balance and public debt dynamics.
- The likelihood of breaching the 60 percent debt ceiling remains low—less than 10 percent—even under simulated shock scenarios.
- Simulation conclusions emphasize:
  - the need to protect the fiscal position against negative shocks;
  - maintaining fiscal buffers to withstand adverse shocks; and
  - preserving fiscal space for growth-enhancing investment and development priorities.

### Structural balance rule: rationale and measurement of SACU revenues
- A structural balance rule is recommended to ensure coherence between debt and deficit targets and to accommodate cyclical adjustments and revenue volatility, especially for SACU receipts.
- Preferred measure of underlying “structural” SACU revenues:
  - the lower quartile of SACU receipts over the past 8 years, chosen from various windows of 4 to 20 years for its relative stability, conservatism, and political defensibility.
  - This choice aims to reduce procyclicality and provide a prudent anchor for structural deficit rules, strengthening medium-term fiscal planning.

### Fiscal rules calibration — scenarios, results, and trade-offs
- Calibration setup:
  - three adjustment paths simulated using the IMF fiscal rules calibration tool;
  - debt ceiling: 60 percent of GDP;
  - long-term trend nominal GDP growth rate: 6.5 percent.
- Three simulated adjustment paths and results:
  - (i) constant balance stabilizing debt at its ceiling over the long term: implies a fiscal deficit of -3.1 percent of GDP every year for five years; debt converges to 50 percent of GDP in about 15 years.
  - (ii) convergence to a 50 percent of GDP debt anchor within five years: requires a fiscal deficit of -1.9 percent of GDP every year for five years.
  - (iii) front-loaded adjustment to reach 50 percent of GDP within five years: entails -0.5 percent of GDP in year 1 → -1.5 percent of GDP in year 2 → -2.5 percent of GDP in years 3–5.
- Feasibility and policy implications:
  - The simulated results suggest that a 3 percent of GDP structural deficit rule is feasible for Lesotho.
  - Using the preferred underlying revenue measure (lower quartile of SACU and grant revenues over the past eight years), baseline projections suggest the structural fiscal balance will remain in surplus over the medium term.
  - Opportunity identified to save revenue windfalls and allocate resources toward retiring costly domestic debt to strengthen fiscal buffers and reduce debt vulnerabilities.
  - Given authorities have not revised future borrowing plans or committed to financing capital spending from domestic resources, prudent priority is to begin repaying costly debt to build fiscal space and resilience.

### Forward-looking scenario analysis — rules, scenarios, and comparative performance
- Simulation design:
  - rule introduced in the first year and simulated over the forecast horizon;
  - four macro scenarios:
    - baseline scenario consistent with the macroframework discussed in the 2025 Article IV Staff Report;
    - low-growth scenario: large and temporary shock to growth in the first year with no permanent effect on long-run real GDP level;
    - boom-and-bust scenario: long period of strong growth followed by a decline with permanent effects on the level of real GDP;
    - contingent liabilities scenario: contingent liabilities amount to 15 percent of GDP in the first year while other macro variables follow the baseline.
  - three operational rules applied under each scenario:
    - structural deficit rule of 3 percent of GDP;
    - spending-to-GDP rule of 55 percent;
    - real spending growth rule capped at 0 percent (indicating nominal spending growth at inflation rate).
- Key comparative findings:
  - Across all four scenarios, the structural balance rule yields the strongest debt reduction path, ensuring a steady and significant decline in the debt-to-GDP ratio over time.
  - The spending growth rule offers moderate debt containment, performing better than no rule but more vulnerable to shocks, especially under the boom-and-bust scenario.
  - The spending-to-GDP rule tends to stabilize debt but is less effective at placing debt on a downward trajectory under adverse or volatile conditions.
  - The no rule scenario results in rising or flat debt paths across simulations, underscoring the importance of adopting fiscal rules.
  - Overall conclusion: rules anchored in fiscal balances provide the strongest safeguard against debt escalation amid growth volatility or contingent fiscal pressures.

