## sipea2025140

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---

### Major macroeconomic challenges and structural vulnerabilities
- Heavy reliance on Southern African Customs Union (SACU) receipts makes the country’s fiscal position highly volatile and vulnerable to regional economic conditions.
- Limited economic diversification exposes the economy to external demand shocks and competitiveness pressures.
- Fiscal management has been procyclical and is complicated by rigidity of public expenditures, particularly the large wage bill.
- Fixed exchange rate peg to the South African rand (member of the Common Monetary Area) restricts monetary policy responses to shocks.
- Limited access to international financing reduces the ability to buffer revenue shortfalls.
- A relatively small private sector and episodes of political instability complicate sustaining fiscal stability, uninterrupted delivery of public services, and resilient economic growth.

### Recent developments and fiscal opportunity
- Emergence of a fiscal surplus starting from FY23/24 driven by strong SACU receipts and a break from prior procyclical spending.
- Renegotiation of water royalty rates under the Treaty on the Lesotho Highlands Water Project (LHWP-II) now provides a significantly higher and more stable revenue stream, reducing reliance on SACU transfers.
- Caveats: low capital spending efficiency, chronic arrears, and still elevated debt-to-GDP ratios require disciplined fiscal management and strategic saving/investment of additional revenues.

### Institutional reforms proposed
- Authorities advanced a policy paper stipulating a fiscal rules framework, emphasizing legally binding, well-calibrated, enforceable rules that are simple, transparent, and easy to operate.
- Proposed legal underpinnings: draft Public Finance Management and Accountability Bill and the existing Public Debt Management Act.
- Proposal to establish an independent Fiscal Council to validate macro assumptions, assess fiscal performance, publish compliance reports, review corrective actions and escape clause triggers.
  - Fiscal Council design: comprising five members with at least one external expert, and an outsourced secretariat.
- Proposed Revenue Stabilization Fund to save volatile SACU windfalls and shield capital expenditure during downturns.

### Key elements of the proposed fiscal rules framework
- Legally binding debt ceiling of 60 percent of GDP, complemented by a debt anchor of 50 percent of GDP and a structural deficit rule set at 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.
- Pre-specified debt correction thresholds:
  - If debt-to-GDP exceeds 45, 50, or 55 percent, government must adopt adjustment plans with increasing intensity.
  - Once debt exceeds 60 percent, short-term adjustments prioritized (spending cuts and/or targeted revenue increases).
- Escape clauses for exceptional events subject to transparent justification and requirement to return to compliance within three years.
- Framework allows future revisions to accommodate capacity improvements and a forthcoming GDP rebasing.

### Public debt status and comparators
- Public debt declined from 61.5 percent of GDP in FY23/24 to 56.8 percent of GDP in FY24/25 in Lesotho, due to pickup in redemption of domestic securities and arrears clearance.
- Lesotho’s debt carrying capacity (CI score) is described as medium.
- Lesotho’s debt ceiling of 60 percent of GDP is higher than thresholds adopted by most regional and global peers and aligns with the average across sub-Saharan Africa and low-income economies; it exceeds averages in advanced economies and middle-income economies.

### Debt ceiling and anchor calibration
- Rationale for 60 percent debt ceiling: aligned with SADC’s fiscal prudence guidelines and serves as feasible safeguard while preserving fiscal space.
- DSA projection: by 2045 Lesotho’s nominal public debt-to-GDP ratio is projected to remain close to the ceiling (61 percent) and its PV equivalent would be around 52 percent, close to the DSA’s 55 percent threshold.
- Calibration approach:
  - Stochastic simulations leveraging Baum et al (2017) method to compute a safety margin below the maximum debt limit.
  - Key variables: GDP growth, interest rates on public debt, exchange rate fluctuations, terms-of-trade shocks, external loan disbursements and concessionality, SACU revenue volatility, and LHWP-II dependence.
  - Two complementary approaches: (i) fiscal reaction function (FRF) estimated econometrically using a panel of LIDCs; (ii) ad hoc fiscal balance path aligning targets with medium-term macro framework.

