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---

### A. Introduction
- Lesotho has made considerable progress in macroeconomic stability: fiscal position and external current account improved, inflation slowed, and net international reserves increased.
- Poverty remains widespread and is aggravated by a high incidence of HIV/AIDS.
- Historical growth:
  - In the 1990s, Lesotho grew as fast as 6 percent per year.
  - More recently growth slowed to about 3 percent on average, before surging to 7 percent in 2006.
- Major shocks weakening growth:
  - Substantial real appreciation of the rand (to which the loti is pegged);
  - Removal of textile quotas by industrial countries;
  - Continuing decline in the terms of trade;
  - Persistent drought.
- Downside risks: further trade preference erosion, possible decline in SACU revenue receipts, and falling remittances from Lesotho workers in South Africa.
- Policy goal: restore external competitiveness and promote rapid, broad based growth to reduce poverty and achieve the Millennium Development Goals (MDGs).

### B. Accounting for Sources of Growth — Social Accounting Matrix (SAM) analysis
- SAM decomposition (World Bank):
  - Assessed marginal contributions from decline in miners’ remittances, LHWP investment, expansion of textile and garment industry.
- High LHWP period (1987/88–1998/99) SAM:
  - Model GDP growth average: 6.2 percent per annum.
  - Decomposition of 6.2 percent:
    - 4.8 percent growth associated with LHWP investments;
    - 2.3 percent growth from the increase in garment exports;
    - 1.0 percent reduction in growth due to declining migrant remittances.
  - Selected table entries (as presented):
    - GDP growth contributions: Decline in remittances -14.8 2.3 6.2.
    - Jobs created (Number): Decline in remittances -7,600; Increase in LHWP investment 14,000; Rise in garment exports 10,000; Combined effects 17,000.
    - Employment changes entries: -1.6 3.1 2.3 3.7.
    - Household income effect — Change in income distribution: -2.1 2.5 1.2 1.7.
    - High income households: -1.9 2.5 1.2 1.7.
    - Low income households: -3.3 2.2 1.3 2.1.
    - Urban households: -11.6 0.9 1.5.
    - Rural households: -4.1 4.3 2 2.2.
  - Key insights:
    - Sustained 6.2 percent GDP growth was accompanied by insufficient job creation and limited increases in household incomes.
    - Per annum employment growth was less than 4 percent; average incomes grew less than 2 percent.
    - Causes: slow growth in sectors that support the poor; contraction in primary sector GDP; capital-intensive growth; decline in remittances depressed job creation.
    - Economy-wide job creation at 3.7 percent per annum was insufficient given unemployment rates over 25 percent.
    - About 40 percent of new jobs were in the primary sector (low earnings); about 32 percent in manufacturing (urban, low wages, especially textiles).
- Post-LHWP period (1998/99–2000/01) SAM:
  - Model GDP growth: 3.6 percent after 1999/00.
  - Sources of 3.6 percent:
    - 2.3 percent decline in GDP fueled by persistently declining remittances;
    - 3 percent growth related to LHWP investments (declining but still large);
    - 2.8 percent growth attributable to steady garment exports.
  - Selected table entries (as presented):
    - GDP growth contributions: Decline in remittances -2.3 2.8 3.6.
    - Jobs created (Number): Decline in remittances -1,820; Increase in LHWP investment 9,000; Rise in garment exports 13,000; Combined effects 3,800.
    - Employment entries: -4 23 1.
    - Household income effect — Change in income distribution: -5 1.6 1.6 -1.7.
    - High income households: -4.6 1.6 1.6 -1.9.
    - Low income households: -7.9 1.4 1.6 -0.3.
    - Urban households: -2.4 11.1 -0.2.
    - Rural households: -9.9 2.7 2.5 -4.6.
- Recent sectoral drivers (2004–06):
  - Growth mainly driven by garment and mining sectors; agriculture limited.
  - Mining contributed roughly 65 percent to real GDP growth between 2004 and 2006 due to diamond mine reopenings.
  - Diamond production: 97,097 carats in 2006 compared with 47,633 in 2005.
  - Garment sector:
    - Loss of about 10,000 jobs between December 2004 and June 2005.
    - Sector rebounded in 2006, contributing roughly 10 percent to GDP growth.
  - Sectoral contribution table (selected entries as presented):
    - Real GDP Growth: 2004 = 4.0; 2005 = 3.1; 2006 = 7.2.
    - Primary sector: 2004 = -7.6; 2005 = 0.7; 2006 = 3.2.
    - Secondary sector: 2004 = 79.1; 2005 = 130.4; 2006 = 60.1.
    - Mining: 2004 = 56.0; 2005 = 104.0; 2006 = 28.5.
    - Manuf.&handicraft: 2004 = 11.6; 2005 = -54.7; 2006 = 20.8.
    - Tertiary sector: 2004 = 8.1; 2005 = -1.2; 2006 = 26.8.
    - GDP at constant factor cost: 2004 = 86.3; 2005 = 144.0; 2006 = 90.0.
    - Net taxes on products: 2004 = 13.9; 2005 = -48.6; 2006 = 10.0.
    - GDP at constant 1995 market prices (incl. LHWP): 2004 = 100.0; 2005 = 100.0; 2006 = 100.0.

### Growth Accounting Exercise (long-run 1960–2002)
- Real GDP annual growth: 3.4.
- Factor accumulation: 3.5 percent per annum, accounting for roughly 105 percent of growth.
  - Physical capital contribution: roughly 74 percent of growth (physical capital entry 2.5).
  - Labor contribution: roughly 31 percent of growth (labor entry 1.1).
- Total factor productivity (TFP) growth: -0.1 percent (contribution of -5 percent to real GDP growth).
- Selected table entries:
  - Investment/GDP: 44.2.
  - Real GDP growth: 3.4.
  - Physical capital: 2.5.
  - Labor: 1.1.
  - Total factor productivity: -0.1.
- Interpretation:
  - High investment-to-GDP ratio but lower real GDP growth relative to some peers.
  - One of the lowest labor contributions to growth in SSA.
  - Productivity growth slightly lower than the sub-Saharan African average.
- Determinants of TFP growth (literature): institutions quality, human capital, favorable macroeconomic environment, economic diversification.

### C. Promoting Growth in Lesotho: Key Constraints and Challenges (Cross-Cutting)
- Structural constraints:
  - Small domestic market and high dependence on South Africa (though dependence has declined).
- Potential approaches to exploit proximity to South Africa:
  - Use South Africa’s institutions as a template (with modifications).
  - Use South Africa’s superior services to promote Lesotho’s development goals.
  - Partner with South Africa’s tourism authorities to include and promote Lesotho.

### Agriculture — backbone of the rural economy
- Demographics and land:
  - About 70 percent of Lesotho’s population lives in rural/mountainous areas dependent on subsistence agriculture and herding.
  - Average household plot holding: about half a hectare.
  - Only two-thirds of households have access to land.
  - 70 percent of plots are sharecropped informally.
- Agricultural performance:
  - Agriculture stagnant since early-1990s; negative per-capita agricultural output growth.
  - Constraints: eroding natural resource base, lack of infrastructure, vulnerability to drought, high HIV/AIDS prevalence.
- Policy priorities:
  - Shift from maize-driven self-sufficiency to food security by focusing on comparative advantage (certain vegetables and fruits) and production support aimed at the poor.
  - Key elements: national land policy, intensification, block farming pilots in horticulture and fruit trees, strengthening/decentralization of extension service.
  - Further needs: increase agricultural investment, promote cash cropping, encourage agro processing.
- Infrastructure constraints affecting agriculture and rural development:
  - Poor roads limit market, school, health access and tourism potential.
  - Neglect of Maseru railhead hampers sandstone quarrying and manufacturing.
  - Private sector affected by poor telecommunications, limited water availability (constrains garment industry), and power and transportation weaknesses.
  - Power: costs not high internationally but service quality poor; outages cause larger losses because firms less likely to have generators.
  - Public infrastructure needs: improve efficiency of road, rail and energy sectors and harness water for human, industrial and irrigation needs.

