Kingdom of Lesotho: 2022 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Kingdom of Lesotho

The Lesotho economy is exposed to a wide array of external shocks. Over the past two years, the authorities had to contend simultaneously with the pandemic, declining SACU transfers, climate events and impacts from the war in Ukraine, all generating significant fiscal and balance of payments stress. While the authorities undertook effective measures in response to the pandemic, containing its spread, rolling out vaccinations, shielding vulnerable households, and reducing social and economic effects, subsequent shocks are undermining the recovery. Current fiscal and external pressures highlight the importance of measures to resuscitate growth and revenues by developing the private sector and boosting production in pursuit of positive per capita income growth and a sustainable and inclusive post-pandemic recovery. While the spillovers from the war in Ukraine on commodity prices, fertilizer supplies, agricultural production, and food security present renewed risks to the outlook, the authorities are hopeful that efforts to stabilize the economy in the short-to-medium term will combine with stronger performance in the mining and construction sectors, continuing “megaprojects” and recent progress on Millennium Challenge Corporation support for agriculture and business development, to boost medium term growth above the 2 percent projected by staff.


The Lesotho economy is exposed to a wide array of external shocks. Over the past two years, the authorities had to contend simultaneously with the pandemic, declining SACU transfers, climate events and impacts from the war in Ukraine, all generating significant fiscal and balance of payments stress. While the authorities undertook effective measures in response to the pandemic, containing its spread, rolling out vaccinations, shielding vulnerable households, and reducing social and economic effects, subsequent shocks are undermining the recovery. Current fiscal and external pressures highlight the importance of measures to resuscitate growth and revenues by developing the private sector and boosting production in pursuit of positive per capita income growth and a sustainable and inclusive post-pandemic recovery. While the spillovers from the war in Ukraine on commodity prices, fertilizer supplies, agricultural production, and food security present renewed risks to the outlook, the authorities are hopeful that efforts to stabilize the economy in the short-to-medium term will combine with stronger performance in the mining and construction sectors, continuing “megaprojects” and recent progress on Millennium Challenge Corporation support for agriculture and business development, to boost medium term growth above the 2 percent projected by staff.


1. Lesotho has been facing significant structural challenges even before the COVID-19 pandemic.1The economy has stagnated since 2016 and is estimated to have shrunk by almost 10 percent.2 The country’s export base—historically concentrated in textiles and mining—has been losing competitiveness.3 Lesotho’s geography makes it vulnerable to climate shocks, which have increased over the past decade. As one of the countries in the region most affected by natural disasters and with over two-thirds of the population dependent on rain-fed subsistence agriculture, poverty and food insecurity remain high.4 Health indicators remain relatively weak, with 21.1 percent of adults infected by HIV and maternal mortality at over 1,000 for every 100,000 live births (Table 6).


Poverty and Subsistence Farming

(Percent of population; latest available)

Citation: IMF Staff Country Reports 2022, 161; 10.5089/9798400212789.002.A001

Sources: World Bank World Development Indicators (WDI) and IMF staff calculations.

2. After three waves of the pandemic, reported cases remain low. The authorities undertook measures to mitigate the health and economic consequences in FY20/21 (Annex II). Restrictions have been gradually lifted with the country moving to its lowest alert level in October 2021. With 53 percent of the target population fully vaccinated as of April 30, 2022, the government remains confident that the pandemic can be contained.5


Evolution of COVID-19 in Lesotho

Citation: IMF Staff Country Reports 2022, 161; 10.5089/9798400212789.002.A001

Sources: Johns Hopkins University, University of Oxford, Our World in Data, WHO, and IMF staff calculations.Notes: New case per million and new deaths per milionare 7-day moving averages; the Stringency Index measures government responses to COVID-19, specifically containment and closure policies including school closures and restrictions in movement, 100- strongest; Vaccine doses administered may not equal population vaccinated, given the specific dose regime (e.g., single dose vs. multiple doses),

3. The government-driven growth model remains a challenge for sustainable and inclusive growth, displacing resources from the private sector. The fiscal landscape is characterized by gaps in PFM and a heavy reliance on large and volatile transfers from SACU—the latter contributing to high public expenditures that increase when transfers are buoyant but are not scaled back when transfers fall. The public sector is the major employer, with a high public wage premium crowding out private sector employment.6

4. Private-sector development and job creation have also been hampered by limitations in financial access, human capital, governance and corruption, and the overall business environment. The largely foreign-owned banking sector is well-capitalized and liquid but plays a limited role in intermediating credit, particularly to micro-, small- and medium-sized enterprises (MSMEs). Government arrears also create liquidity shortages. High credit and setup costs, skills mismatches, and gaps in legal frameworks, dispute resolution, insolvency resolution, and property rights continue to inhibit business development. With private sector growth concentrated in capital-intensive industries, new labor market entrants face fewer opportunities, often pushing them into informality.


Public Wage Premium and Total Spending

(Percent; Most recent year available for public wage premium estimates)

Citation: IMF Staff Country Reports 2022, 161; 10.5089/9798400212789.002.A001

Source: IMF staff calculations.Note: The public wage premium is estimated using Mincer equations. The log incomes of individuals/households are regressed on a public employment dummy, education, age, and disabilitystatus (as a proxy for experience and skills), gender, household size, marital status, and regional dummies. Propensity score matching is used to ensure robustness. Estimates for Botswana are based on 2020 Quarterly Multi-TopicSurvey; for Namibia, based on 2018 Labor Force Survey, and for South Africa, FAD CD report. Estimates for Eswatiniand Lesotho are from the SACU 2018 Spring Meeting workshop. Total spending in percent of GDP is calculated using 2021 data.

