## sipea2022003 — Introduction & "Policy coordination would be instrumental to help depoliticize macroeconomic policies"

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---

### An overview of economic institutions and arrangements in Lesotho
- Lesotho is a small open economy with its currency pegged to the South African rand under the Common Monetary Area (CMA), formally established December 5, 1974 (RMA agreement) and revised April 1986.
- Under the CMA:
  - The South African rand and the loti (plural: Maloti) are legal tender in Lesotho and pegged at par.
  - Article 2 of the CMA Agreement permits SACU members to issue national currencies; bilateral agreements with South Africa define the areas in which national currencies are legal tender.
  - Both countries must allow authorized dealers to convert, at par, notes issued by the Central Bank of Lesotho (CBL) or the South African Reserve Bank (SARB) without restriction and subject only to normal handling charges.
- The CBL is required to maintain foreign reserves equivalent to the total amount of maloti currency that it issues (Article 4 of the Lesotho–South Africa bilateral agreement).
- Maloti and rand cash circulate freely and in parallel; market confidence is indicated by the low share of rand-denominated bank deposits (about 2 percent).
- The CBL’s reserves may comprise rand balances, rand currency in a Special Rand Deposit Account with the SARB, South African government stock (up to 10 percent of total reserves), and investments with the Corporation for Public Deposit in South Africa.

### Reserve coverage and currency-board–like arrangement
- All maloti currency issued by the CBL is backed entirely by the central bank’s foreign exchange reserves, giving the arrangement currency-board characteristics (but without the legal prohibition on acquiring domestic assets typical of classical currency boards).
- The CBL maintains high reserve coverage of monetary aggregates to enhance buffers and allow some domestic liquidity control:
  - Coverage focusing on a wider measure of short-term bank liabilities ("M1 plus") has remained comfortably above 100 percent — 130 percent as of December 2021 — providing significant firepower to defend the peg.

### Macroeconomic policy effectiveness under the peg
- Under a peg with perfect capital mobility and parallel circulation of loti and rand:
  - The CBL does not have independent control of its money supply; the money supply expands or contracts in line with central bank purchases or sales of foreign exchange.
  - Interest rate movements in Lesotho largely mirror those in South Africa, except for a spread reflecting country risk.
- Monetary policy limitations:
  - Any expansion in domestic credit is offset by an equivalent reduction in net international reserves (NIR), leaving monetary aggregates unchanged and interest rates returning to international levels.
  - Expansionary monetary policy changes the composition of reserves but not the overall level of monetary aggregates or interest rates.
- Fiscal policy effectiveness:
  - Fiscal policy can directly influence aggregate demand because interest rates remain equal to the international rate and the exchange rate is pegged, so expansionary fiscal policy does not produce crowding out of private activity under perfect capital mobility.
- Factors altering policy effectiveness:
  - If capital mobility is less than perfect, fiscal policy loses some effectiveness (domestic interest rates can move and crowding out can occur) and monetary policy gains effectiveness.
  - Presence of nontradable goods reduces fiscal policy effectiveness while increasing monetary policy effectiveness because money supply changes affect nontradable output; higher shares of nontradables make monetary policy more effective even under a peg.

### Limits and risks of relying on fiscal policy
- Fiscal policy as primary shock absorber under a peg carries risks:
  - Excessive fiscal expansion can weaken confidence in the peg and potentially lead to its collapse.
  - Expansionary fiscal policy can produce current account deficits and expectations of devaluation, higher interest rates, inflation, and loss of competitiveness.
  - Historical crises illustrate such risks (examples cited: Indonesia and Thailand during the 1997/98 East Asian Financial Crisis).
- An economy with an exchange rate peg and no monetary independence must rely heavily on fiscal adjustment to cope with shocks.