### External trade and textile sector risks
- MFA expiration and AGOA uncertainty after 2012 present challenges.
- Lesotho’s exports concentrated: narrow range of products to a single market (the U.S.) financed largely by FDI.
- With MFA expiration, Lesotho must compete with China and India; without labor productivity improvements, diversification into higher value-added products will be difficult.
- Risk of FDI relocation to more competitive countries.
- AGOA post-2012 rules of origin clause will require firms to use fabric produced in AGOA to benefit from tariff-free U.S. access (Lesotho presently imports most materials from China).

### HIV/AIDS: scale and macroeconomic impact
- Population-based HIV prevalence survey (2004):
  - 24 percent of the adult population is HIV-positive.
  - Urban prevalence: 29 percent; Rural prevalence: 22 percent.
  - One in nine persons aged 15-24 is HIV-infected:
    - 15 percent among young women;
    - 6 percent among young men.
- Household impacts: depletion of assets for medical and burial costs; loss of income.
- Preliminary macro estimates: slower labor force growth and a lower savings rate could lower output growth by an average of 0.4 percent per year between 2005 and 2014.
- Fiscal impact could be considerable; donors finance a significant portion of HIV/AIDS efforts.

### Public health response and social protection
- With Global Fund support, initiatives include ARV rollout, wider condom distribution, and scaled up prevention.
- Expected outcome: by the end of 2010, ARV would reach about 80 percent of ARV needed population.
- Implementation pace is slow; need to speed up ARV and prevention programs.
- Need to strengthen social safety nets and care for HIV/AIDS-affected households, particularly poor households with children and the elderly, and those facing catastrophic illnesses or caring for orphans.

### Constraints to firm growth (investment climate) — firm survey findings
- Major constraints (World Bank, 2007): crime, access to finance, tax administration, and exchange rate instability — over 40 percent of managers rated each as major or very severe.
- Other obstacles: corruption, electricity shortage, policy uncertainty, access to land, weak legal systems, poor telecommunication infrastructure, skill shortages.
- Inadequate access to finance:
  - About half of firms rated cost of financing as a major or very severe problem.
  - Close to 40 percent rate access to financing the same way.
  - Banking sector small and concentrated; dominated by three South African owned banks.
  - Commercial banks provide little finance to small and medium enterprises.
  - Legal framework issues: slow court proceedings, inadequate foreclosure procedures, absence of credit assessment information, weak enforcement of property rights.
  - Matrimonial law historically treated married women as minors (a law has recently been enacted to improve married women’s access to property rights).
- Crime and security:
  - About 47 percent of manufacturing enterprises and 53 percent of construction firms rate crime, theft and disorder as a major or very severe problem.
  - In manufacturing, managers attributed close to three quarters of losses to employee theft.
  - Garment firm managers attributed over 90 percent of losses due to crime to employee theft (compared to about 43 percent in South Africa).
- Corruption and regulation:
  - Lesotho ranked 84th out of 179 countries in the 2007 Transparency International Corruption Perception Index.
  - About 45 percent of managers mentioned gifts or informal payments needed for taxes, licenses, regulations, and services; median reported payment lower than in most African countries.
  - Regulatory burden: starting a business in 2005 required nine procedures and 92 days; cost $453 and 61.2 percent of per capita income.
  - Median enterprise reported 7 inspections or required meetings in the previous year; comparison medians: South Africa 1, Mozambique 1, Kenya 2, Tanzania 6.
- Exchange rate instability:
  - About 40 percent of firm managers, mainly exporters, rated exchange rate instability as a serious concern.
  - The peg to the rand reduces rand instability but the rand has varied greatly against the U.S. dollar.
  - About 93 percent of garment exports from Lesotho are bound for the U.S. due to AGOA.
  - Recommendation: diversify export markets outside the United States and diversify exports out of the garment sector to reduce vulnerability to dollar-rand fluctuations.
- Tax administration:
  - About 43 percent of firms rated tax rates as a major or very severe obstacle.
  - Under standardized Doing Business assumptions, a manufacturing enterprise would pay less in taxes in Lesotho than in most SSA countries.

### Education, skills and labor productivity
- Worker education and skills limit growth and productivity, especially for export-oriented industries such as the garment industry.
- Despite improvements in educational infrastructure, demand for education beyond primary and success rates are unacceptably low; high cost of secondary education is a factor.
- Needs:
  - Improve delivery and outcomes of education and training;
  - Develop and expand technical education and vocational training;
  - Facilitate diffusion of skills from the export-oriented sector;
  - Public-private training initiatives to integrate the export sector with the rest of the economy.

### Growth policies and reform agenda
- Promote TFP growth, reduce unemployment by enhancing job skills, and improve the investment environment.
- Policies to boost TFP: improving education and skills development, governance institutions, and private sector development.
- Boosting TFP alone insufficient; must also boost level and quality of public and private investments.
- Private investment can be boosted by government investment, stable macroeconomic environment, financial deepening, and improvement in quality of institutions.
- Growth Strategy Paper (GSP) objectives:
  - set out opportunities and binding constraints;
  - provide policy framework and sectoral recommendations;
  - link to budget process and be an implementation tool for Vision 2020 and the PRS;
  - serve as basis for Budget Framework Papers and analyze potential growth sectors with short, medium and long term recommendations.

### Key government initiatives and donor-supported programs
- Reforms fast-tracked: judiciary and administration of justice, financial sector, land tenure and mortgage regimes to improve availability of finance and enable land as collateral.
- Funding and programs:
  - Millennium Challenge Corporation and World Bank’s Private Sector Competitiveness Project expected to fund many reforms.
  - Government signed a $362.6 million Compact with the Millennium Challenge Corporation focusing on:
    - improving provision of water supplies for industrial and domestic use (including construction of Metolong dam to deliver water to garment and textile operations);
    - improving health outcomes (strengthening health care infrastructure and human resources for health capacity to mitigate maternal health, HIV/AIDS and other diseases);
    - removing barriers to foreign and domestic private sector development (improve access to bank finance, reduce transactions costs, increase participation of women in the formal economy).

### Structural reform agenda (key elements)
- Removing regulatory constraints:
  - Restructure and consolidate registration processes to reduce business registration time to under one week;
  - Convert mandatory trade licensing to a reporting requirement; eliminate licensing boards and pioneer industries board;
  - Simplify immigration, customs and work permit procedures;
  - Reduce compliance costs to taxpayers;
  - Make commercial courts functioning.
- Improving private sector access to bank credit:
  - Comprehensive property registry;
  - Introduce a national identification system;
  - Amend Matrimonial Act to allow married women access to bank credit without husbands’ permission;
  - Simplify land transfer procedures;
  - Develop leasing facilities.
- Assisting private investors:
  - Develop a strategy for a competitive textile sector—emphasizing product and market diversification;
  - Attract new FDI through public-private cooperation in an inter-ministerial task force;
  - Improve labor productivity through industry-led, demand-driven skills development programs;
  - Invest in utilities, roads, solid waste and water facilities;
  - Launch outreach marketing programs to secure and improve market access.

### Macroeconomic progress, exchange rate and competitiveness
- Macroeconomic context:
  - Population: 1.8 million (Lesotho) vs. 47.5 million (South Africa).
  - Area: roughly 2½ percent of South Africa’s area.
  - Trade volume: 140 percent of GDP.
  - Imports: about 80 percent come from South Africa.
  - Exports: about 80 percent move outside Africa, primarily to the United States.
- Exchange rate regime:
  - Loti pegged at par to the South African rand within the Common Monetary Area (CMA).
  - Rand is legal tender in all CMA countries.
  - With free capital mobility within the CMA, SARB interest rate policy influences monetary conditions throughout the CMA.
  - Central bank reserves target guided by commitment to maintain the peg.
- Inflation dynamics:
  - Lesotho CPI inflation closely tracks South Africa; correlation coefficient: 0.64.
- REER influences and correlation:
  - Lotis’ REER dominated by rand-U.S. dollar movements; correlation coefficient between Lesotho’s REER and dollar-per-rand movement: 0.99 (figure caption).
  - REER annual data correlation (1996-2006): 0.55.
  - REER monthly data (Jan 1996–Jul 2007) correlation: 0.47.