5. The exchange rate peg provides a nominal anchor and occasional constraint on government spending. Exchange rate and monetary policy cycles are driven by South Africa. In the absence of a formal fiscal anchor, enforcement of the net international reserves (NIR) target acts as a spending brake when SACU transfers dip. This has frequently led to tensions in fiscal-monetary policy coordination between the Ministry of Finance and the Central Bank of Lesotho (CBL).


Changes In SACU Revenues, Government Deposits, and IMIR

(Percent of GDP)

Citation: IMF Staff Country Reports 2022, 161; 10.5089/9798400212789.002.A001

Source: IMF staff calculations.Note: NIR – Net international reserves.

6. Political instability and governance issues have continued to hamper adjustment and the formulation of a coherent medium-term reform strategy (Annex III). Ongoing leadership challenges, the dispersion of key policy portfolios across Ministries, Departments, and Agencies (MDAs), and mounting expenditure pressures—also in the run-up to elections—have constrained the government’s ability to reach consensus on reforms to bring the economy back onto a sustainable growth path.


Political Stability

(Ranges from approx. -2.5 (weak) to 2.5 (strong) governance performance)

Citation: IMF Staff Country Reports 2022, 161; 10.5089/9798400212789.002.A001

Sources: Worldwide Governance Indicators (WGI) and IMF staff calculations.Note: Political Stability and Absence of Violence/Terrorism measures perceptions of the likelihood of political instability and/or politically-motivated violence, including terrorism.

7. The Fund provided financial support during the pandemic. The 2020 RCF/RFI disbursement (US$49.1 million, SDR34.9 million), the August 2021 Special Drawing Rights (SDR) allocation (US$95 million, SDR66.9 million), and debt relief granted through the Catastrophe Containment and Relief Trust (US$5.36 million, SDR3.84 million) helped meet financing needs and build reserve buffers in the short term.

Recent Economic Developments

8. The pandemic caused widespread social and economic disruption during 2020 and continued to drag on activity through 2021. The economy contracted by 6 percent in FY20/21. Weak external demand and supply chain disruptions also weighed on growth and the cost of living. The textiles industry saw closures and job losses and infrastructure “megaprojects”—notably, the Lesotho Highlands Water Project-II (LHWP-II, Annex IV)—were beset by delays. But while mining contracted sharply in 2020, increased quarrying helped the sector rebound in FY21/22:Q1. The recent war in Ukraine has raised commodity prices to the benefit of mining exports, while disrupting grain imports and food security in areas hit by recent flooding. Inflation averaged 6.4 percent in FY21/22 —a percentage point higher than the year before—and is expected to remain elevated at 6.8 percent in FY22/23. Though the relatively low share of wheat in local diets could help moderate inflationary pressures, price increases in food and fuel, which account for over half of the consumer basket, are hurting the vulnerable (Annex V).

9. While fiscal performance in FY20/21 was better than expected, the hard-won savings were not capitalized on in FY21/22 (Annex VI). Revenue performance in FY20/21 was 5.3 percentage points of GDP higher than projected under the 2020 RCF/RFI, due to stronger direct taxes and royalties and lower nominal GDP. By limiting wage increases and spending on goods and services, current expenditure fell by 3.6 percentage points of GDP relative to 2020 RCF/RFI projections. The result was a small fiscal surplus in FY20/21. However, the FY21/22 budget did not build on these gains, setting out double-digit deficits over the medium term with no concrete adjustment measures. While the FY22/23 Budget has provisionally tempered the fiscal outlook, it remains sensitive to revenue collection and the ability to control spending.

10. Efforts to restrain expenditure have also been undermined by growing domestic payments arrears and gaps in PFM. Even though the FY21/22 Mid-Term Budget Review revised down spending, MDAs continued to spend according to previous budget allocations. As a result, the stock of arrears has increased to LSL1.25 billion (3.4 percent of GDP) as of end-November 2021 from LSL720 million (2.1 percent of GDP) at end-March 2021. Recent fraud cases have highlighted vulnerabilities in payment and procurement processes. In the absence of cuts and sufficient donor financing, the government is turning to domestic and external borrowing, deposits, and arrears.

11. Reserves remain stable while credit to the private sector has recently started to recover. With gross international reserves (GIR) at 4.5 months of imports (excluding LHWP-II) in FY21/22, the CBL maintained NIR above a target floor of 120 percent of M1 plus callable deposits to safeguard the peg. Even with the recent SDR allocation, financing needs over the medium term risk reserves falling below adequate levels, estimated at around 4 months of imports. Despite substantial capital buffers, ample liquidity, and low non-performing loans (NPLs; 4.1 percent as of end-2021), banks’ contribution to growth remains limited with lending focused in low-risk investments. Private sector credit growth fell to –1.6 percent in FY20/21:Q2, rebounding to 7.4 percent as of FY21/22:Q4.

12. The external position has continued to deteriorate. Exports and remittances fell by 26 and 12 percent, respectively, and the goods and services trade deficit widened by 8 percentage points of GDP in FY20/21. Despite a recovery in exports and remittances, the drop in SACU transfers widened the current account further over the first nine months of FY21/22. Foreign investment, including FDI, continued to decline given the weak external environment and limited opportunities domestically. Staff assesses the external position in FY21/22 to be substantially weaker than implied by fundamentals and desired policies (Annex VII). Policy gaps, driven by the fiscal stance, contribute significantly to the current account gap.