### Simulation results and implications
- FRF results:
  - Suggested debt anchor at approximately 47 percent of GDP, ensuring only a 15 percent probability of exceeding the 60 percent threshold.
  - Aligns with proposed multi-layered debt anchor framework set at 45, 50, and 55 percent of GDP but indicates a more prudent anchor lies at the lower end.
  - Simulations starting from end-FY24/25 debt level show debt likely to remain below but close to 60 percent; non-negligible probability of breaching ceiling under adverse scenarios.
- Ad hoc fiscal balance scenario:
  - Under baseline macro assumptions and maintained surpluses, public debt projected to decline steadily to below 45 percent of GDP by the end of the medium term.
  - Likelihood of breaching the 60 percent debt ceiling remains low—less than 10 percent—even under simulated shock scenarios.
- Overarching conclusion: maintain fiscal buffers and protect fiscal position against negative shocks while preserving space for growth-enhancing investment.

### Structural balance rule and SACU revenue treatment
- Structural balance rule should account for cyclical adjustments and SACU revenue volatility to ensure coherence with debt targets.
- Preferred measure for underlying “structural” SACU revenues: the lower quartile of SACU receipts over the past 8 years (selected from windows of 4 to 20 years) as a stable, conservative, and politically defensible benchmark to reduce procyclicality.

### Structural-balance calibration scenarios (IMF fiscal rules calibration tool)
- Assumptions: debt ceiling of 60 percent of GDP and a long-term trend nominal GDP growth rate of 6.5 percent.
- Three adjustment paths simulated:
  - (i) Constant balance that stabilizes debt at its ceiling over the long term: structural balance of -3.1 percent of GDP every year for five years.
  - (ii) Path that achieves convergence to a preferred debt anchor of 50 percent of GDP within five years: structural balance of -1.9 percent of GDP every year for five years.
  - (iii) Front-loaded adjustment to reach 50 percent of GDP within five years: -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.
- Trade-offs: balance ambition and feasibility; front-loaded adjustments reduce time to target but require stronger near-term consolidation.

### Strategic considerations and policy priorities
- Institutionalize fiscal discipline through legally binding and enforceable fiscal rules to reduce procyclicality and enhance credibility.
- Strengthen public financial management to improve capital spending efficiency and address chronic arrears.
- Ensure additional revenues (e.g., LHWP-II royalties, SACU windfalls) are saved and invested strategically—Revenue Stabilization Fund proposed.
- Implement indicative expenditure benchmarks and pre-specified correction thresholds to limit recurrent spending biases.
- Establish independent Fiscal Council to validate macro assumptions, monitor compliance, and bolster transparency and technical credibility.
- Allow for reviews and revisions of the framework as data quality, forecasting, and institutional capacity improve (including upcoming GDP rebasing).

### Feasibility of a 3 percent of GDP structural deficit rule (Summary of simulations)
- 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.
- Policy priority identified: save revenue windfalls and allocate resources toward retiring costly domestic debt to strengthen fiscal buffers and reduce debt vulnerabilities.
- Recommended rule set combines:
  - A debt anchor complemented by a structural balance rule to address revenue volatility tied to SACU transfers.
  - Two indicative expenditure rules: a spending-to-GDP rule of 55 percent and a real spending growth rule capped at 0 percent.
- Four macroeconomic scenarios simulated:
  - Baseline scenario consistent with the macroframework discussed in the 2025 Article IV Staff Report.
  - Low-growth scenario: a large and temporary shock to growth in the first year with no permanent effect on the level of real GDP.
  - Boom-and-bust scenario: a long period of strong growth followed by a decline in growth 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 all other macro variables remain as in the baseline.
- Comparative results:
  - The structural balance rule (3 percent of GDP structural deficit) consistently yields the strongest debt reduction path across all four scenarios.
  - The spending growth rule offers moderate debt containment but is more vulnerable under boom-and-bust scenarios.
  - The spending-to-GDP rule tends to stabilize debt but is less effective at putting debt on a downward trajectory under adverse or volatile conditions.
  - The no rule scenario produces rising or flat debt paths across simulations.