### Exchange rate assessment and empirical findings
- Assessment methods discussed: PPP, macro-balance (MB), external sustainability (ES), BEER.
- Cautions: BEER of limited value for Lesotho due to exogenous REER movements dominated by rand-dollar; MB and ES useful for sustainability but limited for exchange rate adjustment inference.
- Balassa-Samuelson (cross-section of 172 countries, 2006) estimated regression:
  - ln(Pi / Pus) = -0.09 + 0.33 ln(Yi / Yus) + (residual)
  - R2 = 0.43; t-ratios: (-1.40) constant, (11.38) coefficient on ln(Yi / Yus).
  - Elasticities for 2000–2005: 0.33 to 0.38; mode 0.34.
- Lesotho-specific PPP/B-S (end-2006):
  - Real exchange rate against the U.S. dollar may have been undervalued by 24 ½ percent (log terms) and 22 percent (levels).
  - Lesotho’s REER undervaluation: 17 percent (log terms) and 19 percent (levels) when accounting for trading partners’ misalignments (South Africa weight ¾; United States weight ¼).
  - Equilibrium real exchange rate (log terms): -1.03; actual real exchange rate: -1.28.
  - Estimated 90 percent confidence interval for equilibrium REER: (-1.78, -0.29), which includes actual REER.
  - Conclusion: null hypothesis of zero misalignment cannot be rejected at the 10 percent level.

### Competitiveness indicators and policy measures
- Unit labor costs:
  - Dollar labor costs in Lesotho’s manufacturing were about 40 percent higher in 2006 than in 2000 after adjusting for productivity.
  - 2006 government measure: reduction of profit tax rate for firms exporting outside SACU from 15 percent to 0 percent, equivalent on average to a 17 percent reduction in labor costs.
  - In 2006 the wage bill was 47 percent of value added.
- Survey-based indicators:
  - Doing Business 2007 rank: 126th out of 178 (text); Table II.1 reports overall Doing Business rank out of 178 as 124.
  - Global Competitiveness Index 2007 rank: 115th out of 128.
  - Strengths: paying taxes, employing workers.
  - Weaknesses: starting a business, registering property, protecting investors, dealing with licenses, trading across borders.
  - Global Competitiveness: strong macroeconomic pillar and institutions; weak business sophistication, infrastructure, market efficiency and skills.
  - Respondents cited low access to credit, government inefficiency and inadequate infrastructure as main impediments (each cited by more than 10 percent).
  - Regional: Lesotho scores better than some SADC countries (Mozambique, Angola) but lags Mauritius, South Africa, Namibia, Botswana.

### MB and ES approaches — findings
- MB approach (methodology caveats):
  - MB estimates for 2007-11 applied CGER regression coefficients to Lesotho fundamentals (including projected reduction in SACU transfers).
  - Caveats: CGER parameters estimated for high- and middle-income countries; Lesotho not in CGER sample; large margins of error for MB results.
- MB findings:
  - 2007 current account: a surplus of 1 ½ percent of GDP.
  - MB implies current account should deteriorate by about 1 ¾ percent of GDP by 2011 to close gap with CA norm.
  - Averaged 2007-11 projection vs average CA norm: gap of ½ percent of GDP.
- ES approach:
  - ES current account norm that stabilizes end-2006 NFA is a deficit of 2.2 percent of GDP.
  - Staff projected CA deficit in 2011: 1 percent of GDP (with surpluses in intervening years).
  - Net foreign assets to GDP ratio in 2006: -22 percent.
  - Average projected growth rates used for 2007-2011:
    - growth of real output: 5.3 percent;
    - GDP deflator: 6.1 percent.
  - Interpretation: under baseline, Lesotho should be able to strengthen its net foreign asset position; no immediate threats to external stability.

### Policy implications and government response
- Government structural reform agenda targets private sector competitiveness, public sector improvement, and private sector development under the MCC compact.
- Conclusion: No immediate threat to external stability nor significant evidence of exchange rate misalignment; conventional methods must be applied with caution given Lesotho’s CMA participation.
- Primary challenge: vigorous implementation of the reform agenda to address competitiveness weaknesses.

### Data highlights (selected exact figures from tables)
- GDP (1995 constant, purchaser's prices): 3,933.6 (2000); 4,856.1 (2006).
- Gross domestic product, current prices (Millions of Maloti): 5,920.1 (2000); 10,119.9 (2006).
- Gross national savings: 1,122.6 (2000); 2,902.6 (2006).
- Investment: 2,519.0 (2000); 2,456.2 (2006).
- Gross official reserves (Millions of U.S. dollars): 458.6 (2000); 737.6 (2006).
- Exports, f.o.b. (Millions of U.S. dollars): 211.6 (2000); 699.5 (2006).
- Diamonds recorded (Maloti): Diamonds 1.7 (2000); 474.6 (2006).
- SACU receipts (Millions of Maloti): 2,306.0 (2000/01); 3,945.0 (2006/07).
- Public and publicly guaranteed external debt outstanding (Millions of U.S. dollars): Total 579.5 (2000); 626.3 (2006).
- Company income tax: 25 percent on all sectors other than manufacturing and farming; 10 percent on manufacturing and farming; 0 percent on manufacturing of goods destined for extra-SACU.
- Monthly general minimum wage: 673 (Sep. 2006).
- Average annual earnings (Maloti): 30,131 (2000); 53,670 (2006).
- Total average number employed (thousands): 64.9 (2000); 50.8 (2006).

*Prepared by Charles Amo Yartey and Hamid R. Davoodi; content based on the IMF staff paper "PROMOTING GROWTH AND PRIVATE INVESTMENT IN LESOTHO" and associated country report tables and chapter text as presented in the provided document.*

### References..............................................................................................................

### PROMOTING GROWTH AND PRIVATE INVESTMENT IN LESOTHO

### A. Introduction
- Lesotho has made considerable progress in macroeconomic stability: fiscal position and external current account improved, inflation slowed, and net international reserves increased.
- Poverty remains widespread and is aggravated by a high incidence of HIV/AIDS.
- Historical growth:
  - In the 1990s, Lesotho grew as fast as 6 percent per year.
  - More recently growth slowed to about 3 percent on average, before surging to 7 percent in 2006.
- Major shocks weakening growth include:
  - Substantial real appreciation of the rand (to which the loti is pegged);
  - Removal of textile quotas by industrial countries;
  - Continuing decline in the terms of trade;
  - Persistent drought.
- Future downside risks highlighted: further trade preference erosion, possible decline in SACU revenue receipts, and falling remittances from Lesotho workers in South Africa.
- Policy goal: restore external competitiveness and promote rapid, broad based growth to reduce poverty and achieve the Millennium Development Goals (MDGs).

### B. Accounting for Sources of Growth — Social Accounting Matrix (SAM) analysis
- The World Bank SAM decomposes marginal contributions to growth, employment and poverty from:
  - decline in miners’ remittances;
  - Lesotho Highland Water Project (LHWP) investment;
  - expansion of the textile and garment industry (World Bank, 2005).