### Interaction of monetary and fiscal policies in Lesotho
- In Lesotho, increases in money supply tend to exit the economy, leaving monetary aggregates unchanged and depleting reserves. Examples of outflows:
  - Businesses deposit government payments in bank accounts at large foreign-owned banks, which transfer funds to parent banks in South Africa.
  - Businesses use government payments to pay for imports.
- Fiscal financing identity (as presented):
  - FD_t = (B_t − B_{t−1}) + (M_t − M_{t−1}) + (A_t − A_{t−1})
    - where at time t:
      - FD_t is the fiscal deficit;
      - B_t is government's borrowing from financial markets (including both domestic and external);
      - M_t is the central bank's net claims on government;
      - A_t is arrears.

### Three scenarios illustrating lack of coordination
- Scenario 1: The Ministry of Finance and the fiscus dominate.
  - Fiscal authority sets the deficit without regard for the peg; where domestic financing is limited, the central bank may be directed to finance through monetary base or government deposits can be drawn down (government deposits were 7 percent of GDP as of end 2021).
  - Outcomes: inflationary pressures, pressures on international reserves and the exchange rate, or accumulation of arrears; financial repression if institutional investors are directed to finance deficits.
- Scenario 2: The central bank and exchange rate policies dominate.
  - Monetary authority determines base money independently; fiscal deficit size constrained by the capacity to borrow or raise revenues.
  - Outcomes: excessive external borrowing with risk of external debt distress; aggressive taxation weighing on incomes and activity; forced fiscal consolidation that may jeopardize growth and social protection.
- Scenario 3: Both authorities act autonomously without coordination.
  - Inconsistent decisions on base money and fiscal deficit lead to unstable equilibrium; one authority becomes subordinated, returning to outcomes similar to Scenarios 1 or 2.
  - Prolonged inconsistency increases loss of confidence, risk to the exchange rate, delays to reforms, stagnant growth, high financing costs, and arrears.

### Historical examples of policy-coordination failures and success
- Failures:
  - 1992/93 UK Exchange Rate Mechanism Crisis: deteriorating fundamentals and inconsistent domestic policy stance relative to rates needed to defend the peg led to crisis.
  - 1994/95 Mexico Peso Crisis: expansionary fiscal and monetary policies inconsistent with a pegged exchange rate contributed to the collapse of the peg.
  - 1997/98 East Asian Financial Crisis: overreliance on foreign savings, mounting current account deficits, heavy short-term foreign borrowing, rapid credit growth, and inadequate supervision produced vulnerabilities that led to peg collapses when confidence evaporated.
- Success:
  - Hong Kong SAR defended its peg during the East Asian Financial Crisis due to a very strong fiscal stance (decades of fiscal surpluses) and decisive structural reforms to restore competitiveness quickly.

### Macro policy trade-offs in the Lesotho context
- Trade-offs among objectives in a small economy with a peg and high capital mobility:
  - Preserving debt sustainability, safeguarding the peg, maintaining investor confidence, and protecting financial stability can be mutually constraining.
  - Limits to borrowing for debt sustainability imply greater use of government deposits (lower reserves) or accumulating arrears, each undermining confidence or financial stability.
  - Preserving fiscal sustainability versus achieving high growth:
    - High growth via investment may require larger fiscal deficits when current spending is sticky, undercutting fiscal sustainability; cutting spending to enhance sustainability can harm growth.

### Role and division of macro policy responsibilities (policy coordination principles)
- Policy coordination and consultation should not entail subordination or compromise both the independence and accountability of the CBL.
- Suggested division of responsibilities:
  - 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.
  - Reserve levels: CBL should determine the reserve level required to safeguard the peg. The CBL can consult with the Ministry of Finance. The reserve requirement will determine the floor on net claims on government (NCG).
  - Fiscal deficit: Safeguarding peg and preserving debt sustainability should determine the affordable fiscal deficit.
  - Spending composition: The government optimizes the composition of spending within the fiscal deficit envelope informed by the CBL to achieve the macro policy objectives—sustainable and inclusive growth.