Outlook and Risks

13. The growth outlook remains subdued and contingent on fiscal retrenchment, structural reforms, donor support, and external developments. Despite positive developments in mining, the decline of key sectors and limited access to finance weigh on the post-pandemic recovery. Growth for FY21/22 was revised down to 2.1 percent from 3.9 percent in the 2020 RCF/RFI and is forecast by staff at 2.7 percent in FY22/23 and 1.4 percent on average thereafter. Growth remains largely dependent on investments from local “megaprojects”, developments in South Africa, and the path of the pandemic, declining after FY26/27 as LHWP-II construction winds down. Sustained growth over the medium and long term will hinge on the successful implementation of structural reforms to improve governance and boost private sector development.


LHWP-II Projected Cash Flow

(LSI million)

Citation: IMF Staff Country Reports 2022, 161; 10.5089/9798400212789.002.A001

Sources: Lesotho Highlands Development Authority and IMF staff calculations.

14. The fiscal outlook remains challenging and upfront consolidation is needed to sustain the external position. Having shrunk by a third in FY21/22, SACU transfers are projected to remain subdued. The current account deficit is expected to reach 7.4 percent of GDP in FY21/22 and 14.4 percent of GDP in FY22/23, due to falling SACU transfers and capital goods imports for the LHWP-II. Spending trade-offs are likely to worsen if shocks persist and in the absence of consolidation the government would be forced to either (i) cut spending abruptly or (ii) accumulate sizeable new arrears, or both.


SACU Transfers

(Percent of GDP)

Citation: IMF Staff Country Reports 2022, 161; 10.5089/9798400212789.002.A001

Source: IMF staff calculations.

15. Risks to the outlook are tilted to the downside (Annex VIII).

  • Domestic. Fresh waves of the pandemic would further delay infrastructure projects and dent investor confidence. Ongoing disruptions to activity, growing unemployment, and income losses could drive social unrest. Governance reforms could stall or reverse, while capacity constraints and PFM issues hinder fiscal consolidation. Political tensions could also increase in the run-up to elections, worsening expenditure pressures. While banks are well-capitalized, growing domestic arrears represent a fiscal risk and could result in higher NPLs.

  • External. A protracted war in Ukraine could weaken global demand and exports. A delayed recovery and additional inward-oriented policies in key foreign markets—notably the EU, South Africa, the U.S.—could further set back exports. Faster-than-expected U.S. monetary policy tightening could spill over through South Africa and balance sheet exposures to rand-denominated assets. Uncertainty about the expiration of the African Growth and Opportunity Act and food insecurity from rising fuel and food prices add to downside risks. Climate shocks remain a major risk to infrastructure, food security, and livelihoods.

16. There are upside risks for growth if opportunities are well-managed. Given Lesotho’s elevation and freshwater endowment, commercialization of agriculture—supported by investment in infrastructure and irrigation, and meeting international standards for integration into global value chains—presents an avenue for export growth and food security. Development of subsectors—such as medical cannabis—are already underway. Other upside risks include a faster global recovery, faster vaccination, spillovers from the second Millennium Challenge Corporation compact, and a pick-up in revenues to buoy the fiscus.7

17. Debt sustainability risks have risen since 2020. While Lesotho’s risk of debt distress remains moderate, the space to absorb shocks has narrowed with present value estimates of both external and total public debt very close to their thresholds under the baseline. The key risk to debt sustainability is delayed fiscal adjustment. Unaddressed contingent liabilities related to the civil service pension fund and other potential liabilities linked to governance issues add further risks.8

Authorities’ Views

18. The authorities concurred with staff’s assessment of risks. The authorities are more optimistic than staff on the medium-term growth outlook, noting the strong performance of the mining and construction sectors, supported by recent price developments and “megaprojects”, and recent progress on the MCC. In the face of financing constraints, they noted the pressure to raise debt to finance growing expenditure needs while acknowledging the risks to debt sustainability over the medium term.

Policy Priorities

19. Discussions centered on policies to promote fiscal sustainability and a diversified, well-resourced private sector that can become the key engine of growth, while also paying due attention to the political context. Credible policies are needed in four critical areas:

  • Fiscal consolidation to align expenditures with resources.

  • Strengthening governance, building strong institutions, streamlining government, and improving policy coordination to support credibility, investor confidence, and macroeconomic stabilization.

  • Maintaining price stability, strengthening financial sector supervision, and reforms to unlock access to finance.

  • Structural reforms to catalyze inclusive, green, job-rich, sustainable, private-sector-led growth.

A. Aligning Expenditure with Available Resources to Ensure Sustainability and Preserve Stability

20. Fiscal consolidation is crucial to reduce imbalances and rebuild much-needed space to protect the vulnerable, finance the recovery, and mitigate external shocks.9 Given the already high revenue ratio, expenditure must bear the brunt of adjustment. The authorities must find ways to contain current spending, scale back unproductive capital spending, and improve efficiency to preserve fiscal sustainability and macroeconomic stability. The risk of ambitious revenue projections and high expenditure jeopardize not only fiscal sustainability, but also resources needed to sustain the peg (see ¶35). Staff advised upfront consolidation to improve the overall balance over the medium term and provide vital space should downside risks materialize.


Spending Inefficiency by Sector

(Efficiency gap (percent))

Citation: IMF Staff Country Reports 2022, 161; 10.5089/9798400212789.002.A001

Sources: Baum. Mogues, and Verdier (2020); Garcia-Escribano, Juarros, and Mogues (2022): and IMF staff calculations.Note: See Chapter 2, IMF April 2021 Fiscal Monitor: efficiency gaps provide a measure (in percent) of the distance between observed output levels and the maximum (the efficient frontier estimated using Data Envelopment Analysis) that could have been obtained given the inputs utilized; the larger the distance from the efficient frontier, the more inefficient the use of inputs for health, output is life expectancy and input is total per capita health expenditure. For education, outputs are test scores and net enrollment rates and input is public education spending per student; for infrastructure, output is the volume and quality of infrastructure and input is public capital stock and GDP per capita.

