LESOTHO 
Memorandum on Economic and Financial Policies

I.   Introduction

1. This memorandum updates the Government of Lesotho’s memorandum on economic and financial policies (MEFP) dated March 1, 2002. It reviews performance over the six months to March 2002 and outlines the economic program for the period July 2002‑March 2003.

2. Medium-term economic objectives center on poverty reduction through employment creation, infrastructure development, natural resource management, human development, and good governance. These are to be achieved through sound fiscal and monetary policies, structural measures to make their implementation more effective and consistent with government objectives, and development of the private sector. Thus, the government aims at economic growth sufficient to raise real per capita income by at least 1 percent a year. The strategy seeks to bolster confidence in the economy, promote domestic and foreign investment, stimulate export growth, and create an environment for the private sector to create jobs.

II.   Performance Under the Program

3. The program promotes macroeconomic stability by limiting government deficits, setting a floor on international reserves of the central bank, and prohibiting nonconcessional external financing of the central government. Monetary policy is determined by the pegged exchange rate regime. Structural measures focus on improving tax administration and expenditure control, but also include initiatives to improve the financial system.

4.   Parliamentary elections were conducted on May 25, 2002. The process went smoothly and was judged free and fair by international observers. All major parties are now represented in Parliament. In consequence, confidence in Lesotho’s economy is already building, and an upswing in private investment can be expected.

5.  Lesotho’s economy has been buffeted by unusual weather conditions during the 2001-02 growing season, the regional food shortage, and sharp swings in the value of the South African rand against major currencies. These shocks have had adverse consequences for the agricultural sector and caused food prices, especially for maize meal, to soar. On the other hand, the currency depreciation has given a boost to competitiveness, and with Lesotho’s AGOA status, helped clothing exports to the United States to surge. Growth in this area is limited by the availability of factory shells. With the uncertainty about the election process now in the past, it is likely that the private sector will begin to invest in more fixed capital in Lesotho and therefore build complete factories, including structures, themselves.

6. The Government of Lesotho declared a state of famine in April 2002. High rainfall in October-November 2001 prohibited planting in many areas, and hail and frost during the growing season exacerbated crop shortfalls. In consequence, the cereal shortfall in 2002/03 is estimated at about 220 thousand metric tons. Government has put in place a response plan for the temporary emergency that will cost an estimated M370 million, approximately three‑fourths of which is to be financed through grants. Details are presented below.

7. Three of the four quantitative targets in the Government’s economic program for end-March 2002 were achieved. The quantitative criterion on domestic financing of the government was exceeded by M 143 million, but this amount was almost entirely due to  delays in a budget support grant from the European Union (M 70 million) and in a payment from the Rand Monetary Compensation Fund (M 66) million. Because these delays were beyond the control of Government and considering that payments have been received, Government requests a waiver on this performance criterion from the IMF.

8.  The accountant general position was not filled because the preferred candidate was unable to move to Lesotho for personal reasons. Because this was beyond its control, Government requests a waiver of this performance criterion. All other structural performance criteria were achieved and all but two structural benchmarks were completed.

A.   Fiscal Policies

9.  As noted above, the Government’s domestic financing requirement for end-March 2002 exceeded the program maximum. However, after adjusting for delays in disbursements from the European Union and the Rand Monetary Compensation Fund noted above, the program target was missed by only M 7 million, or less than 0.1 percent of GDP. Tax revenue was slightly below target, while nontax revenue missed the budget projection by M 65 million, largely due to an overestimate of income from charges and fees in the original budget and the delayed transfer from the Rand Monetary Fund. These shortfalls were offset to some extent by above budget electricity revenue and other property income. Further scrutiny of this item has led to the conclusion that actual collections underperformed relative to budget submissions from many ministries. Collection estimates for 2002/03 have been revised accordingly.