### Institutional setup and formalization in Lesotho
- Existing coordination channels (e.g., the inter-Ministerial Macro Working Group) should be reinvigorated.
- While preserving institutional independence—particularly of the central bank—policy implications should be discussed across MoF and CBL to provide well-informed, consistent decisions.
- Recommended institutional reforms:
  - 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 layers for effective coordination
- Recommended multilayer interaction:
  - 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 (MOF); director of research, director of market operation (CBL); head of the debt office.
    - Members may change by local situation/feedback; meet regularly to implement principals’ agreements.
    - Senior policy makers from relevant MDAs can be included as needed.
  - Technical task forces and working groups:
    - Include existing Macroeconomic Working Group.
    - Technical staff provide inputs/support for forecasting (growth, inflation, revenue, reserves, etc.).

### Example: The 2021 SDR allocation and coordination implications
- 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.
  - Low-income countries will receive about US$21 billion.
  - In some cases this is equivalent to as much as 6 percent of GDP.
  - Lesotho received about US$ 95 million of new SDR allocation.
- The IMF does not impose restrictions on the use of SDR allocation.

### Access routes to SDR allocation: direct vs. indirect
- Direct access:
  - On-lending 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: Direct debt to the government, potentially increasing accountability.
  - Cons: Drawing on SDRs incurs interest costs at SDR rate (holdings < allocation); incur exchange risk; direct increase external debt; repay within 93 days of end of government financial year (CBL Act).
- Indirect access:
  - Government draws down part of its deposits with the CBL, enabled by the SDR allocation automatically increasing NIR (above the current target), creating space for deposit drawdown.
  - Given perfect capital mobility and a high degree of leakage, the drawdown in deposits will lead to a reduction in reserves.
  - Pros: Creates space for government to draw down deposits at CBL; SDR allocation is not drawn down directly, saving interest costs at SDR rate; avoid exchange rate risk.
  - Cons: Hides the actual debt burden; requires positive balances at the CBL.

### Coordination requirement illustrated by the SDR case
- Without policy coordination, the cheaper option of indirectly drawing on the allocation will not be available.
- Lack of agreement over deposit drawdown size and impact on reserves risks endangering the peg.
- Withdrawals must be determined in context of safeguarding the peg, preserving debt sustainability, and maintaining external stability—e.g., maintaining an adequate level of 4 months of import cover.

### Operational framework to align debt, reserves, spending, and financing
- Suggested sequential and parallel steps:
  - a. Debt limits (determined by debt sustainability analysis) suggest a path for the debt stabilizing primary balance (Ministry of Finance, Debt Department and Macro Department).
  - b. In parallel:
    - The central bank can determine a ceiling on the net credit to government (change in government deposits) that will safeguard the peg by maintaining a certain level of NIR and GIR coverage.
    - The Ministry of Finance can review spending needs and determine the composition—current (including social) vs. capital spending—based on socioeconomic and development priorities, in coordination with other key development stakeholders.
  - c. Revenue mobilization (both domestic and external) is estimated by the Ministry of Finance and the Lesotho Revenue Authority.
  - d. Potential financing from domestic financial markets is determined by the central bank, in coordination with the Ministry of Finance’s Debt Department.
  - e. (a), (b), (c), and (d) jointly determine total potential financing sources.
  - f. This resource envelope determines a maximum for total public expenditure for the Ministry of Finance; however, it is not advisable to spend up to this ceiling as fiscal space must be preserved to allow for response to shocks.

### Monetary and balance-sheet mechanics of SDR allocations
- SDR allocations and the external (BOP) sector:
  - “Holdings of SDRs”: Increase long-term debt liabilities (other investment inflows) under the Financial Account by the amount of SDR allocation.
  - “Allocations of SDRs”: Under official reserve assets, increase gross international reserves (GIR) by the amount of the SDR allocation below the line of the BOP.
  - Both above-the-line and below-the-line under the BOP will increase accordingly.
- SDR allocations and the monetary sector:
  - Foreign Assets under Net Foreign Assets (NFA) increase by the amount of SDR allocation in local currency.
  - Foreign liabilities under NFA also increase by the amount of the SDR allocation (in local currency).
  - Because SDRs are recorded as assets and liabilities on the central bank’s balance sheet, net foreign assets will be unchanged; SDR holdings would directly increase GIR. Net international reserves (NIR) will also increase provided only short-term foreign exchange debt liabilities are not subtracted from GIR.
- Impact on base money depends on exchange rate regime:
  - Under a peg/currency board regime, money supply (reserve money) is usually driven by GIR and NIR. With increases in GIR and NIR, money supply (reserve money) should increase accordingly (assuming no leakages).
  - Alternatively, the monetary authority can forcefully break the link between GIR/NIR and money supply; then 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.