21. The public sector wage bill can be contained through a combination of short-term measures and long-term structural reforms. Wage growth, the hiring of non-essential public servants, and perquisites should be restricted in the near term. Over the medium term, additional steps in job grades and merit-based remuneration can also help reduce pay increases. Additional cost-cutting measures should include rationalizing foreign embassies and missions. Compiling a registry of government assets can help identify and dispose of redundant public nonfinancial assets, for example, part of the large government vehicle fleet.

22. Social spending should be rationalized and reprioritized to better target the most vulnerable.10 Social spending is several times that of neighboring countries and dominated by schemes that crowd out funding for other more effective poverty-reducing initiatives, such as the child grants programme. For example, the tertiary education loan bursary scheme provides merit- and quota-based loans to many who typically do not need support and fail to repay. Its costs (estimated at 2.7 percent of GDP for FY21/22) can be reduced by introducing means-testing and pursing loan recovery.11 With the authorities passing recent fuel price increases on to consumers, temporary subsidies for agricultural inputs have been introduced and ways to supplement social assistance programs to target the most vulnerable are being explored as costs of living rise. Staff supports targeted and temporary measures given limited fiscal space.


SACU Social Spending

(Percent of GDP)

Citation: IMF Staff Country Reports 2022, 161; 10.5089/9798400212789.002.A001

Sources: World Bank ASPIRE database and IMF staff calculations.Notes: Spending data are from the latest available years in the ASPIRE database (based on administrative data): 2014–16 for Botswana, 2010–11 for Eswatini, 2014–17 for Lesotho, and 2015 for South Africa. Spending for Namibia are based on the SP note-for the year 2018. Regional averages come from the State of SSN, WB 2018. Data for OECD countries refer to 2013 and are based on the Social Expenditure Database. Economies are divided among income groups according to 2016 GNI per capita, calculated using the World Bank Atlas method. The groups are as follows: low-income, US$1,005 or less; lower-middle-income, US$1,006–3,955; upper-middle-income, $3,956–12,235; and high-income, $12,236 or more.

23. Public investment should finance areas where it will have the maximum growth impact, crowding in private sector investment, and reducing poverty. The capital budget has so far produced a capital stock that is relatively high as a share of GDP but of a quality that is lagging peers. Staff welcomes the reclassification of current spending previously misspecified under the capital budget. Further streamlining the budget by (i) identifying and minimizing stalled projects and (ii) improving accountability, contract design, investment appraisal, and execution, will help ensure that capital spending is more efficient and better targeted to achieve development priorities and maximize growth.


Capital Stock and Infrastructure Quality

(LHS: Percent of GDP; RHS: Ranking (1-best to 144-worst})

Citation: IMF Staff Country Reports 2022, 161; 10.5089/9798400212789.002.A001

Sources: IMF FAD Expenditure Assessment Tool (EAT), World Economic Outlook, World Development Indicator?, IMF Investment and Capital Stock Datasetj World Economic Foruirij aid IMF staff calculations.

24. Domestic revenue mobilization can still help support the adjustment. Despite strong (non-SACU non-grants) domestic revenues—driven by personal income taxes, VAT, and water royalties—all available opportunities to broaden the tax base, improve tax administration, and increase compliance must be exploited to maximize resources.12 These include (i) introducing excises on alcohol and tobacco; (ii) improving administrative efficiency by introducing cashless collection systems, and (iii) improving compliance by enhancing transparency and audit. It is also vital to maintain the integrity of existing taxes, notably ensuring the structure of the VAT is aligned with best practice, and strengthen the tax system to guard against international tax avoidance. Staff recommends a diagnostic assessment of tax administration (TADAT) to help develop a reform plan.


Non-SACU Non-Grant Domestic Revenues

(Percent of GDP)

Citation: IMF Staff Country Reports 2022, 161; 10.5089/9798400212789.002.A001

Source: IMF staff calculations.Notes: EMDE = emerging market and developing economies; SSA = Sub-Saharan Africa; Series for EMDEs and SSA are domestic revenues excluding grants and taxes on trade.

25. External financing should be primarily on concessional terms and grants to preserve debt sustainability. The government has continued to contract debt on both concessional and nonconcessional terms to finance capital projects. Given recent sharp increases in public debt, contingent liabilities from the civil service pension shortfall, and the growing risk of domestic payment arrears, staff recommends a conservative debt management strategy to maintain debt sustainability focused on concessional sources. Financing needs are to be met by official flows—mostly on concessional terms—and domestic borrowing primarily from banks. The authorities should develop domestic public debt markets further while limiting banks’ exposure and crowding out of the private sector.


Public Debt

(Percent of GDP)

Citation: IMF Staff Country Reports 2022, 161; 10.5089/9798400212789.002.A001

26. Lesotho’s experience would suggest that fiscal consolidation as outlined above would be growth friendly. Rising expenditure in recent years has not led to higher growth, likely owing to inefficiencies. Fiscal consolidation through scaling back less-productive expenditure while focusing on more efficient, well-targeted spending, growth-friendly investment, and robust tax policies and revenue administration could, therefore, mitigate risks to growth. Improving social safety nets will also help protect the vulnerable and secure livelihoods.


Growth and Recurrent Public Spending

Citation: IMF Staff Country Reports 2022, 161; 10.5089/9798400212789.002.A001

Source: IMF staff calculations.