### Considerations for a stabilization fund and reserve adequacy
- Recommendation: authorities are strongly encouraged to swiftly operationalize a well-governed stabilization fund, anchored by credible fiscal rules.
- Reserve adequacy and strategy:
  - gross international reserves expected to surpass six months of import coverage in FY25/26—a level deemed appropriate for Lesotho—and staff recommends fiscal surpluses be redirected toward reducing public debt.
  - The IMF Assessment of Reserve Adequacy for Credit Constrained Economies (ARA-CC) framework is used, balancing the absorption-smoothing role of reserves during crises against the opportunity cost of holding reserves.
  - In Lesotho’s case, the marginal opportunity cost of further reserve accumulation is approximated by the cost of external borrowing; the marginal benefit is the economic value of holding an additional unit of reserves to absorb external shocks.
  - From simulations, the optimal level of reserves is about 4.5 to 6 months of imports for Lesotho.
  - Placing debt on a declining path to around 45 percent of GDP would still allow reserve accumulation to reach 7.5 months of imports at the end of the forecast horizon.
  - According to the LIC-DSF framework, this adjustment would improve Lesotho’s status from "limited space to absorb shocks" to "some space to absorb shocks."
- Debt repayment sequencing considerations:
  - domestic debt carries a significantly higher interest cost, but gradual repayment of external debt could reduce external debt vulnerabilities; maintaining some domestic issuance supports local securities market development.
  - Note on concessional borrowing: from Lesotho’s current creditors, the concessional rates range from zero to 2.5 percent.
- Stabilization fund design principles:
  - anchor the fund within the broader fiscal rules framework and medium-term fiscal framework (MTFF);
  - enforce fiscal discipline at the budget level with transparent, rule-based deposit and withdrawal mechanisms to avoid ad hoc political pressures;
  - dual objectives suggested—stabilization (counter-cyclical smoothing during revenue volatility) and investment (building long-term fiscal buffers for growth-enhancing capital expenditure);
  - asset allocation: stabilization tranche invested in low-risk, highly liquid instruments; investment tranche pursues higher returns with longer horizon under prudent risk management;
  - strong governance, clear operational guidelines, and regular reporting required to safeguard integrity and effectiveness.

### Experience from Chile — relevance for Lesotho
- Chile is highlighted as a key international example for establishing a stabilization fund and structural fiscal rule.
- Chile’s 2001 fiscal rule targeted a structural surplus of 1 percent of GDP and anchored policy on estimates of potential output and long-term copper prices provided annually by two independent expert panels.
- Chile’s approach:
  - mitigated procyclical fiscal management tied to volatile commodity revenues;
  - enforced discipline and predictability by adjusting revenues cyclically while keeping expenditure fixed;
  - saved structural surpluses in sovereign wealth funds (Economic and Social Stabilization Fund and Pension Reserve Fund), preserving macroeconomic stability and building buffers for downturns.
- Relevance to Lesotho: lessons on using structural balance rules and stabilization mechanisms to maintain debt within sustainable thresholds and manage revenue volatility.

*Source: Authorities’ data and IMF staff calculations; content extracted from the provided chapter/section.*

### 37.      The rule’s countercyclical design proved effective during major shocks, enabling Chile

### The rule’s countercyclical design proved effective during major shocks, enabling Chile to maintain fiscal credibility while adapting to changing conditions

### Chilean fiscal rule performance and mechanics
- Surpluses accumulated during copper price booms were deployed to finance deficits during the 2008 Global Financial Crisis and the 2014 commodity price crash, allowing the government to avoid abrupt austerity measures.
- Despite a temporary decline in the overall fiscal balance to -4.3 percent of GDP, Chile maintained prudent fiscal management and adjusted its structural target over time—from 1 percent to 0.5 percent, and later to balance—demonstrating the rule’s built-in flexibility while preserving its anchoring role for fiscal policy.
- The stabilization fund (ESSF) served as an effective buffer, enabling a countercyclical response and sustaining investor confidence in the fiscal framework.
- Debt outcomes and fiscal space:
  - Gross debt declined to as low as 4 percent of GDP in the pre-crisis period.
  - Net debt was contained within a 20 percent anchor.
  - Chile anchored its fiscal framework with a debt sustainability objective, maintaining public debt well below its 45 percent of GDP target for much of the pre-pandemic period.