### Key conclusions and policy recommendations
- Macro policy coordination matters given Lesotho’s institutional and economic arrangements: small open economy, large foreign-owned banking sector, pegged exchange arrangement.
- Limited scope for nominal exchange rate adjustment calls for fiscal policy and structural reforms to play the key role in external adjustment.
- Without sound policy coordination, government spending and cash management plans may conflict with:
  - (i) the minimum level of international reserves needed to safeguard the peg,
  - (ii) the level of borrowing needed to preserve debt sustainability, and
  - (iii) minimizing arrears.
- Recommended actions:
  - Reinvigorate the inter-Ministerial Macro Working Group to enhance coordination.
  - Preserve the institutional independence of the central bank within a cohesive, well-coordinated, and commonly agreed macroeconomic framework.
  - Ministry of Finance should determine public debt limits based on prudent debt sustainability analysis.
  - CBL should determine a ceiling on NCG that secures the peg.
  - The interaction of debt limits and NCG ceilings will determine the fiscal deficit, whose composition the Ministry of Finance can optimize to achieve sustainable and inclusive growth.

*Source: IMF Selected Issues paper — "Policy coordination would be instrumental to help depoliticize macroeconomic policies" (sipea2022003).*

### Introduction

### Introduction

### An Overview of Economic Institutions and Arrangements in Lesotho
- Lesotho is a small open economy with its currency pegged to the South African rand under the Common Monetary Area (CMA), formally established December 5, 1974 (RMA agreement) and revised April 1986.  
- Under the CMA:
  - The South African rand and the loti (plural: Maloti) are legal tender in Lesotho and pegged at par.
  - Article 2 of the CMA Agreement permits SACU members to issue national currencies; bilateral agreements with South Africa define the areas in which national currencies are legal tender.
  - Both countries must allow authorized dealers to convert, at par, notes issued by the Central Bank of Lesotho (CBL) or the South African Reserve Bank (SARB) without restriction and subject only to normal handling charges.
- The CBL is required to maintain foreign reserves equivalent to the total amount of maloti currency that it issues (Article 4 of the Lesotho–South Africa bilateral agreement).
- Maloti and rand cash circulate freely and in parallel; market confidence is indicated by the low share of rand-denominated bank deposits (about 2 percent).
- The CBL’s reserves may comprise rand balances, rand currency in a Special Rand Deposit Account with the SARB, South African government stock (up to 10 percent of total reserves), and investments with the Corporation for Public Deposit in South Africa.

### Reserve Coverage and Currency-Board–Like Arrangement
- All maloti currency issued by the CBL is backed entirely by the central bank’s foreign exchange reserves, giving the arrangement currency-board characteristics but without the legal prohibition on acquiring domestic assets typical of classical currency boards.
- To enhance buffers and allow some domestic liquidity control, the CBL maintains a high reserve coverage of monetary aggregates:
  - Coverage focusing on a wider measure of short-term bank liabilities ("M1 plus") has remained comfortably above 100 percent — 130 percent as of December 2021 — providing significant firepower to defend the peg.