Authorities’ Views

27. The authorities acknowledged the need to contain current and capital expenditures and the risks that unchecked expenditure growth poses for debt sustainability and the peg. However, they highlighted the difficulty of implementing consolidation ahead of elections and insufficient capacity to evaluate capital projects. On revenues, the authorities favored the enforcement of a sales tax and the elimination of VAT zero-rating on mining exports on the grounds that the mining sector does not pay its fair share of taxes.13

B. Enhancing Governance and Institutional Capacity

Building Strong Institutions to Support Macroeconomic Stabilization

Ministry of Finance

28. Fiscal reforms must be underpinned by robust PFM to ensure oversight and accountability and avoid corruption. Tight fiscal space makes sound budget and financial management essential but challenging. Capacity development has helped core PFM functions but these remain to be embedded. Robust expenditure control, a transparent and well-coordinated budget process, strong monitoring of SOEs, and centralized government accounts can help avoid instances of fraud, minimize fiscal risks, reduce corruption vulnerabilities, and limit spending overruns and arrears.14

29. Improving budget processes, procurement, and treasury operations in the Ministry of Finance are critical to strengthening fiscal governance.

  • PFM gaps remain a strong risk for audit and expenditure controls and the Ministry of Finance’s overall treasury functions. Staff urged the finalization and submission of the Public Financial Management and Accountability (PFMA) Bill, implementation of which would improve (i) budget analysis, execution, and monitoring; (ii) fiscal reporting, and (iii) cash, expenditure, and (iv) debt management. All budget commitments should be recorded in IFMIS, while sanctions and penalties for officials committing expenditures outside IFMIS should be enforced.15 Over the medium term, the authorities should migrate to accruals-based accounting and a Treasury Single Account.

  • Risks of additional unanticipated pressures on the budget must be mitigated. One-off outlays must be considered carefully and allocated only when deemed critical.16 Building on the 2020 RCF/RFI governance commitments (see below), checks and balances can be introduced by publishing cost-benefit analyses and procurement contracts online—including, where possible, the names of beneficial owners.17

  • Robust PFM controls are also critical to prevent accumulation of arrears. While the Ministry of Finance’s Treasury Department has developed surveys to capture arrears, response rates from MDAs are low. Staff advised both stocktaking and vintage analysis as inputs to a comprehensive arrears clearance strategy. Enacting the PFMA bill and adopting PFM regulations will help minimize arrears in the near term.

  • Digitalization can help improve PFM, revenue mobilization, and expenditure management over the medium term. Digital infrastructures can help decrease leakages, increase efficiency, and provide systems to help protect the vulnerable. They also allow for robust checks and balances, for example, by connecting IFMIS to management information systems in other MDAs and the CBL’s National Payments System. Staff recommended that the Ministry of Finance’s Treasury department develop a road map for digitalizing government payments, in coordination with key MDAs.

30. Fiscal policymaking can be improved through organizational restructuring and boosting institutional capacity. Updating departmental functions within the Ministry of Finance to reflect modern PFM processes can improve coordination and accountability.18 A Tax Policy Unit should be established to support the work of the Tax Policy Committee in the Ministry of Finance.

31. The development, implementation, and commitment to a set of fiscal rules and a fiscal risk management framework will help embed much-needed discipline.19 A fiscal rule framework—supported by appropriate institutions and legal frameworks—could be developed and calibrated over the medium term to provide limits to spending and debt, embed discipline and credibility within the country’s macro-fiscal framework, and provide a bulwark against undue expenditure pressures. Staff also supports the publication of a fiscal risks statement as part of the annual budget process.20

Central Bank of Lesotho

32. The 2021 update safeguards assessment found that the CBL has made notable progress in strengthening its safeguards framework. The CBL has maintained robust external audit arrangements, while internal audit and controls have been strengthened in line with the 2012 safeguards recommendations. Enhancements to reporting have resulted in the Audit Committee receiving key information for effective oversight of the audit and control mechanisms.

33. An independent central bank with robust functions will lend credibility to both monetary and financial sector policies and limit political interference.

  • The CBL Act should be strengthened in line with recommendations from the 2021 update safeguards assessment to align with leading practices in central bank governance, autonomy, and transparency.21 The CBL is taking steps to implement recommendations and has requested CD on drafting amendments. The National Reforms Authority (NRA) has also submitted amendments to anchor the central bank’s independence in the Constitution.22

  • Investment policy should be brought in line with leading practices and liquidity management improved by implementing past CD recommendations to protect against emerging credit and liquidity risks.23 Current passive practices limit room to achieve other goals, including maximizing reserve management efficiency and developing money and secondary bond markets. Amid mounting risks of tighter global financial conditions, exposure to rand-denominated assets should also be monitored closely.

Policy Coordination to Promote Macroeconomic Stability

34. Given policy constraints imposed by the exchange rate peg, coordination between the Ministry of Finance and the CBL is paramount for macroeconomic stability.24 As a small open economy with a large foreign-owned banking sector and pegged exchange rate, macroeconomic policy objectives should be well-articulated and aligned to ensure consistent fiscal and exchange rate policies. While the peg has helped anchor macroeconomic policy and keep inflation stable, the limited scope for nominal exchange rate adjustment calls for fiscal and structural policies to play a more robust role in external adjustment.25

35. The upward trend in expenditure puts pressure on the reserves needed to support the peg. In the absence of close coordination, the government’s spending and cash management plans can be at odds with the minimum reserves needed, particularly when funds are scarce, as in 2017. More recently, disagreements over the use of the 2021 SDR allocation highlighted these competing objectives.26 Under current assumptions for spending and borrowing, NIR—which includes the recent SDR allocation—is projected to drop below the CBL’s target in FY23/24 and decline to below 100 percent in the medium term with GIR skirting the minimum three month import cover.