### Fiscal rule effects on expenditure and revenue cyclicality
- The rule successfully delinked public expenditure from revenue cycles, particularly during commodity-driven booms, and helped maintain prudent fiscal management.
- In the first six years after the rule’s adoption:
  - Average revenue growth was around 15 percent driven by rising copper prices.
  - Expenditure growth was contained to under 9 percent.
- During subsequent shocks—such as the 2009 global financial crisis and the 2014 copper price collapse—the government drew on ESSF savings to avoid abrupt fiscal consolidation, preserving priority expenditures and macroeconomic stability.

### Lessons for Lesotho: transferability and design guidance
- Addressing revenue volatility:
  - Chile adjusted revenues for long-term trends in copper prices via a structural balance rule, limiting fiscal fluctuations outside large external shocks. A similar approach could be applied in Lesotho where SACU transfers are highly volatile to smooth budget execution and support more stable expenditure planning.
- Embedding discipline:
  - Chile’s rule helped curb procyclical and ad hoc spending while channeling windfall revenues into the ESSF, enhancing macro-fiscal stabilization, strengthening budget credibility, and reducing the scope for off-budget mechanisms—reforms that could support Lesotho’s efforts to curb arrears and improve PFM practices.
- Debt anchor and investor confidence:
  - Anchoring the fiscal framework with a debt sustainability objective helped maintain investor confidence and contain financing costs in Chile; this offers a relevant example for Lesotho on how a credible fiscal rule can provide a durable anchor for long-term fiscal sustainability.

### Policy recommendations and proposed framework for Lesotho
- Institutionalize a rules-based framework and a stabilization fund to:
  - Anchor expenditure to structural revenues.
  - Save excess receipts for future stabilization.
  - Address wage bill rigidities, domestic arrears, and debt accumulation.
- Model-based calibration results suggest a fiscal framework comprising:
  - A debt ceiling of 60 percent of GDP.
  - A debt anchor around 50 percent of GDP.
  - A structural deficit rule of 3 percent of GDP.
  - Expenditure operational rules alongside the above.
- Expected benefits of implementing that framework:
  - Support fiscal sustainability while preserving space for priority spending and cyclical responses.
  - Promote greater fiscal transparency, strengthen medium-term budgeting, and reinforce political ownership of fiscal consolidation.
  - Help break the cycle of procyclical spending and foster a more predictable fiscal environment.
- Rule governance:
  - Periodic—but infrequent—review of rule parameters may be appropriate to maintain relevance while preserving credibility.
  - The stabilization fund should be explicitly anchored within the fiscal rules framework and designed to serve dual purposes—short-term stabilization and long-term investment—to cushion shocks, maintain the exchange rate peg, and support capital spending as implementation capacity improves.

### Lesotho context, macro-structural challenges, and potential gains from reforms
- Public sector footprint and fiscal pressures:
  - Public expenditure to GDP ratio: 53 percent.
  - Public sector wages: 17 percent of GDP (2024 estimates), accounting for 72 percent of tax revenue.
  - GDP per capita fell 14 percent between 2016 and 2023.
  - Over half of the economy’s formal workers are public sector employees; they earn, on average, over four times the median private sector wage.
- Labor market and poverty indicators:
  - Labor force participation: 60 percent (vs. more than 70 percent for sub-Saharan Africa).
  - Unemployment rate: 16 percent in 2024 (versus 6 percent in Sub-Saharan Africa and 5 percent for emerging market and developing economies).
  - Informal employment among those participating in the labor market: nearly 80 percent.
  - Extreme poverty: nearly four in ten people live on less than $2.15 per day.
  - Remittances: over 20 percent of GDP annually.
- Sectoral concentration and structural transformation:
  - Textiles sector employment shrunk from a peak of 60,000 workers to around 30,000 currently.
  - Textiles dominate exports to the United States (near 10 percent of GDP) and face risks from potential trade policy changes, including AGOA expiration in September and possible steep tariffs.
  - Lesotho’s product space is concentrated in peripheral clusters (textiles, diamonds, wool, some machinery manufacturing, limited food and beverage manufacturing), limiting diversification and movement to higher value-added activities.
  - Structural transformation has been limited: industry’s share of value added has not increased proportionally with employment growth; services’ share of employment rose while its share of value added fell.
- Reform scenario impacts on jobs:
  - A feasible reform scenario that incorporates macro-fiscal reform could increase growth by 1.5 percentage points (2025 Article IV upside scenario).
  - Using the median elasticity between growth and job creation for sub-Saharan Africa, this 1.5 percentage point growth increase could be associated with the creation of 4,800 jobs per year.
  - If comprehensive reforms boost the job-intensity of growth to levels seen outside the region, the same 1.5 percentage point increase could create 14,000 jobs per year.