### Macroeconomic Policy Effectiveness Under the Peg
- Under a peg with perfect capital mobility and parallel circulation of loti and rand:
  - The CBL does not have independent control of its money supply; the money supply expands or contracts in line with central bank purchases or sales of foreign exchange.
  - Interest rate movements in Lesotho largely mirror those in South Africa, except for a spread reflecting country risk.
- Monetary policy limitations:
  - Any expansion in domestic credit is offset by an equivalent reduction in net international reserves (NIR), leaving monetary aggregates unchanged and interest rates returning to international levels.
  - Expansionary monetary policy changes the composition of reserves but not the overall level of monetary aggregates or interest rates.
- Fiscal policy effectiveness:
  - Fiscal policy can directly influence aggregate demand because interest rates remain equal to the international rate and the exchange rate is pegged, so expansionary fiscal policy does not produce crowding out of private activity under perfect capital mobility.
- Factors altering policy effectiveness:
  - If capital mobility is less than perfect, fiscal policy loses some effectiveness (domestic interest rates can move and crowding out can occur) and monetary policy gains effectiveness.
  - Presence of nontradable goods reduces fiscal policy effectiveness while increasing monetary policy effectiveness because money supply changes affect nontradable output; higher shares of nontradables make monetary policy more effective even under a peg.

### Limits and Risks of Relying on Fiscal Policy
- While fiscal policy is the primary shock absorber under a peg, excessive fiscal expansion can weaken confidence in the peg and potentially lead to its collapse:
  - Expansionary fiscal policy can produce current account deficits and expectations of devaluation, higher interest rates, inflation, and loss of competitiveness.
  - Historical crises (e.g., Indonesia and Thailand during the 1997/98 East Asian Financial Crisis) illustrate such risks.
- Ultimately, an economy with an exchange rate peg and no monetary independence must rely heavily on fiscal adjustment to cope with shocks.

### Interaction of Monetary and Fiscal Policies in Lesotho
- In Lesotho, increases in money supply tend to exit the economy, leaving monetary aggregates unchanged and depleting reserves. Examples of outflows:
  - Businesses deposit government payments in bank accounts at large foreign-owned banks, which transfer funds to parent banks in South Africa.
  - Businesses use government payments to pay for imports.
- Fiscal financing identity (as presented):
  - FD_t = (B_t − B_{t−1}) + (M_t − M_{t−1}) + (A_t − A_{t−1})
    - where at time t:
      - FD_t is the fiscal deficit;
      - B_t is government's borrowing from financial markets (including both domestic and external);
      - M_t is the central bank's net claims on government;
      - A_t is arrears.

### Three Scenarios Illustrating Lack of Coordination
- Scenario 1: The Ministry of Finance and the fiscus dominate.
  - Fiscal authority sets the deficit without regard for the peg; where domestic financing is limited, the central bank may be directed to finance through monetary base or government deposits can be drawn down (government deposits were 7 percent of GDP as of end 2021).
  - Outcomes: inflationary pressures, pressures on international reserves and the exchange rate, or accumulation of arrears; financial repression if institutional investors are directed to finance deficits.
- Scenario 2: The central bank and exchange rate policies dominate.
  - Monetary authority determines base money independently; fiscal deficit size constrained by the capacity to borrow or raise revenues.
  - Outcomes: excessive external borrowing with risk of external debt distress; aggressive taxation weighing on incomes and activity; forced fiscal consolidation that may jeopardize growth and social protection.
- Scenario 3: Both authorities act autonomously without coordination.
  - Inconsistent decisions on base money and fiscal deficit lead to unstable equilibrium; one authority becomes subordinated, returning to outcomes similar to Scenarios 1 or 2.
  - Prolonged inconsistency increases loss of confidence, risk to the exchange rate, delays to reforms, stagnant growth, high financing costs, and arrears.

### Historical Examples of Policy-Coordination Failures and Success
- Examples of crises caused by coordination failures:
  - 1992/93 UK Exchange Rate Mechanism Crisis: deteriorating fundamentals and inconsistent domestic policy stance relative to rates needed to defend the peg led to crisis.
  - 1994/95 Mexico Peso Crisis: expansionary fiscal and monetary policies inconsistent with a pegged exchange rate contributed to the collapse of the peg.
  - 1997/98 East Asian Financial Crisis: overreliance on foreign savings, mounting current account deficits, heavy short-term foreign borrowing, rapid credit growth, and inadequate supervision produced vulnerabilities that led to peg collapses when confidence evaporated.
- Successful coordination example:
  - Hong Kong SAR defended its peg during the East Asian Financial Crisis due to a very strong fiscal stance (decades of fiscal surpluses) and decisive structural reforms to restore competitiveness quickly.