36. The institutional independence of the central bank needs to be preserved within a cohesive, well-coordinated, and commonly agreed macroeconomic policy framework. Current practices can be augmented and formalized. For example, to safeguard the peg and preserve debt sustainability: (i) the debt ceiling can be determined by the Ministry of Finance; and (ii) the CBL can determine a ceiling for net claims on government, in consultation with one another. The government can then optimize the composition of spending within the resource envelope informed by these ceilings.

37. At the operational level, policy consultation and coordination can be embedded through regular cross-institutional high-level meetings and technical working groups.27 The creation of a high-level platform involving top officials from the Ministry of Finance, the CBL and other relevant MDAs would allow for regular engagement, including information exchange and coordination of policy decisions. Technical working groups could have a special focus on key policy areas, including harmonized growth forecasts. In this way, coordination can boost credibility, macroeconomic stabilization, and help depoliticize policymaking.

Progress on Prior Governance Commitments

38. Progress is being made towards fulfilling governance commitments under the 2020 RCF/RFI (Text Table 1). The Procurement Bill has been submitted to Parliament. The internal audit on COVID-19 expenditures for FY20/21 has been published, with audits underway for FY21/22.28 Quarterly budget implementation reports on COVID-19-related spending were published in 2020.29 COVID-19-related procurement contracts from a subset of MDAs have been published online.30 The Anti-Corruption and PFMA Bills are still being (re)drafted. Political and capacity constraints have caused delays and effort is needed to complete remaining measures.

Text Table 1.

Lesotho: Progress on 2020 RCF/RFI Governance Commitments

article image

Original wording referred to completion within 5 months, which deviates from standard practice within the Auditor General’s office.

Notes: The Omnibus Bill sets out constitutional amendments proposed as part of the SADC-sponsored national reforms process and was tabled in Parliament on April 26, 2022. The authorities aim to have the Bill approved and enacted by end-July 2022. DCEO=Directorate on Corruption and Economic Offences; PFMA=public financial management and accountability; SADC=South African Development Community.

39. The authorities have also proposed measures to streamline government. With over 50 MDAs, government functions have experienced problems with accountability, overlapping mandates, service delivery, and spending oversight. The NRA has submitted constitutional amendments that would limit the number of Ministers and Deputy Ministers to 12 percent of the members of both Houses of Parliament.

Authorities’ Views

40. The authorities agreed on the necessity of completing outstanding PFM reforms. The authorities acknowledge PFM gaps are hampering fiscal policy and are committed to minimizing arrears. The importance of better policy coordination between the Ministry of Finance and CBL— through existing and new formal structures—was also mutually acknowledged. The authorities remain committed to implementing the remaining governance measures from the 2020 RCF/RFI. However, they noted that certain commitments are dependent on others. For example, enforcing the submission of COVID-19-related procurement contracts for online publication requires enactment of key legislation, such as the PFMA and Procurement Bills. The NRA is a strong proponent of central bank independence and depoliticizing key processes—such as public sector wage-setting, procurement, debt approval, and cash management.

C. Maintaining Price and Financial Stability and Enhancing Access to Financial Services

41. The exchange rate peg has helped anchor inflation and maintain monetary stability given Lesotho’s very close economic linkages with South Africa. Under the peg, the inflation targeting framework is underpinned by the strong credibility of the South African Reserve Bank (SARB). The CBL has raised the policy rate by 75bp since November 2021 and will continue to track the SARB to import price stability and anchor expectations, while also standing ready to tighten in response to inflationary pressures.

42. Unlocking much-needed access to finance, notably for MSMEs, remains the key enabling factor for economic development and private sector growth. 31 The authorities must improve the credit infrastructure, enhance partial credit guarantee schemes, and support the development of capital markets. Staff advised the authorities to (i) complete the collateral property register; (ii) broaden the coverage and scope of the Credit Reporting Act,32 and (iii) implement the Insolvency Act by developing regulations with detailed provisions for practitioners.33

43. While progress has been made with bank supervision, the nonbank financial sector requires extra attention.

  • The authorities have implemented measures in line with past recommendations on the Basel ll Capital Adequacy Framework, the Risk Based Approach to AML/CFT Supervision, and payments systems. However, due to the pandemic, Basel II.5 implementation was postponed. The resolution framework could be strengthened via amendments to the Financial Institutions Act, and implementation of the FSB Key Attributes of Effective Resolution Regimes for Financial Institutions would help align with international best practice.

  • Nonbank financial supervision is still in its early stages. The Financial Cooperatives Bill should be finalized and submitted to Parliament, to provide the Ministry of Small Business Development, Cooperatives, and Marketing with greater powers to address troubled financial cooperatives and capacity to improve supervisory effectiveness. Actions must also be taken to deal with large financial institutions that continue to operate without a license. A Financial Action Task Force evaluation will help identify priorities for nonbank institutions.

44. Following progress, AML/CFT framework must continue to be effectively implemented in line with international standards. The CBL recently revamped its AML/CFT framework and is currently building capacity at the Financial Intelligence Unit. The CBL must continue to strengthen its AML/CFT capacity, including the effective migration to a risk-based approach to financial sector supervision. Particular attention should be paid to the management of risks associated with Politically Exposed Persons and the collection and retention of beneficial ownership information. Plans to establish a national registry of bank and mobile network operator accounts will provide information to support these efforts.34

45. Fostering digital financial services will broaden financial inclusion and literacy. Staff advised authorities to (i) submit the National Payments Systems Bill to Parliament and implement associated regulations; (ii) implement the Government Payment Gateway; (iii) implement the National Switch—and the associated common data standards and protocols; (iv) implement the National Identification Act; (v) update the Data Protection Act in line with international good practices, and revise and resubmit the Computer Crime and Cybersecurity Bill; (vi) adopt simplified customer due diligence requirements; and (vii) adopt Financial Consumer Protection regulations.