### Annex I: Calibration approaches for overall and primary balance (equations preserved)
- Approach 1: Convergence in the Long Term
  - Equation: 푏푏∗ = 휆휆푑푑∗
  - Where 푏푏∗ represents either balance in percent of GDP, 푑푑∗ is a given debt-to-GDP target, and 휆휆 takes the form of −훾훾/(1+훾훾) for an overall balance target, or (푖푖−훾훾)/(1+훾훾) for a primary balance target, where 훾훾 is the nominal GDP growth over the long term and 푖푖 represents the nominal interest rate paid on public debt.
- Approach 2: Convergence by a Given Date
  - Equation: 푏푏∗ = 휆휆(1+휆휆)푁푁−1 [푑푑0(1 +휆휆)푁푁 − 푑푑∗]
  - This calibrates 푏푏∗ so that the debt ratio hits its target 푑푑∗ after 푁푁 years.
- Approach 3: Convergence by a Given Date Following a Transition Period
  - Equation (piecewise): 
    - 푏푏푡 = { 훼훼훼훼 + 푏푏0, where 0 < 훼훼 < 푇푇
             훼훼푇푇 + 푏푏0 = 푏푏푇푇∗, where 푇푇 ≤ 훼훼 ≤ 푁푁 }
  - Where 훼훼 represents the annual constant amount adjusted until it reaches the target 푏푏푇푇∗ after 푇푇 years. If 푏푏푇푇∗ is maintained afterward, this will ensure convergence to the debt target by the end of year 푁푁.

*Source: Excerpts from the IMF chapter on Chile’s fiscal rule and Lesotho policy recommendations.*

### 10.      Structural transformation requires

### 10.      Structural transformation requires

### Labor intensity and value-added structure
- Many high value-added sectors (e.g. mining, clean energy) are capital intensive, not labor-intensive.
- Figure 5 shows labor intensity of all 2-digit manufacturing sectors internationally (services excluded due to lack of reliable data).
- Textiles, a key Lesotho industry, is one of the most labor-intensive industries internationally.
- Food and beverage and machinery manufacturing are above average in labor intensity.
- Manufacturing of raw materials, most relevant to Lesotho’s diamond industry, is one of the least labor intensive.
- Lower-employment intensity sectors can still generate employment spillovers through ancillary industries and local demand.

### Changing pattern of structural transformation
- Historical pattern: workers moved out of basic agriculture into manufacturing and then modern services (East Asia example).
- Technological change has made manufacturing less labor intensive, making past mass employment pathways harder to replicate (Rodrik 2016, 2022).
- “Industries Without Smokestacks” (Page 2020) present alternative opportunities: modern services such as tourism and financial services, high value agriculture and agro-processing, which feature some labor intensity, scope for productivity growth and export capacity.

### Tourism: potential and constraints
- Tourism is job intensive and Lesotho has significant tourism growth potential (UN 2023), particularly in rural areas.
- Key barriers:
  - Inadequate infrastructure: poor road and electricity access hampering investment and site development.
  - Air connectivity is limited and expensive; bus options are long and indirect.
  - Trains currently provide only freight services.
  - Visa process: high costs and an unreliable online system.
  - Reliance on South African statistics for traveler data and lack of comprehensive internal data collection.
  - Political influences on infrastructure development decisions.
- As a result, Lesotho has been unable to capitalize on regional tourism opportunities despite location in a heavily tourism-focused region.

### Agro-processing and high-value agriculture: potential and constraints
- Lesotho has significant potential in horticulture, herbal (e.g. rosehip oil), natural cosmetics, honey and food processing industries.
- Key constraints:
  - Rural infrastructure deficiencies: insufficient irrigation, quality roads, rural logistics hubs, and cold chain storage.
  - No current laboratory able to certify International Standards Organization (ISO) requirements.
  - Development partners (MCC, GIZ) support development of industry specific national standards; African Development Bank is funding a local standards lab to be built in the coming years.
  - Lack of a functioning e-commerce platform because the current national payments system is not compatible with online payments, making access to larger markets difficult.

