On April 26, 2019, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Kingdom of Lesotho.
Over the past decade, capital intensive projects and government consumption have driven growth in Lesotho. Most recently, work is beginning on Phase 2 of the Lesotho Highlands Water Project, and together with a recovery in the diamond and textile sectors, has resulted in growth of around 3 percent of GDP in 2018/19. However, with SACU revenues below historical averages and government expenditure persistently high, the government has run into fiscal difficulties, leading to the emergence of government payment arrears.
The recently passed FY 2019/20 budget envisages strong fiscal consolidation which should ensure a fully financed deficit and allow space for the clearance of arrears. The authorities plan to increase the VAT on telecoms and introduce a levy on alcohol and tobacco. On the expenditure side, savings will be generated by a zero cost of living adjustment for civil servants, which will begin to address the issue of the wage bill, currently one of the largest in the world as a percent of GDP.
While external pressures have subsided, buffers have shrunk, and balance of payments weaknesses persist. The current account deficit is projected to widen to 8.4 percent of GDP in FY 2018/19, due to a fall in SACU revenues coupled with a depreciation of the loti. Reserves are projected to fall to 3½ months of imports at the end of FY 2018/19, down from 3¾ the previous year. However, the peg to the rand has supported monetary stability, and inflation has remained subdued.
The banking sector in Lesotho remains sound. Nevertheless, the sector’s contribution to growth has been limited, and lending to the corporate sector and SMEs has been anemic. Reforms to improve the legal framework aim to encourage lending, while technological change, such as the rapid growth in the mobile money sector, is providing new channels for households and small businesses to access the formal financial system.
Directors welcomed the progress made in restoring peace and stability, but however, noted that Lesotho continues to face significant challenges, stemming mainly from the declining Southern African Customs Union (SACU) revenues and high government expenditures. Against this background, Directors underscored the need for both short- and medium-term measures to preserve fiscal and external sustainability, as well as generate strong and inclusive growth.
Directors welcomed the ambitious FY 2019/20 budget and emphasized that its strict implementation will be key to preserving fiscal sustainability, especially in terms of clearing the accumulated domestic arrears and strengthening the external position. They underscored the importance of strengthening expenditure controls, resisting pressure to enact additional spending, and improving tax administration. Directors recommended improvements to debt management, a prudent approach to debt contracting, and addressing contingent liabilities related to the public sector pension fund to strengthen debt sustainability.
Directors emphasized that the fiscal adjustment needs to be reoriented to favor growth and efficiency. Reducing the high public wage bill over time will provide space for the authorities’ strategic priorities. Directors also stressed the need for greater efficiency in health and education spending to ensure better outcomes. They further urged for enhanced public financial management, including through improved financial reporting and cash management, which will accelerate the clearance of arrears. Directors welcomed the authorities’ efforts to protect the most vulnerable from the impact of the adjustment.
Directors welcomed the steps being taken to strengthen the financial sector’s contribution to growth. They highlighted the need to continue to closely monitor household indebtedness and credit concentration as well as to further enforce the AML/CFT framework. Strengthening the regulation of the non-bank financial sector will also be needed to support the financial inclusion agenda.
Directors supported efforts to encourage job creation and underscored the need for continued improvements to the business climate. They highlighted the importance of a stable regulatory framework, with greater engagement with the private sector prior to the introduction of new regulations.