Authorities’ Views

46. The CBL agreed on the importance of closely monitoring inflation risks and monetary policy developments in South Africa given recent shocks. The CBL also agreed on the macro-criticality of increasing financial inclusion, noting progress in digitalizing financial services, the passage of the 2021 Insolvency Bill through Parliament, and recent pricing directives to alleviate financial transaction costs. However, the CBL highlighted that the rapidly growing nonbank financial sector is stretching its supervisory capacity and requires greater attention.

D. Catalyzing Inclusive, Sustainable, Private Sector-led Growth

47. Given the need for fiscal consolidation, broader structural reforms will be vital to help reenergize growth in the economy.

  • A stable and well-regulated business environment is an essential foundation for sustainable private sector-oriented growth. Staff recommended reforms to improve the business environment, including establishing commercial standards, developing an investment law that provides for open and competitive foreign and domestic investment, implementing digital verification systems for businesses,35 increasing private-sector participation in SOEs, and strengthening the rule of law.

  • As growth has been predominantly dependent on preferential trade schemes in a few sectors, the need to diversify and improve competitiveness is clear. Robust policies focusing on governance, education, infrastructure, and removing barriers to trade can support competitiveness and diversification. These include (i) human capital development to close skills gaps; (ii) moving businesses up the value chain; (iii) infrastructure investment to enhance connectivity, and (iv) easing nontariff barriers, especially on critical intermediate goods. The authorities are also looking to special economic zones to boost investment. Staff advised that careful attention must be paid to the design of incentives to avoid disrupting national tax policy, ceding tax base, and generating unjustified advantages, nonneutralities, and distortions. Consultation with stakeholders, including the private sector, will be critical.

48. Vulnerability to climate shocks such as floods and droughts underscores the importance of building climate-resilient infrastructure.36 Specifically, measures to improve irrigation systems, halt soil degradation, and regulatory reforms to promote climate-smart agricultural practices could help strengthen resilience in agriculture.

49. Building on positive strides in recent years, further efforts to address structural gender inequalities would help boost growth.37 Gender parity has been achieved at most levels of education. However, female labor remains concentrated in informal, low-skilled, contact-intensive sectors, which were among the hardest hit during the pandemic. Furthermore, local laws limit women’s access to finance, land, and employment. To promote active female labor force participation, staff advised the authorities to improve paid parental leave policies, take measures to reduce girls’ school drop-out rates, and improve female health outcomes, particularly in maternal health and HIV. The authorities have also begun work with development partners to introduce gender responsive budgeting.38


Labor Market

(Female to male ratio)

Citation: IMF Staff Country Reports 2022, 161; 10.5089/9798400212789.002.A001

Sources: UNDP Human Development Index (HDI), World Bank World Development Indicators (WDI), and IMF staff calculations.Notes: Unemployment rates are for 2018 and labor force participation rates are latest available for each country. SACU and SSA rates are median values.

50. Work has begun on the successor to the government’s current national development strategy (NSDP II), which is set to expire in 2023. The NSDP-II aimed to shift Lesotho from a consumer- and government-driven economy to a producer-based economy led by the private sector. The list of reforms was ambitious and progress slow due to persistent structural challenges and disruptions caused by the pandemic. The new plan should set out an achievable development agenda with measurable outcomes over the planning horizon.

Authorities’ Views

51. The authorities acknowledge that structural reforms can help resuscitate and reenergize growth alongside fiscal consolidation. The authorities welcomed the discussion on climate issues and are already embarking on piloting gender-responsive budgeting in selected MDAs.

Other Issues

52. Capacity development will be critical in supporting the authorities’ reform efforts (Annex IX). Priorities remain to strengthen PFM, financial sector oversight, liquidity and reserves management, tax policy and administration, and implement the anti-corruption legal framework.

53. Data are broadly adequate for surveillance. However, improvements are called for in the areas of debt, government finance statistics, national accounts, and trade:

  • On government finance statistics, coverage should be improved to eliminate discrepancies between above- and below-the-line transactions, and to include the largest extrabudgetary units. The timeliness and consistency of fiscal data should also be improved.

  • On debt, reliability and granularity of the public debt data should be improved to achieve greater accuracy of debt service projections. Contingent liabilities and guarantees should also be fully recorded and disclosed.

  • On national accounts, quality should be improved through greater data sharing with the Bureau of Statistics and implementing the planned rebasing of the annual national accounts. Efforts to improve quarterly and expenditure-side GDP data should continue.

  • On trade, granular data on values and volumes of products exported and imported could help assess sectoral performance. Such data should be supplemented with detailed publicly-available tariff schedules to help importers determine amounts owed upon importation.

Authorities’ Views

54. The authorities acknowledged weaknesses in both data quality and timeliness. The Ministry of Finance aims to eliminate above- and below-the-line discrepancies, which will require improved coordination with the CBL and the Ministry of Development Planning. The Bureau of Statistics will continue their efforts to improve national accounts data.

Staff Appraisal

55. Lesotho has been simultaneously buffeted by the pandemic and declining SACU transfers. The government responded swiftly to the pandemic—through containment, social, and economic mitigation measures, and vaccination. Nevertheless, the resulting fiscal pressures are weakening the external position, which is assessed in FY21/22 to be substantially weaker than implied by fundamentals and desired policies, underlining the fragility of the current economic model and the urgent need to consolidate public finances. Alongside, broad-ranging structural reforms will be vital to support a durable, resilient post-pandemic recovery built on green, inclusive, job-rich, and sustainable, private sector-led growth.