10. Current expenditure was M 65 million below the program target despite overruns in some areas. A weaker-than programmed exchange rate during the last quarter of the financial year pushed up external debt service costs, while wages paid to foreign mission employees were above the expected amount. Pension costs rose above budget in part because of Government’s decision to enforce its mandatory retirement age of 55 years. Spending on other goods and services was under budget by approximately M 90 million after reclassification that moved some items such as veterans’ pensions and contract gratuities to the transfers heading. Some of the decline cannot be attributed to specific categories because of weaknesses in budget reporting. Ministry staff have made some headway in reducing this category and anticipate that more progress will be made over the next few months. Externally financed capital spending was above projection because of improvements in project planning.

B.   Monetary Policies

11.  Net foreign and domestic assets of the Central Bank of Lesotho (CBL) were within their respective floor and ceiling targets for end-March 2002. Yields on treasury bills generally remained above those in South Africa, but the gap narrowed significantly during the period to June. The lack of financial intermediation remains a serious problem: the ratio of commercial bank loans to deposits averaged less than 15 percent in 2001.

C.   Structural Measures

12.  Through end-July 2002, the Government of Lesotho made significant progress toward all structural measures in its economic program, with the exception of filling the Accountant General position. The Commissioner General of the Lesotho Revenue Authority (LRA) was in place by the end of July (a performance criterion). However, owing to an accident involving a family member, the designated Accountant General withdrew his acceptance of Government’s offer. As presented in more detail below, substantial progress has been made in preparing action plans to strengthen the Accountant General’s office and upgrade or replace the government’s financial management system. These are now being reevaluated in light of the setback in filling the Accountant General position. Government has made less progress toward its objective of introducing performance based pay for public employees, but nevertheless remains committed to this principle. It hopes that with the elections over, more attention can be placed on this means of improving government operations.

13. Over the six months to June 2002, the Central Bank of Lesotho focused on the smooth functioning of the new treasury bill auction, strengthening data preparation, macroeconomic research, and developing financial markets. It has established guidelines and regulations for ancillary markets covering ownership, governance, and overall viability of businesses providing nonbank financial services. The Bank has also developed a strategy for strengthening Lesotho’s financial markets (a performance criterion) that focuses on alleviating structural impediments by first encouraging competition in the banking system and reviewing laws that have a bearing on financial intermediation. So far, and with the Central Bank’s encouragement, Lesotho’s commercial banks brought delinquent accounts to the Commercial Court, but these efforts have yet to pan out. Thus, the Bank achieved its structural performance criterion and benchmarks, with the exception of announcing guidelines for foreign exchange dealers. This benchmark was postponed as the Bank decided it should be linked to capital account liberalization in the future.

III.   The Economic Program for the Period April 2002–March 2003

14.  The economic program aims to implement the 2002/03 budget approved by Parliament in January 2002, improve financial management and tax administration, and work on financial market development, albeit at a measured pace. Major, long-term changes to fiscal policy will await the completion of Lesotho’s Poverty Reduction Strategy Paper, now timed for November 2002. Government is addressing forcefully the regional food situation within this framework and the revenue shortfall that has recently come to light.

A.   Revisions to the 2002/03 Program

15.  The fiscal stance in the 2002/03 budget was to be approximately neutral, with only modest changes envisaged in the domestic balance compared with 2001/02. It was sustainable in terms of the domestic borrowing requirement and in terms of foreign debt. Excluding Government’s response to the food situation, which is outlined in Section B below, the overall fiscal stance is projected to remain broadly the same. Some revenue and expenditure projections have been adjusted to reflect new information, and as outlined below, new policies considered, including M 45 million in supplementary spending cuts to offset revenue projections that have been revised downward. Estimates indicate that when Government’s response to the famine are factored in, budget and monetary measures of performance would remain acceptable provided the anticipated response from the international community is forthcoming.

16. Recurrent spending is expected to fall below budget, owing to the supplementary spending cuts. These include reductions in international travel and spending on office equipment. To guard against slippages, Cabinet has been advised that new requests for spending beyond what can be covered by the contingency should not be made, except for those directly related to famine relief or important health care needs. Other revisions to the fiscal projections include pension costs that are now expected to be higher because of further classification improvements but also reflecting end-of-service payments to Ministers, members of Parliament, and teachers at the Lerotholi Polytechnic Institute, which is to become autonomous. Vehicle lease costs appear to be running above budget, and in response Government intends to implement cost saving measures that have been recommended by a task force of government representatives working with Imperial Fleet Services. Cabinet has agreed to increase subventions to the Christian Health Association of Lesotho. The estimated wage bill has been lowered in line with anticipated vacancy rates.