- High LHWP period (1987/88–1998/99) SAM results:
  - Model yields GDP growth rates averaging 6.2 percent per annum (close to actual 6 percent per annum).
  - Decomposition of 6.2 percent:
    - 4.8 percent growth associated with LHWP investments;
    - 2.3 percent growth from the increase in garment exports;
    - 1.0 percent reduction in growth due to declining migrant remittances.
  - Table I.1 (selected entries, in percent or numbers as in source):
    - GDP growth contributions: Decline in remittances -14.8 2.3 6.2 (as presented in the table).
    - Number of jobs created (Number): Decline in remittances -7,600; Increase in LHWP investment 14,000; Rise in garment exports 10,000; Combined effects 17,000.
    - Employment changes: -1.6 3.1 2.3 3.7 (as presented).
    - Household income effect — Change in income distribution: -2.1 2.5 1.2 1.7.
    - High income households: -1.9 2.5 1.2 1.7.
    - Low income households: -3.3 2.2 1.3 2.1.
    - Urban households: -11.6 0.9 1.5 (as presented).
    - Rural households: -4.1 4.3 2 2.2 (as presented).
  - Key insights:
    - Sustained 6.2 percent GDP growth was accompanied by insufficient job creation and limited increases in household incomes.
    - Per annum employment growth was less than 4 percent; average incomes grew less than 2 percent.
    - Causes for weak poverty impact despite high GDP growth:
      - Sectors that support the poor grew slowly; contraction in primary sector GDP reduced rural job opportunities.
      - Growth was capital intensive; decline in remittances depressed job creation.
      - Economy-wide job creation at 3.7 percent per annum was insufficient relative to unemployment rates over 25 percent.
      - Roughly 40 percent of new jobs were in the primary sector with low average earnings; about 32 percent of new jobs were in manufacturing (urban, low wages, especially textiles).

- Post-LHWP period (1998/99–2000/01) SAM results:
  - Model yields GDP growth of 3.6 percent after 1999/00.
  - Sources of the 3.6 percent:
    - 2.3 percent decline in GDP fueled by persistently declining remittances;
    - 3 percent growth related to LHWP investments (declining but still large);
    - 2.8 percent growth attributable to steady performance of garment exports.
  - Table I.2 (selected entries, in percent or numbers as in source):
    - GDP growth contributions: Decline in remittances -2.3 2.8 3.6 (as presented).
    - Number of jobs created (Number): Decline in remittances -1,820; Increase in LHWP investment 9,000; Rise in garment exports 13,000; Combined effects 3,800.
    - Employment: -4 23 1 (as presented).
    - Household income effect — Change in income distribution: -5 1.6 1.6 -1.7 (as presented).
    - High income households: -4.6 1.6 1.6 -1.9 (as presented).
    - Low income households: -7.9 1.4 1.6 -0.3 (as presented).
    - Urban households: -2.4 11.1 -0.2 (as presented).
    - Rural households: -9.9 2.7 2.5 -4.6 (as presented).

- Recent sectoral drivers (2004–06):
  - Growth driven mainly by the garment and mining sectors; agriculture played a limited role.
  - Mining contributed roughly 65 percent to real GDP growth between 2004 and 2006 due to diamond mine reopenings.
  - Diamond production: 97,097 carats in 2006 compared with 47,633 in 2005 (Central Bank of Lesotho, 2007).
  - Garment sector:
    - Strong performance except in 2005 due to strong exchange rate and end of quotas.
    - About 10,000 jobs lost between December 2004 and June 2005 via factory closures and production cuts.
    - Sector rebounded in 2006, contributing roughly 10 percent to GDP growth.
  - Agriculture contributed minimally because of adverse weather conditions.
  - Table I.3. Lesotho: Sectoral Contribution to Real GDP Growth (2004–06) (selected entries as presented):
    - Real GDP Growth: 2004 = 4.0; 2005 = 3.1; 2006 = 7.2.
    - Primary sector: 2004 = -7.6; 2005 = 0.7; 2006 = 3.2.
    - Secondary sector: 2004 = 79.1; 2005 = 130.4; 2006 = 60.1.
    - Mining: 2004 = 56.0; 2005 = 104.0; 2006 = 28.5.
    - Manuf.&handicraft: 2004 = 11.6; 2005 = -54.7; 2006 = 20.8.
    - Tertiary sector: 2004 = 8.1; 2005 = -1.2; 2006 = 26.8.
    - GDP at constant factor cost: 2004 = 86.3; 2005 = 144.0; 2006 = 90.0.
    - Net taxes on products: 2004 = 13.9; 2005 = -48.6; 2006 = 10.0.
    - GDP at constant 1995 market prices (incl. LHWP): 2004 = 100.0; 2005 = 100.0; 2006 = 100.0.

### Growth Accounting Exercise
- Long-run (1960–2002) findings (Table I.4 and text):
  - Real GDP posted a positive annual growth rate of 3.4 (1960–2002).
  - Factor accumulation occurred at an annual rate of 3.5 percent, accounting for roughly 105 percent of growth.
    - Physical capital accounted for roughly 74 percent of growth.
    - Labor accounted for roughly 31 percent of growth.
  - Total factor productivity (TFP) growth was -0.1 percent during the period, representing a contribution of -5 percent to real GDP growth.
  - Selected table entries (as presented):
    - Lesotho: Investment/GDP 44.2; Real GDP growth 3.4; Physical capital 2.5; Labor 1.1; Total factor productivity -0.1.
  - Interpretation:
    - High investment-to-GDP ratio but lower real GDP growth than some countries with lower investment ratios.
    - One of the lowest contributions to growth from labor in SSA.
    - Productivity growth slightly lower than the sub-Saharan African average.
- Determinants of TFP growth in empirical literature: good quality institutions, human capital development, favorable macroeconomic environment, economic diversification.
  - Better institutions: rule of law, secure property rights, enforce contracts, limit political powers → increase incentives for investment.
  - Human capital: better education and health increase knowledge, innovation, and technology adoption.
  - Diversification from agriculture to secondary and tertiary sectors supports higher TFP growth (Berthelemy and Soderling (2001)).

### C. Promoting Growth in Lesotho: Key Constraints and Challenges (Cross-Cutting)
- Lesotho faces structural constraints:
  - Small domestic market and a peculiar location; high dependence on South Africa (though dependence has declined).
- Challenge: exploit proximity to South Africa and tailor spillovers to Lesotho’s advantage. Possible approaches mentioned:
  - Use design of South Africa’s institutions as a template (with appropriate modifications).
  - Use South Africa’s superior services proactively to promote Lesotho’s development goals.
  - Partner with South Africa’s tourism authorities to include and promote Lesotho as a destination.

_Italic source: Prepared by Charles Amo Yartey; content based on the IMF staff paper "PROMOTING GROWTH AND PRIVATE INVESTMENT IN LESOTHO" (sections and tables as presented in the provided document)._

### 16.      Agriculture—the backbone of the rural economy and the sector that employs

### Agriculture—the backbone of the rural economy and the sector that employs most of the poor

### Agriculture and rural livelihoods
- About 70 percent of Lesotho’s population lives in the rural regions and mountainous areas where income is generated from traditional, largely subsistence, low-value-added agriculture and herding.
- The average household plot holding is about half a hectare.
- Only two-thirds of households have access to land.
- 70 percent of the plots are sharecropped informally.
- Agriculture has been stagnant since the early-1990s; the poor performance has led to negative per-capita growth in agriculture output with serious consequences for food security.
- Agricultural performance is heavily affected by:
  - an eroding natural resource base;
  - lack of infrastructure;
  - vulnerability to drought;
  - high HIV/AIDS prevalence.

### Agriculture policy priorities and initiatives
- Government priority: move away from maize-driven food self-sufficiency to food security by developing production where the country has a comparative advantage and access to markets (certain vegetables and fruits) and through production support aimed directly at the poor.
- Key elements to achieve objectives:
  - development of a national land policy;
  - intensification of agricultural production;
  - piloting a block farming approach in horticulture and fruit trees;
  - strengthening and decentralization of the extension service.
- Further needs: increase agriculture investment, promote cash cropping and encourage agro processing.