56. Fiscal sustainability will require determined efforts to contain spending upfront and implement PFM reforms. Fiscal and debt sustainability—and the ability to maintain sufficient reserves—are at risk under current policies. If unchanged, they could result in abrupt adjustment with a significant impact on macroeconomic stability, growth, and inequality. Critical for adjustment is containing current spending—notably high rigid public sector wages—and rationalizing capital spending. Fiscal consolidation complemented by both PFM and revenue reforms to minimize arrears, improve efficiency, control expenditure, and boost tax policy administration can improve fiscal outcomes in the near term, while minimizing the impact on growth. The government would then find itself better placed to finance key development priorities over the medium term.

57. The premium on undertaking structural reforms as soon as possible to create a growth-friendly environment is higher than ever. Staff strongly encourages efforts to improve the business environment, broaden financial inclusion, strengthen financial sector stability, and help the financial sector contribute more to growth by enhancing lending to businesses. To support these objectives, constraints related to credit reporting, collateral management, insolvency frameworks, liquidity management, and property rights need to be addressed. The nonbank financial sector needs to be developed. The authorities are encouraged to develop a financial sector development strategy based on the findings and recommendations of the IMF’s Financial Sector Stability Review and the World Bank’s Financial Sector Assessment Program Development Module.

58. Staff strongly encourages the authorities to continue their efforts to improve broader governance, build robust institutions, and coordinate closely across institutions on macroeconomic policies.

  • Policy coordination across institutions is essential for effective macroeconomic stabilization. The fixed exchange rate leaves the weight of adjustment to fall on fiscal policy and structural reforms. Staff welcomes efforts to strengthen central bank independence and governance to ensure price and exchange rate stability. Close coordination between fiscal and monetary authorities is necessary to balance competing objectives for spending, debt, and reserves; boost credibility and investor confidence, and ensure consistency of macroeconomic policies with the exchange rate regime.

  • Staff urges the authorities to implement the full range of governance commitments made under the 2020 RCF/RFI in a timely manner and extend them to areas beyond COVID-19 public spending, where warranted. Governance improvements will help macroeconomic stability, the business environment, and growth.

59. Notwithstanding the elections this year, a key set of macro-critical reforms that have broad support are important to pursue (Annex X). These include: overdue PFM reforms, which can help contain expenditure and arrears; auditing and prioritizing the capital budget; digitalizing government payment systems, and implementing the Insolvency Act.

60. Staff recommends that the next Article IV consultation for Lesotho be held on the standard 12-month cycle.

Figure 1.
Figure 1.

Lesotho: A Closer Look at Lesotho’s Economic Model

Citation: IMF Staff Country Reports 2022, 161; 10.5089/9798400212789.002.A001

Sources: Bureau of Statistics, Ministry of Finance, World Economic Forum Global Competitiveness Index 2018, World Governance Indicators 2020, IMF World Economic Outlook, and IMF staff calculations.Notes: SACU=Southern African Customs Union; WEO=World Economic Outlook; BWA=Botswana; LSO=Lesotho; NAM=Namibia; SSA=sub-Saharan Africa; SWZ=Eswatini; ZAF=South Africa.
Figure 2.
Figure 2.

Lesotho: The Impact of COVID-19

Citation: IMF Staff Country Reports 2022, 161; 10.5089/9798400212789.002.A001

Sources: Central Bank of Lesotho, Lesotho COVID-19 Socio-Economic Impact on Households Survey, Johns Hopkins University, University of Oxford, and IMF staff calculations.
Figure 3.
Figure 3.

Lesotho: Fiscal Developments

Citation: IMF Staff Country Reports 2022, 161; 10.5089/9798400212789.002.A001

Sources: Ministry of Finance and IMF staff calculations.
Figure 4.
Figure 4.

Lesotho: Monetary Policy and the Financial Sector

Citation: IMF Staff Country Reports 2022, 161; 10.5089/9798400212789.002.A001

Sources: Central Bank of Lesotho, World Bank Enterprise Surveys, IMF Financial Soundness Indicators, and IMF staff calculations.
Figure 5.
Figure 5.

Lesotho: External Sector and Debt

Citation: IMF Staff Country Reports 2022, 161; 10.5089/9798400212789.002.A001

Sources: Central Bank of Lesotho, Ministry of Finance, and IMF staff calculations. Notes: SACU=Southern African Customs Union; FDI=foreign direct investment.
Table 1.

Lesotho: Selected Economic Indicators, 2018/19–2027/281

article image
Sources: Lesotho authorities, World Bank, and IMF staff calculations.

The fiscal year runs from April 1 to March 31.

IMF Information Notice System trade-weighted; end of period.

12-month time deposits rate.

Table 2.

Lesotho: Fiscal Operations of the Central Government, 2018/19–2027/281,2

(LSL millions)

article image
Sources: Lesotho authorities and IMF staff calculations.

The fiscal year runs from April 1 to March 31.

Data for 2017/18 and 2018/19 are presented on a modified cash basis to correctly reflect current year expenses.

Other taxes are not shown in the table.

Table 3.

Lesotho: Fiscal Operations of the Central Government, 2018/19–2027/281,2

(Percent of GDP)

article image
Sources: Lesotho authorities and IMF staff calculations.

The fiscal year runs from April 1 to March 31.

Data for 2017/18 and 2018/19 are presented on a modified cash basis to correctly reflect current year expenses.

Other taxes are not shown in the table.