### MSMEs and employment
- MSMEs employed an estimated 360,000 people in 2023, with 55 percent of MSMEs owned by women (FinScope, 2025).
- Sector composition: almost half of MSMEs in wholesale or retail; 20 percent in agriculture; 17 percent in manufacturing.
- Formalization rate increased from 18 percent in 2016 to 24 percent in 2023.
- Average monthly turnover ranges from USD $390 in manufacturing firms to USD $1,100 in household firms.
- Eighty-two percent of firms are informal (unregistered); half of informal firms cite small size as the primary reason for informality.
- Many informal firms report they would formalize if registration were free, benefits were clear, or they had more information.

### Firm growth barriers and business environment
- Primary barrier: access to finance — around 40 percent of firms report accessing finance is a major or very severe obstacle.
- Other major barriers: political and governance challenges (regulation, tax rates, corruption, political instability).
- Lesotho performs relatively strongly on effectiveness of the court system and labor regulations (World Bank B-READY).
- Adequacy of education is not a key constraint; labor demand is the main challenge.
- Administrative burdens and delays:
  - 15 days to obtain an operating license.
  - 73 days to obtain an import license.
  - 78 days to obtain a construction related permit.
  - Firms report paying unofficial ‘compliance fees’ for permits and services.
- Transparency International CPI score: 37 out of 100 in 2024, with a steady decline since 2012.
- Government tendering inefficiencies: 152 days for firms to receive payment under government contract (more than twice the sub- Saharan African average).
- Market competition assessed as weak (B-READY).
- Recommendations implicit: streamlining tax and licensing systems and leveraging digital tools to unburden administrative procedures and track compliance (World Bank 2024).

### Informality and formalization incentives
- Informality driven by weak institutional support, limited access to finance, and lack of incentives to formalize.
- Four in five informal sector firms state willingness to formalize if registration were free, benefits clear, or it was less time consuming (Finscope 2025).
- Government recently announced free registration for youth led businesses.
- Formalization increases attractiveness if it enables greater access to finance, social protections and public procurement opportunities (ILO 2025).

### Electricity sector constraints
- Reliability and accessibility of electricity is a private-sector bottleneck despite low nominal prices.
- About 65 percent of businesses experience electricity outages.
- Only about a quarter of Lesotho’s businesses have access to a back-up electricity generator, compared to nearly half of sub-Saharan African firms (World Bank B-Ready).
- Time to obtain electrical connection: 52 days versus the SACU average of 38 days.
- About 30 percent of businesses identified electricity as a major to severe obstacle.
- USA ITA estimate: only one-fifth of a potential 450 MW is currently utilized.
- Electricity price for businesses in Lesotho: 0.021USD/kWh; African average: 0.123USD/kwh (Global Petrol Prices).
- LEC imports around 50 percent of total electricity demand from South Africa and Mozambique and sells at a loss.
- LEC declared bankruptcy in 2025.
- Recommendation: efficiently explore renewable electricity potential and implement deep reforms to the electricity market and LEC governance to establish an efficient, accessible and reliable electricity sector that supports foreign direct investment.

### Geographic and sectoral distribution of barriers
- Barriers are broadly shared across industries and locations; some variation exists:
  - Manufacturing more constrained by electricity than services.
  - Crime, theft and disorder matter more for services.
- Many barriers are more binding in rural areas (access to finance, internet and electricity) (FinScope 2025).
- Addressing the steepest barriers will benefit a wide swath of Lesotho’s private sector.

### Empirical impacts of barriers on firm outcomes
- Principal component analysis consolidates barriers into seven indexes: financial constraints, informal competition, corruption, inadequate labor education, weak business environment, inadequate infrastructure and lack of security.
- Regression analysis (three-year growth rate of employment or revenue regressed on these indexes) finds:
  - A one standard deviation increase in financial constraints in Lesotho is associated with a drop in firm employment growth by 0.5 percent over three years.
  - Negative employment effects are also found at the SACU level for informal competition, corruption, and inadequate education.
- Conclusion: addressing these barriers is critical to unlocking employment growth in Lesotho.