### Infrastructure constraints affecting agriculture and broader rural development
- Absence of good roads prevents access to mountain areas with tourism potential and prevents the rural population from accessing markets, schools and health facilities.
- In Maseru, neglect of the railhead at Maseru Station is hampering development of the sandstone quarrying and other manufacturing sectors.
- Poor quality of infrastructure services is a serious problem for the private sector:
  - telecommunications service quality is relatively poor;
  - availability of water places constraints on the garment industry;
  - power and transportation sectors are among the greatest constraints.
- Despite price increases in early 2004, power cost does not appear high by international standards but service quality is poor; outages cause greater losses than in several African countries because firms in Lesotho are less likely to have generators.
- Public infrastructure needs: improve efficiency of road, rail and energy sectors and harness water resources for human, industrial and irrigation needs.

### External trade and textile sector risks
- Expiration of the Multi Fiber Arrangement (MFA) and uncertainty after 2012 of the AGOA rules of origin clauses are challenges to the growth outlook.
- Lesotho’s exports include a narrow range of products to a single market (the US) financed largely by FDI.
- With the expiration of the MFA, Lesotho’s textile exports must compete with highly efficient producers including China and India; without labor productivity improvements, diversification into higher value added products will be difficult.
- Risk that FDI may relocate to more competitive countries.
- AGOA post-2012 rules of origin clause will require firms in Lesotho (which presently import almost all materials from China) to use fabric produced in AGOA to benefit from tariff-free access to the US markets.

### HIV/AIDS: scale and macroeconomic impact
- Lesotho has one of the highest HIV/AIDS prevalence rates among sub-Saharan African countries.
- Population-based HIV prevalence survey (2004) results:
  - 24 percent of the adult population is HIV-positive.
  - Prevalence higher in urban areas (29 percent) than in rural areas (22 percent).
  - One in nine persons aged 15-24 is HIV-infected:
    - 15 percent among young women;
    - 6 percent among young men.
- Household impacts: depletion of assets to cover medical and burial costs; loss of income as productive members become ill and die.
- Preliminary macro estimates: slower labor force growth and a lower savings rate could lower output growth by an average of 0.4 percent per year between 2005 and 2014.
- Fiscal impact could be considerable, although donors finance a significant proportion of HIV/AIDS efforts.

### Public health response and social protection
- With Global Fund support, government initiatives include ARV rollout, wider condom distribution, and scaled up prevention.
- Expected outcome: by the end of 2010, ARV would reach about 80 percent of ARV needed population.
- Implementation pace is slow; efforts needed to speed up ARV and prevention programs.
- Need to strengthen social safety nets and care for HIV/AIDS-affected households, particularly poor households with children and the elderly, and those facing catastrophic illnesses or caring for orphans.

### Constraints to firm growth (investment climate)
- Major constraints identified in firm-level survey (World Bank, 2007): crime, access to finance, tax administration, and exchange rate instability — over 40 percent of managers rated each as a major or very severe problem.
- Other obstacles cited: corruption, electricity shortage, policy uncertainty, access to land, weak legal systems, poor telecommunication infrastructure, and skill shortage.

Sub-constraints and survey figures:
- Inadequate access to finance:
  - About half of firms rated the cost of financing as a major or very severe problem.
  - Close to 40 percent rate access to financing the same way.
  - Banking sector is small and concentrated; dominated by three South African owned banks.
  - Commercial banks provide little finance to small and medium enterprises.
  - Legal framework deters financial intermediation: slow court proceedings, inadequate foreclosure procedures, absence of credit assessment information, weak enforcement of property rights.
  - Matrimonial law historically treated married women as minors (note: a law has recently been enacted to improve the status of married women and ensure access of married women to property rights).
- Crime and security:
  - About 47 percent of manufacturing enterprises and 53 percent of construction firms rate crime, theft and disorder as a major or very severe problem.
  - Employee theft: in manufacturing, managers attributed close to three quarters of losses to employee theft.
  - Garment firm managers attributed over 90 percent of losses due to crime to employee theft (compared to about 43 percent in South Africa).
- Corruption and regulation:
  - Lesotho ranked 84th out of 179 countries in the 2007 Transparency International Corruption Perception Index.
  - About 45 percent of managers mentioned that gifts or informal payments were needed to get things done for taxes, licenses, regulations, and services; the median reported payment was lower than in most African countries.
  - Regulatory burden is high: managers spend more time dealing with government regulations, inspections and required meetings than managers in South Africa.
  - Starting a business in 2005 required nine procedures and 92 days; cost was $453 and 61.2 percent of per capita income.
  - Median enterprise in Lesotho reported 7 inspections or required meetings in the previous year; medians reported for comparison: South Africa 1, Mozambique 1, Kenya 2, Tanzania 6.
- Exchange rate instability:
  - About 40 percent of firm managers, mainly exporters, rated exchange rate instability as a serious concern.
  - The peg to the rand reduces rand instability but the rand has varied greatly against the US dollar.
  - About 93 percent of garment exports from Lesotho are bound for the U.S. due to AGOA.
  - Recommendation: diversify export markets outside of the United States and diversify exports out of the garment sector to reduce vulnerability to dollar-rand fluctuations.
- Tax administration:
  - About 43 percent of firms rated tax rates as a major or very severe obstacle.
  - Under standardized Doing Business assumptions, a manufacturing enterprise would pay less in taxes in Lesotho than in most SSA countries.

### Education, skills and labor productivity
- Worker education and skills limit growth and productivity, especially for export-oriented industries such as the garment industry.
- Despite improvements in educational infrastructure, demand for education beyond primary levels and success rates are unacceptably low; high cost of secondary education is a factor.
- Needs:
  - Improve delivery and outcomes of education and training;
  - Develop and expand technical education and vocational training;
  - Facilitate diffusion of skills from the export-oriented sector;
  - Public-private initiatives in training to integrate the export sector with the rest of the economy.

### Growth policies and reform agenda
- Promoting total factor productivity (TFP) growth is important: maintain TFP growth, reduce unemployment by enhancing job skills, and improve the investment environment.
- Policies to boost TFP include improving education and skills development, governance institutions, and private sector development.
- Boosting TFP alone is insufficient; must also boost level and quality of public and private investments. Private investment can be boosted by government investment, stable macroeconomic environment, financial deepening, and improvement in quality of institutions.
- Government is developing a Growth Strategy Paper (GSP) to achieve broad based and sustainable growth; GSP will:
  - set out opportunities and binding constraints;
  - provide policy framework and sectoral recommendations;
  - link to the budget process and become an implementation tool for the growth component of Vision 2020 and the PRS;
  - be the basis for Budget Framework Papers and analyze potential growth sectors with short, medium and long term recommendations.

### Key government initiatives and donor-supported programs
- Reforms being fast-tracked in judiciary and administration of justice, the financial sector, and land tenure and mortgage regimes to improve availability of finance and enable land as collateral.
- Many reforms expected to be funded by the Millennium Challenge Corporation and the World Bank’s Private Sector Competitiveness Project.
- The government signed a $362.6 million Compact with the Millennium Challenge Corporation to promote growth and reduce poverty; Compact focus:
  - improving provision of water supplies for industrial and domestic use (including construction of Metolong dam to deliver water to garment and textile operations);
  - improving health outcomes (strengthening health care infrastructure and human resources for health capacity to mitigate maternal health, HIV/AIDS and other diseases);
  - removing barriers to foreign and domestic private sector development (improve access to bank finance, reduce transactions costs, and increase participation of women in the formal economy).