### Stabilization fund: objectives, sizing, sequencing, and governance
- Immediate recommendation: swiftly operationalize a well-governed stabilization fund anchored by credible fiscal rules.
- Reserve adequacy and debt targets:
  - Gross international reserves are expected to surpass six months of import coverage in FY25/26.
  - Staff recommends fiscal surpluses be redirected toward reducing public debt.
  - Reducing debt to 50 percent of GDP over the next five years would significantly lower the risk of a shift to high-risk of debt distress.
- ARA-CC framework and optimal reserves:
  - Optimal level of reserves is about 4.5 to 6 months of imports for Lesotho.
  - From this optimal estimate, rapid debt repayment options are feasible:
    - 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 composition and sequencing considerations:
  - Domestic debt carries significantly higher interest cost.
  - Gradual external debt repayment could reduce external vulnerabilities.
  - Maintaining some domestic issuance supports local securities market development.
  - Current concessional rates from Lesotho’s creditors range from zero to 2.5 percent.
- Design and governance features:
  - Transparent and rule-based deposit and withdrawal mechanisms.
  - Dual objectives: stabilization tranche (liquid, low-risk instruments) and investment tranche (longer horizon, diversified portfolio).
  - Strong governance arrangements and regular reporting.
- Trade-offs: Dual-purpose design must prevent stabilization needs from being crowded out by long-term savings, given Lesotho’s low capacity and high volatility.

### Lessons from Chile relevant for Lesotho
- Chile adopted a structural surplus target of 1 percent of GDP in 2001 anchored on potential output and long-term commodity prices, with estimates provided by two independent expert panels.
- Chile’s structural rule enabled spending smoothing across cycles and accumulation of surpluses in sovereign wealth funds; during major shocks surpluses financed deficits (e.g., 2008 and 2014), avoiding abrupt austerity even when overall fiscal balance temporarily declined to -4.3 percent of GDP.
- Transferable lessons:
  - Address revenue volatility via a structural balance rule that adjusts for long-term trends.
  - Embed discipline into the budget process to reduce procyclical and ad hoc spending and channel windfalls into stabilization funds.
  - Anchor fiscal rules with a debt sustainability objective to maintain investor confidence and contain financing costs.

### Conclusion and recommended fiscal framework
- Model-based calibration suggests the following framework would support sustainability while preserving space for priority spending:
  - 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.
  - Accompanying expenditure operational rules.
- Benefits and implementation guidance:
  - The framework would promote fiscal transparency, strengthen medium-term budgeting, and reinforce political ownership of consolidation.
  - Periodic—but infrequent—reviews of rule parameters may be appropriate to maintain relevance while preserving credibility.
  - The stabilization fund should be explicitly anchored within this fiscal rules framework to serve both short-term stabilization and long-term investment roles, cushion shocks, support the exchange rate peg, and facilitate capital spending once implementation capacity improves.

### Annex I — Calibration approaches for Overall and Primary Balance
- Approach 1: Convergence in the Long Term
  - Overall or primary balance target: b* = λ d*, where b* is balance in percent of GDP, d* is debt-to-GD target, and λ = −γ/(1+γ) for overall balance or (i−γ)/(1+γ) for primary balance; γ is nominal GDP growth over the long term and i is nominal interest rate on public debt.
- Approach 2: Convergence by a Given Date
  - b* = λ (1+λ)^(N−1) [ d0 (1 + λ)^N − d* ] (equation as provided).
- Approach 3: Convergence by a Given Date Following a Transition Period
  - b_t = { α α + b_0, where 0 < α < T; α/T + b_0 = b_T^*, where T ≤ α ≤ N } (equation and definitions as provided).
- These approaches allow calibration of the balance that leads to gradual convergence toward a debt target either in the long term or by a specified date, with optional transition periods.