17.  Tax collection projections have been lowered slightly. Projections of income tax collections were reduced reflecting new information and despite higher nominal GDP growth.  Much of the expansion would come from higher textile production, where most employees fall below the income tax cutoff. Sales tax collections have been revised down based on actual receipts in the first quarter and because the earlier projections had not taken into account tax refunds, which are now netted from gross collections according to the new Government Financial Statistics (GFS) standard. There is a risk that they could fall further over the next six months. In response, the sales tax department is redoubling its efforts to reduce tax avoidance at border posts. There has been a significant downward revision to the other nontax category because scrutiny of administrative fees revealed that budget projections, reflecting ministry submissions, were overstated.

B.   Famine Relief

18.  Lesotho has been hit by adverse weather conditions that have cut the harvest. In addition, maize prices in the regional market have approximately doubled since last year. In mid-April, Government announced a famine relief program that will reduce the impact of these developments on Lesotho’s poor. The plan, developed by a task force led by the Ministry of Agriculture, provides unsifted maize meal at no cost (100 percent subsidy) to children, the elderly, and the sick (Table 1). Unemployed persons would also receive free unsifted maize meal in exchange for work on public projects. To address the impact of higher prices on other low-income individuals, the plan provides a 20 percent subsidy on unsifted maize meal sold. This food would be distributed through existing suppliers and transportation channels to the extent possible. Recipients of free maize meal are already being screened and procedures are being put in place to reduce the chance of fraud. The total cost of the plan is estimated at M 373 million (approximately $37 million).

19.   The subsidies to maize meal are intended to last only until the next harvest when prices in the region are expected to return to pre-crisis levels. To bolster next year’s crop, donors, led by UNDP, are looking at ways to provide seed and other inputs, as well as technical assistance to strengthen farming techniques. They also hope to provide health and other aid in rural areas. Government will review these offers and adapt the economic program as necessary while keeping the overall macroeconomic objectives in mind.

20.  Government has already identified approximately M 23 million in funding for famine relief and has appealed to donors for the remaining M 350 million. As of end-July, donors have committed to providing 59,000 tons of grain. In addition, Government expects to receive an additional M 136 million ($13.5 million). The shortfall, approximately M 82 million, would be financed by drawing down Government balances at the central bank.  Government considered requesting additional financial assistance from the IMF, but at the present time has decided against this avenue. It would reconsider IMF assistance later in the year if costs of famine relief are higher than expected or if donor assistance does not materialize

21.  Government financing of famine relief will result in changes to the quantitative performance criteria in the economic program. Specifically, domestic financing will rise by about M 83 million by end-March 2003 and net domestic assets of the central bank will rise by about the same amount. Because most of the spending will be for imported maize and medical supplies for the young, international reserves will decline by a corresponding $8 million. Government believes that these changes will not jeopardize macroeconomic stability, provided it maintains control of other parts of the budget. Because of the uncertainties involved in predicting famine related costs—including the price of maize meal—and donor support, adjustment clauses have been added to the Technical Memorandum of Understanding. These allow for the quantitative performance criteria to change automatically if costs or support assumptions are not realized.

22.  To reduce the impact of the shock to food prices on the poor, Government has considered exempting unsifted maize meal from the 10 percent sales tax. On further consideration, Government has decided that it would be more efficient to increase the general unsifted maize meal subsidy under the relief plan from 20 percent to 30 percent and leave the tax in place. The cost saving on unsifted maize meal for the population would be the same in both cases, 30 percent, but the subsidy-only plan would be easier to administer. Tax officials had concluded that it would be difficult to exempt unsifted maize meal only, and they would need to exempt all maize products. Moreover, Government has concluded that it would make more sense to leave tax policy unchanged at this time and address the impact of all tax policies on the poor in the context of the PRSP and during deliberations on the budget. The unsifted maize meal subsidy is intended to be temporary and would come to an end after the completion of the famine relief program. In the future, Government could decide, in this broader context, to cut taxes on unsifted maize meal or provide assistance to the poor in other ways that would also benefit farmers.