### Financial access as a bottleneck (Box 1)
- Financial sector features:
  - Dominated by four commercial banks—three subsidiaries of South African banks and one state-owned bank—primarily serving salaried individuals through payroll-based personal loans.
  - Sector characterized by excess liquidity, limited competition, and a narrow product offering.
  - Non-bank financial institutions (NBFIs) play a marginal role.
  - Capital markets are nascent with only one equity listing on the Maseru Securities Market.
- Household financial access gains:
  - 7 percent of Basotho had financial access in 2021, up from 60 percent in 2011 (Finscope 2024). [Note: source text contains this contradictory phrasing; preserved exactly as presented.]
- Firm financial access constraints:
  - Two thirds of firms highlight insufficient operational cash flow as a key challenge (Finscope 2025).
  - Only 17 percent of MSMEs have a formal bank account and only 10 percent receive credit from a formal financial institution in 2023 (Finscope 2025).
  - Sixty-six percent of MSMEs rely on mobile money for transactions.
  - 89 percent of firms not covered for any personal or business risk (insurance gap).
- Lending obstacles:
  - High degree of informality and lack of financial records: only 22 percent of MSMEs reliably keep financial records and only 18 percent are registered (Finscope 2025).
  - Weak credit infrastructure: only banks and the few largest NBFIs consistently share credit information to the bureau; MSMEs currently excluded from credit record coverage.
  - Collateral challenges: lack of asset recognition and enforceability limits secured transactions.
  - LERIMA launched in 2021; World Bank CAFI project plans a collateral registry.
- Demand-side constraints:
  - Only 11 percent of businesses have a written business plan; only 35 percent have a business budget (Finscope 2025).
  - Only four in ten firms are aware of support organizations such as the Basotho Enterprises Development Corporation (BEDCO).
  - Thirty-three percent of firms report “unfavorable rates, collateral, or procedures as main reason for not applying to loans” (B Ready Lesotho 2025).
- Public programs and reforms:
  - Government programs include direct grants and partial credit guarantee schemes (PCGs) but grants are low value and PCG take-up is underwhelming.
  - June 2025 discussions noted increasing take up of the main PCG and banks/NBFIs experimenting with new MSME-focused lending products.
  - Coordination across actors (BEDCO, banks, MFIs, industry groups, development partners) appears to be improving.
  - Authorities’ reform agenda: National Financial Inclusion Strategy II (2024–28) and forthcoming Financial Sector Development Strategy II (2025–30).
  - Key pillars: strengthen credit infrastructure (e.g., expanding credit bureau coverage to include MSMEs, integrating registries), enhance public support instruments (e.g., reform PCGs, establish a development finance institution), promote financial literacy, emphasize digitization, fintech regulation, and inclusive financial products.
  - Success conditional on sustained political commitment, effective institutional collaboration, and mobilization of resources from public and private sectors.

*Source: 1lsoea2025002-source-pdf - 10.      Structural transformation requires (IMF chapter).*

### 22.      Without established employment experience, youths struggle to enter the labor

### 22.      Without established employment experience, youths struggle to enter the labor market

### Youth labor market outcomes and challenges
- Youth unemployment rate: 24.8 percent for 15–24 year olds versus 10.1 percent for sub-Saharan Africa (Figure 8).
- More than one in three youths are “neither in employment, education or training” (NEET); rate reaches over 40 percent for young women (ILOSTAT).
- Experience paradox: the longer an individual is unemployed, the harder it can be to find employment as skills and networks atrophy (ILO 2024).
- Poor labor market outcomes early in a career are associated with poorer outcomes decades later (ILO and ADB 2020; Kahn 2010).
- Rural youth face steeper challenges: less access to job opportunities, lower wages when employed, and higher likelihood of working in the informal sector.
- Interventions linked to skills training and entrepreneurship are found to have a larger impact on youth labor market outcomes than employment services or subsidized employment (ILO 2025).