*Source: https://www.imf.org/-/media/files/publications/selected-issues-papers/2025/english/sipea2025140.pdf*

### 1. Lesotho’s small, open economy faces persistent macroeconomic challenges, with structural

### 1. Lesotho’s small, open economy faces persistent macroeconomic challenges, with structural

### Major macroeconomic challenges and structural vulnerabilities
- Heavy reliance on Southern African Customs Union (SACU) receipts makes the country’s fiscal position highly volatile and vulnerable to regional economic conditions.
- Limited economic diversification exposes the economy to external demand shocks and competitiveness pressures.
- Fiscal management has been procyclical and is complicated by rigidity of public expenditures, particularly the large wage bill.
- Fixed exchange rate peg to the South African rand (member of the Common Monetary Area) restricts monetary policy responses to shocks.
- Limited access to international financing reduces the ability to buffer revenue shortfalls.
- A relatively small private sector and episodes of political instability complicate sustaining fiscal stability, uninterrupted delivery of public services, and resilient economic growth.

### Recent developments and fiscal opportunity
- Emergence of a fiscal surplus starting from FY23/24 driven by strong SACU receipts and a break from prior procyclical spending.
- Renegotiation of water royalty rates under the Treaty on the Lesotho Highlands Water Project (LHWP-II) now provides a significantly higher and more stable revenue stream, reducing reliance on SACU transfers.
- Caveats: low capital spending efficiency, chronic arrears, and still elevated debt-to-GDP ratios require disciplined fiscal management and strategic saving/investment of additional revenues.

### Institutional reforms proposed
- Authorities advanced a policy paper stipulating a fiscal rules framework, emphasizing legally binding, well-calibrated, enforceable rules that are simple, transparent, and easy to operate.
- Proposed legal underpinnings: draft Public Finance Management and Accountability Bill and the existing Public Debt Management Act.
- Proposal to establish an independent Fiscal Council to validate macro assumptions, assess fiscal performance, publish compliance reports, review corrective actions and escape clause triggers.
  - Fiscal Council design: comprising five members with at least one external expert, and an outsourced secretariat.
- Proposed Revenue Stabilization Fund to save volatile SACU windfalls and shield capital expenditure during downturns.

### Key elements of the proposed fiscal rules framework
- Legally binding debt ceiling of 60 percent of GDP, complemented by a debt anchor of 50 percent of GDP and a structural deficit rule set at 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.
- Pre-specified debt correction thresholds: if debt-to-GDP exceeds 45, 50, or 55 percent, government must adopt adjustment plans with increasing intensity; once debt exceeds 60 percent, short-term adjustments prioritized (spending cuts and/or targeted revenue increases).
- Escape clauses for exceptional events subject to transparent justification and requirement to return to compliance within three years.
- Framework allows future revisions to accommodate capacity improvements and a forthcoming GDP rebasing.

### Public debt status and comparators
- Public debt declined from 61.5 percent of GDP in FY23/24 to 56.8 percent of GDP in FY24/25 in Lesotho, due to pickup in redemption of domestic securities and arrears clearance.
- Lesotho’s debt carrying capacity (CI score) is described as medium.
- Lesotho’s debt ceiling of 60 percent of GDP is higher than thresholds adopted by most regional and global peers and aligns with the average across sub-Saharan Africa and low-income economies; it exceeds averages in advanced economies and middle-income economies.