C.   Strengthening Financial Management and Tax Administration

23.   Government is committed to improving its financial systems. Over the next nine months, Government intends to strengthen management of the Treasury department, begin the process of upgrading or replacing its financial management system, and bring to an end the longstanding problem of unaudited public accounts. These tasks are difficult, but can be successfully completed with unwavering support at the highest levels. In the end, the objective is for financial accounts that are transparent, comprehensive, capable of independent verification, and reviewed by Parliament. Government is cognizant that improvements could require additional funds.

24.     Government’s attempts to recruit a new Accountant General fell through at the last minute, as explained above. In consequence, it is rethinking how best to achieve its objective of improved financial tracking and spending control in the near term and a revamped financial management system in the medium term.. It remains committed to building a strong management team in the Treasury Department, and will appoint at least two Deputy Accountants General. A local Accountant General designate will be named within 12 months of the new Accountant General taking office, on his or her advice. The details of this expanded structure will be worked out when the Accountant General is in place and would likely require technical assistance or deputies experienced in the day to day operations of a smooth-functioning government treasury. Government will restart the process by advertising the Accountant General position no later than end-September. In the meantime, Government will seek an international resident advisor to assist the acting Accountant General in the interim period.

25.  Government recognizes the critical importance of preparing audited accounts for presentation to Parliament. This task has not been completed for several years and recent attempts to bring audits up to date have been hampered by gaps in the records and more generally the passage of time. In addition, there have been differences in professional views on how to achieve this objective. Government has decided that the best way to proceed in these circumstances is to establish a balance sheet or “statement of affairs” as of end-March 2002 that would involve reconstructing balances from third parties such as the Central Bank. Other financial assets and liabilities would be treated in the same way. As a matter of urgency, Government will establish a team consisting of accountants, the Auditor General, and outside assistance with international expertise in government accounting for this task. The team will prepare the best possible financial statement within a fixed time frame and present it to Parliament. Substantial differences between these reconstructed balances and those currently on the government books would need to be classified as unauthorized expenditure that would need to be investigated and, if not resolved, then ratified by Parliament. In this way, Government would have a clean starting point for future annual audits beginning with the 2002/03 financial year.

26.   Lesotho’s current financial tracking system, GOLFIS, has some deficiencies including the lack of a general ledger module. In addition, it currently does not capture all government accounts, is not integrated with other government systems, and does not always prevent expenditure over warranted amounts. To address these and other shortcomings, Government will initiate a two part study aimed at improving or replacing GOLFIS. The first phase will review the needs of government in this area and compare these with the capabilities of available systems including GOLFIS. The second phase will specify the desired system and prepare necessary tender documents. A study will begin shortly to plan later phases of this project.

27.   The Treasury Department is currently overburdened with voucher-related activities, in part because of a high number of emergency requests. These requests take up resources that otherwise could be devoted to budget monitoring, preparing reports for management, and other critical tasks. As a near-term solution, the Accountant General will reintroduce the batch system for voucher processing. In this system, ministries and departments will submit vouchers in bundles (batches) on designated days only. Experience has shown that this process will help to streamline work flow, ensure that all payments are properly recorded, and that all expenditure is authorized in the budget.

28.   The Government of Lesotho is pressing ahead with efforts to improve tax administration. In the near term these efforts will help to bolster tax compliance, while later on they will provide Government with choices in tax policy, including the establishment of a resource base with which to address priorities identified in the PRSP.

29.   The Commissioner General of the new LRA assumed duty on July 29, 2002. The appointee has considerable experience in tax administration in Southern Africa. Government is committed to supporting the LRA and the efficient tax administration it will bring. Government is moving ahead with the LRA preparations and has provided M30 million in this year’s budget for startup expenses so that the LRA can begin operations by end-December 2002, if not sooner.