### Structural reform agenda (Box I.1: key elements)
- Removing regulatory constraints:
  - Restructure and consolidate registration processes to reduce the time it takes to register a business to under one week;
  - Convert mandatory trade licensing to a reporting requirement, eliminate the licensing boards and the pioneer industries board;
  - Simplify and streamline immigration, customs and work permit procedures;
  - Reduce the compliance costs to tax payers;
  - Make the commercial courts functioning.
- Improving the Private Sector’s Access to Bank Credit:
  - Put in place a comprehensive and easily accessible property registry;
  - Introduce a national identification system;
  - Amend the Matrimonial Act to allow married women access to bank credit without their husbands’ permission;
  - Simplify and streamline land transfer procedures;
  - Develop leasing facilities.
- Assisting adjustment of Private Investors:
  - Develop a strategy for a competitive textile sector—emphasizing product and market diversification—in the context of the “Multi Fiber Agreement”;
  - Attract new FDI through public-private cooperation in the inter-ministerial task force;
  - Improve labor productivity through industry led, demand driven skills development programs;
  - Invest in utilities, roads, and solid waste and water facilities;
  - Launch outreach marketing programs to secure and improve market access.

*Source: IMF Country Report No. 06/404 (chapter text provided).*

### 34.      Lesotho has made considerable progress in macroeconomic stability in the past

### 34.      Lesotho has made considerable progress in macroeconomic stability in the past

### Macroeconomic progress and challenges
- Lesotho has made considerable progress in macroeconomic stability in the past few years but sustaining fast growth remains a challenge.
- Recent growth has surged but has at times been weakened by the persistent drought, the real appreciation of the loti, and the removal of textile quotas by industrial countries.
- The country faces the challenge of restoring external competitiveness and promoting rapid and broad based growth to reduce poverty and achieve the Millennium Development Goals (MDGs).

### Policy reforms needed (identified priorities)
- Multiple policy reforms are required to accelerate economic growth in core areas:
  - property rights
  - infrastructure
  - education and skills development
  - agricultural development
  - governance
  - private sector development
  - social safety nets
- Government actions underway:
  - Efforts to improve access and affordability of basic physical infrastructure.
  - Recent fast-tracked reform areas: the judiciary and administration of justice, the financial sector, and the land tenure and mortgage regimes (expected to improve availability of finance).
- Further required actions:
  - Exploit growth potential of the rural economy.
  - Improve regulatory and institutional framework.
  - Improve transportation links to South Africa.
  - Strengthen education and skills development programs.
  - Improve labor productivity and accelerate diversification.
- Strategic planning:
  - Work on the Growth Strategy Paper, closely aligned with the production of a new PRS, is expected to be key for prioritization.

### Background and structural context
- Lesotho is a small, open economy highly dependent on trade with South Africa.
  - Population: 1.8 million (Lesotho) vs. 47.5 million (South Africa).
  - Area: roughly 2½ percent of South Africa’s area.
  - Trade volume: 140 percent of GDP.
  - Imports: about 80 percent come from South Africa.
  - Exports: about 80 percent move outside Africa, primarily to the United States.
- Exchange rate regime and monetary context:
  - The loti is pegged at par to the South African rand within the Common Monetary Area (CMA) (members: South Africa, Swaziland, Namibia, Lesotho).
  - The rand is legal tender in all CMA member countries.
  - With free capital mobility within the CMA, the interest rate policy of the South African Reserve Bank (SARB) influences monetary conditions throughout the CMA.
  - The target for central bank reserves in Lesotho is guided primarily by the commitment to maintain the peg to the rand.
- Inflation dynamics:
  - Lesotho’s CPI inflation rate closely tracks that of South Africa because of the peg and large trade dependence.
  - Reported correlation coefficient between South Africa and Lesotho CPI inflation: 0.64.
- External influences on REER:
  - Movements in the loti’s real exchange rate (REER) are largely exogenous to developments in Lesotho; the loti’s REER is dominated by movements in the rand-U.S. dollar exchange rate.
  - Reported correlation coefficient between Lesotho’s REER and dollar-per-rand movement: 0.99 (figure caption).
  - Real Effective Exchange Rate, annual data correlation (1996-2006): 0.55.
  - Real Effective Exchange Rate, monthly data (January 1996-July 2007) correlation: 0.47.

### Exchange rate assessment approaches and limitations
- Methods for assessing the real exchange rate mentioned:
  - absolute purchasing power parity (PPP) approach
  - macro-balance (MB) approach
  - external sustainability approach (ES)
  - Behavioral Equilibrium Exchange Rate (BEER) approach
- General cautions:
  - BEER and similar methods are of little value for Lesotho because REER movements are dominated by external factors (rand-dollar movements) and Lesotho cannot influence relative prices of major partners.
  - South Africa and Lesotho have different export structures (precious metals vs. textiles), weakening some BEER explanatory variables (e.g., commodity terms of trade).
  - MB and ES approaches are useful for assessing sustainability of the current account balance but not reliable for inferring exchange rate adjustments for Lesotho given the peg and external constraints.
  - Lesotho’s current account depends heavily on factors unrelated to REER, such as trade preferences under AGOA.

### Key empirical findings — PPP and Balassa-Samuelson (B-S) analysis
- The Balassa-Samuelson effect and estimated regression (cross-section of 172 countries, 2006):
  - Estimated regression: ln(Pi / Pus) = -0.09 + 0.33 ln(Yi / Yus) + (residual)
  - Reported R2 = 0.43
  - t-ratios shown: (-1.40) for constant, (11.38) for coefficient on ln(Yi / Yus)
  - Elasticities in similar specifications for 2000–2005 range from 0.33 to 0.38; 0.34 represents the mode.
  - Rogoff (1996) produced a B-S elasticity of 0.37 and an R2 of 0.42 for 1990.
- Lesotho-specific PPP/B-S results (end-2006):
  - Lesotho’s real exchange rate against the U.S. dollar may have been undervalued by 24 ½ percent in logarithmic terms and 22 percent in levels as of end-2006.
    - The 24 ½ percent is the value of the regression residual expressed in percent.
    - The 22 percent is [exp(residual) -1]*100.
  - Lesotho’s REER undervaluation: some 17 percent (logarithmic terms) and 19 percent (levels).
    - These REER estimates account for exchange rate “misalignments” of Lesotho’s main trading partners (United States and South Africa), which account for 90 percent of Lesotho’s trade.
    - South Africa weight: ¾; United States weight: ¼.
  - Statistical significance:
    - Equilibrium real exchange rate for the loti in logarithmic terms: -1.03; actual real exchange rate: -1.28.
    - Estimated 90 percent confidence interval for the equilibrium real exchange rate: (-1.78, -0.29), which includes the actual real exchange rate.
    - Conclusion: the null hypothesis of zero misalignment cannot be rejected at the 10 percent level (i.e., evidence does not show statistically significant misalignment).

### Competitiveness indicators and sectoral notes
- Unit labor costs:
  - Unit labor costs indices (adjusted for productivity) in Lesotho’s textile sector have been rising faster than in the manufacturing sectors of China and Kenya.
  - Mitigating factors: Lesotho’s 2006 tax cuts and the depreciation of the rand against the U.S. dollar have helped restore some lost ground.
- Survey-based indicators:
  - Survey indicators of competitiveness rank Lesotho low in many areas that the government has identified as weaknesses and is targeting in the structural reform agenda.

*Prepared by Hamid R. Davoodi (content from IMF staff report chapter).*

### 19.      The MB approach compares the current account balance projected over the

### The MB approach compares the current account balance projected over the medium term with an estimated equilibrium current account (CA) balance or “CA norm” driven by some fundamental factors

### MB approach: methodology and caveats
- MB estimates for Lesotho over 2007-11 were obtained by applying coefficients from the CGER regression (IMF, 2006, Table 1, p. 10, column 1) to Lesotho’s fundamentals over the same period.
- Fundamentals used: the fiscal balance (which incorporates a projected reduction in SACU transfers as a ratio to GDP), the old-age dependency ratio, population growth, oil balance and relative income.
- Important caveats:
  - The CGER parameters were estimated for a sample of high- and middle- income countries; comparable parameters have not been convincingly estimated for African countries.
  - Lesotho was not in the CGER sample (the only African country in the CGER sample is South Africa), implying especially large margins of error for MB results applied to Lesotho.
  - Some MB regressions using sub-Saharan African data alone have produced counterintuitive results and wrong signs on some fundamentals (Isard et al., 2001; Chinn and Ito, 2005).
  - Despite limitations, qualitative signs of relationships (e.g., fiscal balance impact) are likely to be correctly identified by CGER regressions.