### Debt ceiling and anchor calibration
- Rationale for 60 percent debt ceiling: aligned with SADC’s fiscal prudence guidelines and serves as feasible safeguard while preserving fiscal space.
- DSA projection: by 2045 Lesotho’s nominal public debt-to-GDP ratio is projected to remain close to the ceiling (61 percent) and its PV equivalent would be around 52 percent, close to the DSA’s 55 percent threshold.
- Calibration approach:
  - Stochastic simulations leveraging Baum et al (2017) method to compute a safety margin below the maximum debt limit.
  - Key variables: GDP growth, interest rates on public debt, exchange rate fluctuations, terms-of-trade shocks, external loan disbursements and concessionality, SACU revenue volatility, and LHWP-II dependence.
  - Two complementary approaches: (i) fiscal reaction function (FRF) estimated econometrically using a panel of LIDCs; (ii) ad hoc fiscal balance path aligning targets with medium-term macro framework.

### Simulation results and implications
- FRF results:
  - Suggested debt anchor at approximately 47 percent of GDP, ensuring only a 15 percent probability of exceeding the 60 percent threshold.
  - Aligns with proposed multi-layered debt anchor framework set at 45, 50, and 55 percent of GDP but indicates a more prudent anchor lies at the lower end.
  - Simulations starting from end-FY24/25 debt level show debt likely to remain below but close to 60 percent; non-negligible probability of breaching ceiling under adverse scenarios.
- Ad hoc fiscal balance scenario:
  - Under baseline macro assumptions and maintained surpluses, public debt projected to decline steadily to below 45 percent of GDP by the end of the medium term.
  - Likelihood of breaching the 60 percent debt ceiling remains low—less than 10 percent—even under simulated shock scenarios.
- Overarching conclusion: maintain fiscal buffers and protect fiscal position against negative shocks while preserving space for growth-enhancing investment.

### Structural balance rule and SACU revenue treatment
- Structural balance rule should account for cyclical adjustments and SACU revenue volatility to ensure coherence with debt targets.
- Preferred measure for underlying “structural” SACU revenues: the lower quartile of SACU receipts over the past 8 years (selected from windows of 4 to 20 years) as a stable, conservative, and politically defensible benchmark to reduce procyclicality.

### Structural-balance calibration scenarios (IMF fiscal rules calibration tool)
- Assumptions: debt ceiling of 60 percent of GDP and a long-term trend nominal GDP growth rate of 6.5 percent.
- Three adjustment paths simulated:
  - (i) Constant balance that stabilizes debt at its ceiling over the long term: structural balance of -3.1 percent of GDP every year for five years.
  - (ii) Path that achieves convergence to a preferred debt anchor of 50 percent of GDP within five years: structural balance of -1.9 percent of GDP every year for five years.
  - (iii) Front-loaded adjustment to reach 50 percent of GDP within five years: -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.
- Trade-offs: balance ambition and feasibility; front-loaded adjustments reduce time to target but require stronger near-term consolidation.

### Strategic considerations and policy priorities
- Institutionalize fiscal discipline through legally binding and enforceable fiscal rules to reduce procyclicality and enhance credibility.
- Strengthen public financial management to improve capital spending efficiency and address chronic arrears.
- Ensure additional revenues (e.g., LHWP-II royalties, SACU windfalls) are saved and invested strategically—Revenue Stabilization Fund proposed.
- Implement indicative expenditure benchmarks and pre-specified correction thresholds to limit recurrent spending biases.
- Establish independent Fiscal Council to validate macro assumptions, monitor compliance, and bolster transparency and technical credibility.
- Allow for reviews and revisions of the framework as data quality, forecasting, and institutional capacity improve (including upcoming GDP rebasing).

*Source: https://www.imf.org/-/media/files/publications/selected-issues-papers/2025/english/sipea2025140.pdf*

### 21. The simulated results suggest that a 3 percent of GDP structural deficit rule is feasible for

### 21. The simulated results suggest that a 3 percent of GDP structural deficit rule is feasible for

### Overview and key finding
- Using the preferred measure of underlying revenue—calculated using the lower quartile of SACU and grant revenues over the past eight years—baseline projections suggest that the structural fiscal balance will remain in surplus over the medium term.
- This projected structural surplus provides an opportunity to:
  - Save revenue windfalls.
  - Allocate resources toward retiring costly domestic debt to strengthen fiscal buffers and reduce debt vulnerabilities.
- Given authorities have not revised future borrowing plans nor committed to financing capital spending from domestic resources, repaying costly domestic debt is identified as a prudent priority to build fiscal space and resilience.