### Gender-specific barriers and outcomes
- Young women unemployment: 37 percent versus 18 percent for young men (Figure 8).
- Labor force participation rates (2024): 48.7 percent for women versus 67.7 percent for men.
- Higher reliance on informal employment among women (ILOSTAT).
- Female entrepreneurship: Lesotho has a high rate relative to sub-Saharan Africa average, but women’s businesses tend to be smaller, employ fewer people, operate in less-profitable sectors, and are subject to greater shocks (Cucagna and others 2025).
- Drivers of gender gaps include cultural, regulatory and legislative barriers (including differences between legislative progress and customary law), steeper domestic childcare responsibilities, early childbearing and maternal health challenges, and digital and financial access gaps (World Bank 2022; Kolovich and Newiak 2025).
- Maternal mortality: 478 deaths per 100,000 live births in 2020, significantly higher than the regional average.
- Adolescent childbirth: 71 in every 1,000 girls aged 15–19 gave birth in 2023 (World Bank gender indicators).
- Women face constraints in accessing bank business loans: required to provide husband’s name and income statements, and are less likely to be approved than men, particularly if unmarried (Robakowski-Van Stralen and Roberts 2024).

### Skills mismatch and labor market data gaps
- Paradox in unemployment by education: those with advanced levels of education in Lesotho (and sub-Saharan Africa broadly) have higher unemployment rates than those with intermediate levels (Figure 9) — evidence of potential skills mismatch (ILO 2019).
- Two-thirds of tertiary graduates studied social sciences and education, while most private and public investment is oriented towards agriculture, manufacturing, tourism, and technology (Rasagam and others 2023).
- Skills mismatch exacerbated by lack of robust labor market data: no detailed understanding of growing sectors or skills in demand.
- Governance around skills development is fragmented: Ministry of Labor lacks influence over training programs; programs often run independently by the Prime Minister’s office without coordination or clear feedback mechanisms.
- Weak career guidance and under-resourced training centers.
- South Africa’s model of inclusive governance in skills development offers a regional example, but South Africa’s extremely high youth unemployment indicates that addressing labor supply alone is insufficient.

### Policy priorities to spur job creation (Section E)
- Overarching need: coordinated, concerted structural reform effort to spur private sector–led job creation; prioritize broad-based structural (“first generation”) reforms focused on removing barriers to diversification and firm-level growth.
- Complementary labor supply policies: support job seekers and address skill mismatches.
- Reform design principles: learn international best practice, tailor to Lesotho circumstances, sustain multi-year reform effort, secure political and social support, use effective consultation and communication strategies, and apply appropriate bundling, sequencing, and pacing with demonstrable upfront gains (IMF 2024b, 2024c, 2025a).

### Fiscal-structural reforms and public sector role
- Public sector dominance means fiscal-structural reforms are essential for private sector success; public sector should switch from substitute to enabler of private sector development.
- Improve public sector investment performance: build capacity across the project management cycle to improve capital budget execution, reduce delays, and generate stronger spillovers to local construction economy.
- Public procurement: focus on efficiency and transparency.
- Prevent public sector arrears to improve direct links with private firms.
- Address distortions from comparatively high public sector wages to reduce labor market crowding out (Thevenot 2024 provides guidance on trade-offs and setting public sector wages).
- Coordinate government efforts to spur private sector development; subject all programs to transparency and evaluation throughout their lifecycle.

### Caution on industrial policies and public employment programs
- Industrial policies: approach with caution. Structural reforms addressing growth barriers (access to finance, electricity market failures, business environment weaknesses, infrastructure deficits) bring larger benefits than “picking winners” or directly supporting individual firms/sectors (IMF 2025b). Risks of industrial policy include fiscal costliness, distortions, governance challenges, difficulty of unwinding programs, and failure to solve underlying market failures.
- Public employment programs: checkered history; often fail due to lack of coordination, poor transparency and governance, and insufficient exit pathways (ILO 2012, 2020).
  - If used as temporary social support, design principles include:
    - Strong coordination mechanisms across agencies.
    - Time-limited employment with formal transition plans.
    - Embed training and skills development throughout.
    - Prioritize transparency and accountability.
    - Design evaluation from the start to build evidence and improve performance.
  - Emphasis: such programs are no substitute for deep reforms required to spur durable, private sector–led job creation.

*Source: Extracted chapter content from the Lesotho country report (PDF content provided).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2025/english/1lsoea2025002-source-pdf.pdf_