### MB approach: findings for Lesotho
- The MB approach produces a CA norm that is weaker than the staff projection for Lesotho.
- Specific comparisons:
  - 2007 current account: a surplus of 1 ½ percent of GDP.
  - Comparison with CA norm in 2011 suggests the current account should deteriorate by about 1 ¾ percent of GDP to close the gap.
  - Comparison of the 2007-11 averaged projection with the average CA norm over the same period shows a smaller gap of ½ percent of GDP.

### ES approach: methodology and findings
- The ES approach computes the current account norm that stabilizes the ratio of net foreign assets (NFA) to GDP at the end-2006 level.
- Findings:
  - The ES current account norm that stabilizes end-2006 NFA is a deficit of 2.2 percent of GDP.
  - Staff projected CA deficit in 2011: 1 percent of GDP (with surpluses projected in the intervening years).
  - The net foreign assets to GDP ratio in 2006 was -22 percent.
  - For the norm computation, staff used average projected growth rates for 2007-2011 of:
    - growth of real output: 5.3 percent
    - GDP deflator: 6.1 percent
  - Using end-2006 NFA as a reference point is a convenience and is not implied to be “optimal” or desirable.
- Interpretation:
  - Under the baseline scenario, Lesotho should be able to strengthen its net foreign asset position over the next several years.
  - This scenario does not contain immediate threats to external stability.
  - These results are consistent with the Debt Sustainability Analysis carried out as part of the 2007 Article IV consultation.

### Competitiveness: alternative measures and indicators
- Limitations of standard REER estimates for Lesotho motivate use of additional indicators.
- Unit labor cost measure (manufacturing, U.S. dollar basis) constructed for Lesotho, Kenya and China:
  - In 2006, dollar labor costs in Lesotho’s manufacturing sector were about 40 percent higher than in 2000, after adjusting for changes in worker productivity.
  - Factors: trend increase in loti wages (slower than Lesotho price level) and major swings in the dollar-rand exchange rate.
  - Government measure in 2006: reduction of the profit tax rate for firms exporting outside SACU, providing on average a benefit roughly equivalent to a reduction of 17 percent in labor costs.
  - The income tax rate for these firms was lowered from 15 percent to zero.
  - In 2006, the wage bill was 47 percent of value added; the tax-base approximation used subtracts the wage bill from value added.
  - Figure II.2 (described) indicates that the labor-cost gap opened by rand appreciation since 2000 appears to have been reduced recently and largely offset by the 2006 tax cut.
- Survey-based competitiveness indicators:
  - Doing Business (2007) and Global Competitiveness Index (2007) provide snapshots.
  - Textual statement: Lesotho ranks 126th out of 178 countries in the 2007 Doing Business index, and 115th out of 128 countries in the 2007 Global Competitiveness index.
  - Table II.1 (survey details) reports an overall Doing Business rank out of 178 as 124 and overall Global Competitiveness rank out of 128 as 115.
  - Key Doing Business strengths and weaknesses (Table II.1 and text):
    - Ranks relatively well in paying taxes and employing workers.
    - Ranks poorly in starting a business, registering property, protecting investors, and dealing with licenses.
    - Ranks poorly on trading across borders (Doing Business).
  - Global Competitiveness findings:
    - Lesotho ranks especially high in the macroeconomic pillar and relatively well in the institutions pillar.
    - Weaker rankings in business sophistication, infrastructure, market efficiency and skills.
    - Survey respondents cited low access to credit, government inefficiency and inadequate infrastructure as main impediments to doing business (each cited by more than 10 percent of respondents).
  - Regional competitiveness (Table II.2 summary):
    - Lesotho’s competitiveness scores better than some SADC countries (e.g., Mozambique and Angola) but lags behind Mauritius, South Africa, Namibia and Botswana.

### Policy implications and government response
- The government’s structural reform agenda targets many flagged areas:
  - Private Sector Competitiveness Program.
  - Public Sector Improvement Program.
  - Private sector development component of the compact with the Millennium Challenge Corporation.
- Conclusion on policy stance:
  - No immediate threat to external stability nor significant evidence of exchange rate misalignment.
  - Likelihood that Lesotho’s net external position will strengthen in the next few years.
  - Conventional methods must be applied with caution given Lesotho’s characteristics as a small open economy participating in the Common Monetary Area of the rand.
  - The challenge is vigorous implementation of the government’s reform agenda to address competitiveness weaknesses.

### Data appendix: sources and measurement notes
- Price level and real PPP per capita GDP:
  - Data used in the B-S regression come from Heston-Summers-Aten (S-H-A) data set, version 6.2 (ICP project with the World Bank).
  - p = price level of GDP (S-H notation); rgdpch = chain weight per capita PPP GDP in 2000 international dollar prices (S-H-A notation).
  - S-H-A data on p and rgdpch end in 2004; later-year values were obtained by applying the growth rate of the implicit GDP price deflator and real GDP in local currency to the S-H-A levels.
- Net Foreign Assets (NFA):
  - No official Lesotho international investment position available.
  - Proxy used: NFA of central bank + NFA of rest of banking system − public external debt − stock of foreign direct investment liabilities (UN World Investment Report).
  - NFA for future years generated by adding the current account for the current year to the NFA of the previous year.

*Source: IMF staff chapter text.*

### References

### _cr08135 - References

### References cited
- Bergin, Paul, Reuven Glick and Alan M. Taylor, 2004, “Productivity, Tradability, and the Long-Run Price Puzzle” NBER Working Paper 10569.
- Chinn, Menzie D, and Hiro Ito, 2005, “Current Account Balances, Financial Development and Institutions: Assaying the World Saving Glut,” NBER Working Paper no 11761.
- Frankel, Jeffrey, 2005, “On the Renminbi: The Choice between Adjustment under a Fixed Exchange Rate and Adjustment under a Flexible Rate” NBER Working Paper 11274.
- Heston, Alan, Robert Summers and Bettina Aten, Penn World Table Version 6.2, 2006, Center for International Comparisons of Production, Income and Prices at the University of Pennsylvania, September 2006. available from http://pwt.econ.upenn.edu/
- International Monetary Fund, 2005, “Competitiveness and Export Performance in Lesotho” IMF Country Report 05/438 (International Monetary Fund: Washington D.C).
- International Monetary Fund, 2006, “Methodology for Exchange Rate Assessments” available from http://www.imf.org/external/ns/search.aspx?NewQuery=cger&col
- Isard, Peter, Hamid Faruqee, G. Russell Kinkaid, and Martin Fetherston, 2001, Methodology for Current Account and Exchange Rate Assessments, Occasional Paper no 209 (International Monetary Fund: Washington D.C).
- Kim and Kuijs (forthcoming) “Price and Wage Pressures and Profitability in China’s Industry” World Bank Discussion paper (World Bank: Washington D.C).
- Rogoff, 1996 “The Purchasing Power Parity Puzzle” Journal of Economic Literature, Vol. XXXIV, June pp.647-668.
- Wang, Jian-Ye, Iyabo Masha, Kazuko Shirono and Leighton Harris, 2007, “The Common Monetary Area in Southern Africa: Shocks, Adjustment, and Policy Challenges” IMF Working Paper IMF/07/158 (International Monetary Fund: Washington D.C).