### Fiscal rules selection and rationale
- The recommended rule set for Lesotho combines:
  - A debt anchor complemented by a structural balance rule to address revenue volatility tied to SACU transfers.
  - Two indicative expenditure rules as operational tools to cap total expenditure growth and the wage bill.
- Rationale:
  - A debt rule gives a transparent signal of long-term sustainability.
  - A structural balance rule introduces flexibility to accommodate cyclical fluctuations and revenue shocks.
  - Expenditure rules reinforce fiscal discipline, limit procyclical spending, and support medium-term consolidation.
- Implementation considerations:
  - Selection must account for institutional capacity, data quality, and economic structure.
  - A structural balance rule requires reliable estimates of potential output and structurally adjusted revenues.

### Simulation scenarios and operational rules
- Simulations are conducted over the forecast horizon assuming the rule is introduced in the first year.
- Four macroeconomic scenarios:
  - Baseline scenario consistent with the macroframework discussed in the 2025 Article IV Staff Report.
  - Low-growth scenario: a large and temporary shock to growth in the first year with no permanent effect on the level of real GDP.
  - Boom-and-bust scenario: a long period of strong growth followed by a decline in growth 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 all other macro variables remain as in the baseline.
- Three operational rules applied in each scenario:
  - A structural deficit rule of 3 percent of GDP.
  - A spending-to-GDP rule of 55 percent.
  - A real spending growth rule capped at 0 percent (indicating nominal spending growth at inflation rate).
- Comparative results:
  - The structural balance rule consistently yields the strongest debt reduction path across all four scenarios, 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 putting debt on a downward trajectory under adverse or volatile conditions.
  - The no rule scenario produces rising or flat debt paths across simulations, underscoring the importance of adopting fiscal rules.
- Conclusion from simulations:
  - Rules anchored in fiscal balances offer the strongest safeguard against debt escalation, particularly amid growth volatility or contingent fiscal pressures.

### Stabilization fund: objectives, sizing, and sequencing
- Immediate recommendation:
  - Swiftly operationalize a well-governed stabilization fund anchored by credible fiscal rules.
- Reserve adequacy and debt targets:
  - Gross international reserves are expected to surpass six months of import coverage in FY25/26.
  - Staff recommends fiscal surpluses be redirected toward reducing public debt.
  - Reducing debt to 50 percent of GDP over the next five years would significantly lower the risk of a shift to high-risk of debt distress.
- ARA-CC framework and optimal reserves:
  - The IMF Assessment of Reserve Adequacy for Credit Constrained Economies (ARA-CC) is used to derive optimal reserve levels for Lesotho.
  - Based on the simulation, the optimal level of reserves is about 4.5 to 6 months of imports for Lesotho.
  - The marginal opportunity cost of further reserve accumulation is approximated by the cost of external borrowing; marginal benefit is the value of added insurance against shocks.
  - From this optimal estimate, rapid debt repayment options are feasible:
    - 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 composition and sequencing considerations:
  - Domestic debt carries significantly higher interest cost.
  - Gradual external debt repayment could reduce external vulnerabilities.
  - Maintaining some domestic issuance supports local securities market development.
  - Current concessional rates from Lesotho’s creditors range from zero to 2.5 percent.