### Macro Policy Trade-offs in the Lesotho Context
- Lesotho is characterized as a small economy with perfect capital mobility and a small (informal) nontradables sector under a peg, facing trade-offs among objectives:
  - Preserving debt sustainability, safeguarding the peg, maintaining investor confidence, and protecting financial stability:
    - Limits to borrowing for debt sustainability imply greater use of government deposits (lower reserves) or accumulating arrears, each undermining confidence or financial stability.
  - Preserving fiscal sustainability versus achieving high growth:
    - High growth via investment may require larger fiscal deficits when current spending is sticky, undercutting fiscal sustainability; cutting spending to enhance sustainability can harm growth.

*Source: sipea2022003 - Introduction (IMF Selected Issues Paper — Introduction).*

### 21. Policy coordination would be instrumental to help depoliticize macroeconomic policies

### 21. Policy coordination would be instrumental to help depoliticize macroeconomic policies

### Role and division of macro policy responsibilities
- Policy coordination and consultation should not entail subordination or compromise both the independence and accountability of the CBL.
- Key fiscal and monetary policies can be determined as follows:
  - 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.
  - Reserve levels: CBL should determine the reserve level required to safeguard the peg. The CBL can consult with the Ministry of Finance. The reserve requirement will determine the floor on net claims on government (NCG).
  - Fiscal deficit: Safeguarding peg and preserving debt sustainability should determine the affordable fiscal deficit.
  - Spending composition: The government optimizes the composition of spending within the fiscal deficit envelope informed by the CBL to achieve the macro policy objectives—sustainable and inclusive growth.

### Institutional setup and formalization in Lesotho
- Lesotho has existing institutional channels for coordination (for example, the inter-Ministerial Macro Working Group) that should be reinvigorated.
- While institutional independence—particularly of the central bank—must be preserved, policy implications should be discussed across MoF and CBL to provide well-informed, consistent decisions.
- Recommended institutional reforms:
  - 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 layers for effective coordination
- Interaction at multiple layers (principals, directors, and technical staff) is recommended to ensure effective 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 (MOF); director of research, director of market operation (CBL); head of the debt office.
    - Members may change by local situation/feedback; meet regularly to implement principals’ agreements.
    - Senior policy makers from relevant MDAs can be included as needed.
  - Technical task forces and working groups:
    - Include existing Macroeconomic Working Group.
    - Technical staff provide inputs/support for forecasting (growth, inflation, revenue, reserves, etc.).

### Example: The 2021 SDR allocation and coordination implications
- 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.
  - Low-income countries will receive about US$21 billion.
  - In some cases this is equivalent to as much as 6 percent of GDP.
  - Lesotho received about US$ 95 million of new SDR allocation.
- The IMF does not impose restrictions on the use of SDR allocation.

### Access routes to SDR allocation: direct vs. indirect
- Two theoretical approaches to government access:
  - Direct access:
    - On-lending 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:
      - Pros: Direct debt to the government, potentially increasing accountability.
      - Cons: Drawing on SDRs incurs interest costs at SDR rate (holdings < allocation); incur exchange risk; direct increase external debt; repay within 93 days of end of government financial year (CBL Act).
  - Indirect access:
    - Government draws down part of its deposits with the CBL, enabled by the SDR allocation automatically increasing NIR (above the current target), creating space for deposit drawdown.
    - 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:
      - Pros: Creates space for government to draw down deposits at CBL; SDR allocation is not drawn down directly, saving interest costs at SDR rate; avoid exchange rate risk.
      - Cons: Hides the actual debt burden; requires positive balances at the CBL.