### Key macroeconomic aggregates and sectoral GDP (selected exact figures from tables)
- GDP at purchaser's prices (1995 constant prices): 3,933.6 (2000); 4,856.1 (2006).
- GDP at producer's prices (1995 constant prices): 3,535.0 (2000); 4,327.7 (2006).
- GDP by sector, current prices (Millions of Maloti): Primary sector 960.9 (2000) to 1,460.6 (2006); Secondary sector 2,219.8 (2000) to 3,872.3 (2006); Tertiary sector 2,180.9 (2000) to 3,628.1 (2006).
- Gross domestic product, current prices (Millions of Maloti): 5,920.1 (2000); 10,119.9 (2006).

### National accounts by expenditure (exact figures)
- Gross domestic product (Millions of Maloti): 5,920.1 (2000); 10,119.9 (2006).
- Net factor income from abroad: 1,580.3 (2000); 2,569.7 (2006).
- Gross national product: 7,500.4 (2000); 12,689.5 (2006).
- Unrequited transfers: 936.1 (2000); 2,635.4 (2006).
- Gross national disposable income: 8,436.6 (2000); 15,324.9 (2006).
- Consumption: 7,314.0 (2000); 12,422.4 (2006).
- Gross national savings: 1,122.6 (2000); 2,902.6 (2006).
- Investment: 2,519.0 (2000); 2,456.2 (2006).
- Gross national savings less investment (external current account balance equivalent): -1,396.4 (2000); 446.4 (2006).

### Consumer price indices and inflation (exact values)
- CPI (Dec. series, Dec 1997=100): 100.0 (2000); 190.2 (2006).
- Food and non-alcoholic beverages index: 100.0 (2000); 211.1 (2006).
- Annual CPI inflation rates (percent; end of period): 5.5 (2000); 6.4 (2006).

### Labor and wages (selected exact figures)
- Monthly minimum wages (Maloti): General minimum wage 673 (Sep. 2006).
- Public service employment (Units): Total 31,930 (2000/01); 37,096 (2006/07).
- Average annual earnings (Maloti): 30,131 (2000); 53,670 (2006).
- Total average number employed (thousands): 64.9 (2000); 50.8 (2006).

### Central government operations (selected exact figures)
- Revenue (Millions of Maloti): 2,626.6 (2000/01); 6,386.8 (2006/07).
- Tax revenue: 1,941.9 (2000/01); 5,787.1 (2006/07).
- Total expenditure and net lending: 2,864.2 (2000/01); 4,799.4 (2006/07).
- Overall balance before grants (Millions of Maloti): -237.6 (2000/01); 587.4 (2006/07).
- Overall balance after grants: -112.0 (2000/01); 679.8 (2006/07).
- Grants from abroad: 125.6 (2000/01); 92.4 (2006/07).
- GDP at market prices (Memorandum): 6,137.2 (2000/01); 10,408.3 (2006/07).

### SACU receipts and revenue-sharing (exact figures)
- Actual fiscal year SACU receipt (Millions of Maloti): 2,306.0 (2000/01); 3,945.0 (2006/07).
- In percent of GDP: 24.7 (2000/01); 37.9 (2006/07).
- Dutiable base (Lesotho's imports, Maloti): 6,021.1 (data year 1998/99) to 9,585.8 (data year 2006/07).
- Stabilized rate (actual) applied: 17.0 (multiple years shown).

### Monetary and banking sector (selected exact figures)
- Money and quasi-money (M2, Millions of Maloti): 1,700.9 (2000); 3,507.9 (2006).
- Net foreign assets (Millions of Maloti): 3,585.2 (2000); 6,205.3 (2006).
- Net domestic assets (Millions of Maloti): -1,884.3 (2000); -2,697.4 (2006).
- Commercial banks: Deposits (end-2006, December) 3,006.3; Credit (end-2006) 802.0.
- Interest rates (selected): Central Bank 91-Day T-Bill Rate 9.30 (2000) to 6.76 (2006); Commercial banks prime lending 17.00 (2000) to 13.50 (2006).

### Balance of payments and external sector (exact figures)
- Balance of payments: Trade balance (Millions of U.S. dollars) -516.2 (2000) to -667.4 (2006).
- Exports, f.o.b. (Millions of U.S. dollars): 211.6 (2000) to 699.5 (2006).
- Imports, f.o.b. (Millions of U.S. dollars): -727.8 (2000) to -1,366.9 (2006).
- Income (net, Millions of U.S. dollars): 227.7 (2000) to 379.5 (2006).
- Unrequited transfers (Millions of U.S. dollars): 134.9 (2000) to 389.2 (2006).
- Current account (including official transfers, Millions of U.S. dollars): -153.3 (2000) to 65.9 (2006).
- Gross official reserves (Millions of U.S. dollars): 458.6 (2000) to 737.6 (2006).
- Gross official reserves (Months of imports of goods and services): 7.1 (2000) to 6.1 (2006).
- Exchange rate (maloti per U.S. dollar, average): 6.9 (2000) to 6.8 (2006).

### Trade composition and direction (selected exact figures)
- Recorded exports by commodity (Millions of Maloti): Total exports 1,468.4 (2000); 4,736.7 (2006).
  - Clothing, etc.: 953.2 (2000); 3,841.1 (2006).
  - Water: 63.9 (2000); 138.2 (2006).
  - Diamonds: 1.7 (2000); 474.6 (2006).
- Direction of trade (Millions of Maloti): World imports 5,611.1 and exports 1,468.4 (2000); imports 10,160.0 and exports 4,736.7 (2006).
  - SACU imports 4,309.2 (2000) and SACU exports 606.9 (2000); SACU imports 8,524.6 and SACU exports 817.5 (2006).

### External debt and financing (exact figures)
- Public and publicly guaranteed external debt outstanding (Millions of U.S. dollars): Total 579.5 (2000); 626.3 (2006).
- Total (Percent of GDP): 75.8 (2000); 43.1 (2006).
- Major multilateral creditors (Millions of U.S. dollars): World Bank Group 181.2 (2000) to 268.4 (2006); IMF 10.2 (2000) to 35.2 (2006).

### Tax system summary (structure and rates: selected exact excerpts)
- Company income tax: 25 percent on all sectors other than manufacturing and farming; 10 percent on manufacturing and farming; 0 percent on manufacturing of goods destined for extra-SACU. For nonresident companies, 10 percent Withholding Tax as a final tax.
- Gambling levy: 15 percent.

*Source: _cr08135 - References (PDF chapter/section), tables and reference list as supplied*

### 1.2       Taxes       on       individuals

### 1.2       Taxes       on       individuals

### 1.2.1 Income tax (Income Tax Act 1993)
- Nature:
  - A tax on the current year's income from all geographical sources (in the case of residents).
  - Gross income includes incomes in kind, except for benefits subject to fringe benefits tax.
- Withholding at source:
  - Tax is withheld at source at a rate of 10 percent on interest paid (in excess of the exempt amounts).
  - Tax is withheld at source at a rate of 5 percent on payments made by government and non-government withholding agents to Lesotho resident contractors and subcontractors.
  - Such withheld amounts are a credit against the final amount of tax assessed for the recipient.
- Exemptions and credits:
  - Exempt incomes include the first M 500 of interest from savings, income from subsistence/primary farming, scholarships, and foreign-source property income of expatriate taxpayers.
  - A uniform personal tax credit of M 2,911 per taxpayer was introduced in April 2006.
- Marginal rates:
  - Residents marginal rate (in percent):
    - First M 33,075: 25 percent
    - Over M 33,075: 35 percent
  - Nonresident marginal rate (in percent):
    - All chargeable Income: 25 percent

### 1.2.2 Withholding tax (Income Tax Act 1993)
- Nature:
  - A tax on income from dividends, interest, royalties, natural resource payments, management charges, or service contracts earned within Lesotho by nonresidents.
- Exemptions:
  - Dividends from manufacturing companies are exempt.
- Rates:
  - Withholding tax is 25 percent.
  - For royalties from non-manufacturing companies: 15 percent.
  - On service contracts earned within Lesotho by nonresidents: 10 percent.

*Source: _cr08135 - 1.2       Taxes       on       individuals*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08135.pdf_