### Design and governance of the stabilization fund
- The stabilization fund should be firmly anchored within the broader fiscal rules framework and integrated into the medium-term fiscal framework (MTFF).
- Key design features:
  - Transparent and rule-based deposit and withdrawal mechanisms to ensure predictability and guard against ad hoc political pressures.
  - Dual objectives: stabilization (countercyclical smoothing of revenue volatility) and investment (building long-term fiscal buffers for growth-enhancing capital expenditure when capacity allows).
  - Distinct asset allocation strategies:
    - Stabilization tranche: liquid, low-risk, highly liquid instruments to support the budget.
    - Investment tranche: longer horizon, diversified portfolio for higher returns subject to prudent risk management.
  - Strong governance arrangements and regular reporting to safeguard fund integrity and effectiveness.
- Trade-offs:
  - Dual-purpose design must prevent stabilization needs from being crowded out by long-term savings, particularly given Lesotho’s low capacity and high volatility.

### Experience from Chile: relevant lessons for Lesotho
- Chile’s fiscal rule since 2001 is a prominent international example for managing commodity-related revenue volatility.
- Chile’s approach and outcomes:
  - Adopted a structural surplus target of 1 percent of GDP in 2001, anchored on potential output and long-term commodity prices, with estimates provided by two independent expert panels.
  - The structural rule enabled spending smoothing across cycles and the accumulation of surpluses in sovereign wealth funds (ESSF and PRF).
  - During major shocks, surpluses financed deficits (e.g., 2008 Global Financial Crisis and 2014 commodity price crash), avoiding abrupt austerity even when overall fiscal balance temporarily declined to -4.3 percent of GDP.
  - Initial post-rule years: average revenue growth of around 15 percent while expenditure growth was contained to under 9 percent.
  - Debt outcomes: gross debt declined to as low as 4 percent of GDP in the pre-crisis period; net debt contained within a 20 percent anchor.
- Transferable lessons for Lesotho:
  - Addressing revenue volatility via a structural balance rule that adjusts for long-term trends (analogous to long-term copper prices in Chile) can smooth budget execution where SACU transfers are volatile.
  - Embedding discipline into the budget process reduces procyclical and ad hoc spending and channels windfalls into stabilization funds.
  - Anchoring fiscal rules with a debt sustainability objective maintains investor confidence and contains financing costs.

### Conclusion and recommended fiscal framework
- Lesotho faces a critical opportunity to institutionalize fiscal discipline and enhance macroeconomic resilience through a legally binding fiscal rule and a stabilization fund.
- Model-based calibration suggests the following framework would support sustainability while preserving space for priority spending:
  - 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.
  - Accompanying expenditure operational rules.
- Benefits and implementation guidance:
  - The framework would promote fiscal transparency, strengthen medium-term budgeting, and reinforce political ownership of consolidation.
  - Periodic—but infrequent—reviews of rule parameters may be appropriate to maintain relevance while preserving credibility.
  - The stabilization fund should be explicitly anchored within this fiscal rules framework to serve both short-term stabilization and long-term investment roles, cushion shocks, support the exchange rate peg, and facilitate capital spending once implementation capacity improves.

### Annex I — Calibration of Overall Balance and Primary Balance (approaches)
- Approach 1: Convergence in the Long Term
  - Overall or primary balance target: b* = λ d*, where b* is balance in percent of GDP, d* is debt-to-GD target, and λ = −γ/(1+γ) for overall balance or (i−γ)/(1+γ) for primary balance; γ is nominal GDP growth over the long term and i is nominal interest rate on public debt.
- Approach 2: Convergence by a Given Date
  - b* = λ (1+λ)^(N−1) [ d0 (1 + λ)^N − d* ] (equation as provided).
- Approach 3: Convergence by a Given Date Following a Transition Period
  - b_t = { α α + b_0, where 0 < α < T; α/T + b_0 = b_T^*, where T ≤ α ≤ N } (equation and definitions as provided).
- These approaches allow calibration of the balance that leads to gradual convergence toward a debt target either in the long term or by a specified date, with optional transition periods.

*Source: Authorities’ data and IMF staff calculations.*

---


_Source: https://www.imf.org/-/media/files/publications/selected-issues-papers/2025/english/sipea2025140.pdf_