### Coordination requirement illustrated by SDR case
- Without policy coordination, the cheaper option of indirectly drawing on the allocation will not be available.
- Lack of agreement over deposit drawdown size and impact on reserves risks endangering the peg.
- Withdrawals must be determined in context of safeguarding the peg, preserving debt sustainability, and maintaining external stability—e.g., maintaining an adequate level of 4 months of import cover.

### Operational framework to align debt, reserves, spending, and financing
- Suggested sequential and parallel steps:
  - a. Debt limits (determined by debt sustainability analysis) suggest a path for the debt stabilizing primary balance (Ministry of Finance, Debt Department and Macro Department).
  - b. In parallel:
    - The central bank can determine a ceiling on the net credit to government (change in government deposits) that will safeguard the peg by maintaining a certain level of NIR and GIR coverage.
    - The Ministry of Finance can review spending needs and determine the composition—current (including social) vs. capital spending—based on socioeconomic and development priorities, in coordination with other key development stakeholders.
  - c. Revenue mobilization (both domestic and external) is estimated by the Ministry of Finance and the Lesotho Revenue Authority.
  - d. Potential financing from domestic financial markets is determined by the central bank, in coordination with the Ministry of Finance’s Debt Department.
  - e. (a), (b), (c), and (d) jointly determine total potential financing sources.
  - f. This resource envelope determines a maximum for total public expenditure for the Ministry of Finance; however, it is not advisable to spend up to this ceiling as fiscal space must be preserved to allow for response to shocks.

### Monetary and balance sheet mechanics of SDR allocations (Box 2)
- SDR allocations and the external (BOP) sector:
  - “Holdings of SDRs”: Increase long-term debt liabilities (other investment inflows) under the Financial Account by the amount of SDR allocation.
  - “Allocations of SDRs”: Under official reserve assets, increase gross international reserves (GIR) by the amount of the SDR allocation below the line of the BOP.
  - Both above-the-line and below-the-line under the BOP will increase accordingly.
- SDR allocations and the monetary sector:
  - Foreign Assets under Net Foreign Assets (NFA) increase by the amount of SDR allocation in local currency.
  - Foreign liabilities under NFA also increase by the amount of the SDR allocation (in local currency).
  - Because SDRs are recorded as assets and liabilities on the central bank’s balance sheet, net foreign assets will be unchanged; SDR holdings would directly increase GIR. Net international reserves (NIR) will also increase provided only short-term foreign exchange debt liabilities are not subtracted from GIR.
- Impact on base money depends on exchange rate regime:
  - Under a peg/currency board regime, money supply (reserve money) is usually driven by GIR and NIR. With increases in GIR and NIR, money supply (reserve money) should increase accordingly (assuming no leakages).
  - Alternatively, the monetary authority can forcefully break the link between GIR/NIR and money supply; then 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.

### Key conclusions and policy recommendations
- Macro policy coordination matters given Lesotho’s institutional and economic arrangements: small open economy, large foreign-owned banking sector, pegged exchange arrangement.
- Limited scope for nominal exchange rate adjustment calls for fiscal policy and structural reforms to play the key role in external adjustment.
- Without sound policy coordination, government spending and cash management plans may conflict with:
  - (i) the minimum level of international reserves needed to safeguard the peg,
  - (ii) the level of borrowing needed to preserve debt sustainability, and
  - (iii) minimizing arrears.
- Recommended actions:
  - Reinvigorate the inter-Ministerial Macro Working Group to enhance coordination.
  - Preserve the institutional independence of the central bank within a cohesive, well-coordinated, and commonly agreed macroeconomic framework.
  - Ministry of Finance should determine public debt limits based on prudent debt sustainability analysis.
  - CBL should determine a ceiling on NCG that secures the peg.
  - The interaction of debt limits and NCG ceilings will determine the fiscal deficit, whose composition the Ministry of Finance can optimize to achieve sustainable and inclusive growth.

*Source: IMF Selected Issues paper — "Policy coordination would be instrumental to help depoliticize macroeconomic policies" (sipea2022003)*

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_Source: https://www.imf.org/-/media/files/publications/selected-issues-papers/2022/english/sipea2022003.pdf_