30.   Government recognizes that tax collections, especially at border posts, are running below expectations, in part due to the transition to the LRA. Therefore, over the next few months, tax officials will continue to strengthen compliance. Officers have been reminded of their duties and Government’s policy of no tolerance toward tax evasion. Government will also re-deploy its task force on sales tax evasion at border posts.

D.   Monitoring the Macroeconomy and Financial Market Development

31.  In the period ahead, the Central Bank of Lesotho will continue to strengthen its macroeconomic capabilities. It will refine its macroeconomic projections and will look into publishing these projections on a semiannual basis. Currently, the Ministries of Finance and of Development Planning are attempting to build capacity in the areas of macroeconomic policy, economic projections, and fiscal strategy. These agencies will cooperate in these initiatives, both in the context of the PRSP and the annual plan and budget process.

32.   The Central Bank has identified the need to bolster balance of payments data and analysis, in particular in view of the declining, yet still important, remittances from Basotho miners in South Africa, the expansion of textile-related trade flows, and questions concerning the accuracy of trade flow and capital account data with respect to South Africa.

33.   One of the main impediments to faster economic growth is the lack of financial intermediation. As part of the comprehensive strategy to tackle institutional and structural weaknesses that are hindering private credit growth, the Central Bank of Lesotho has decided to establish a credit bureau. This decision is supported by Lesotho’s financial institutions because it would provide creditors valuable information on the creditworthiness of customers. In the same way, it would benefit borrowers by rewarding them with less costly access to credit. The economy as a whole would benefit as the establishment of a credit bureau would contribute toward a culture of loan repayment that in turn would raise the growth potential of the economy. The Bank hopes to have the bureau operating by end-January 2003, but recognizes that the timetable is uncertain because the bureau would necessarily involve participation of the private sector. As part of its overall strategy, Bank officials are committed to gradual liberalization of capital controls with a view toward better alignment of Lesotho’s exchange controls with those of other countries in the Common Monetary Area.

E.   The PRSP

34.   The poverty reduction strategy paper (PRSP) process is moving ahead and gaining speed. The government now expects first drafts of the paper to be reviewed by Cabinet in November 2002. A progress report was submitted to the IMF and World Bank Executive Boards in January 2002.

IV.   Program Monitoring

35.  To monitor policy implementation under the program, quantitative and structural performance criteria and benchmarks are set out in Tables 2 and 3 of this memorandum. Quantitative performance criteria for end-September 2002 will be conditions for the fifth disbursement and criteria for end-March 2003 will be conditions for the sixth disbursement. Structural performance criteria in Table 2 will also be conditions for the fifth and sixth disbursements as indicated.

36.   The Government of Lesotho will keep the IMF informed of the progress in the implementation of the program. In particular, the government will continue to send to the IMF fiscal and monetary data on a monthly basis, as well as balance of payments and health and education spending data at least on a quarterly basis. It will send domestic debt (by holder and instrument) and external debt data on a monthly basis and information on monthly treasury bill auctions. A calendar for the provision of data appears in the Technical Memorandum of Understanding.

37.  Government recognizes that there have been delays in providing data in the recent past. It is making every effort to rectify this situation as timely and accurate information facilitate program monitoring. Government notes that some delays were due to efforts to reclassify data and improve quality more generally.

38.    During the program period, the government does not intend to (a) impose or intensify any restrictions on payments and transfers for current international transactions; (b) introduce or modify multiple currency practices; (c) conclude bilateral payments agreements that are inconsistent with Article VIII of the Fund’s Articles of Agreement; or (d) impose or intensify any restrictions on imports for balance of payments reasons.

Table 1. Lesotho: Food Relief Program and Assumptions, 2002/03 1/                                                              

Source: Ministry of Finance.                                                                                                                                     

1/ Fiscal year begins April.                                                                   

2/ Millions of maloti.                                                                

3/ Metric tons.                                                 

Table 2.  Quantitative Benchmarks and Performance Criteria, June 2002 - June 2003                                                                                                                                 

Table 3. Lesotho: Structural Benchmarks and Performance Criteria, July 2002— March 2003