Public Information Notice No. 11/75

Public Information Notice: IMF Executive Board Concludes 2009 Article IV Consultation with the Kingdom of Lesotho

June 15, 2011

On February 22, 2010, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Kingdom of Lesotho.¹

Background

After several years of improved economic management, Lesotho’s fiscal and external balances deteriorated in 2009 owing to the global economic crisis and a sharp increase in expenditure. Real GDP growth is projected to slowdown in 2009 due to reduced demand for Lesotho’s main exports of textiles and diamonds and lower remittances from South Africa. Reflecting a sharp increase in government spending, the fiscal position is projected to record a small deficit in 2009/10, after five consecutive years of surpluses, while the external current account position is expected to shift from a surplus in 2008 to a deficit in 2009.

A steep decline in Southern African Customs Union (SACU) revenues over the next few years is expected to result in large, albeit declining, fiscal and external current account deficits. Containing growth of expenditures, particularly the wage bill, and strengthening non-SACU revenues will be key to achieving fiscal and external sustainability in the medium-term.

The financial sector appears to have weathered the impact of the global financial crisis, and banks remain well capitalized, liquid and profitable. Financial sector vulnerabilities stemming from weakly supervised nonbank financial institutions are being addressed through the strengthening of regulations and supervision, including on illegal financial schemes.

Lesotho’s medium-term growth prospects will depend significantly on the construction of two water projects. The outlook is subjected to significant downside risks arising from a more protracted global recovery, delays in undertaking fiscal adjustment, and potentially lower SACU revenues.

Executive Board Assessment

Executive Directors commended the authorities for their prudent macroeconomic management, which has contributed to the recent strong economic performance and a continued build-up of international reserves. Directors noted, however, that Lesotho continues to face the challenges of sustaining economic growth, tackling widespread poverty and the high incidence of HIV/AIDS, and achieving the Millennium Development Goals (MDGs). Addressing these challenges has been further complicated by the on-going global economic and financial crisis, which could result in a reduction in SACU revenues, remittances, and exports of textiles and minerals.

Against this background, Directors emphasized the need for continued vigilance on the macroeconomic front, with a view to preserving fiscal and external stability. They also considered it crucial to fast-track the implementation of structural reforms, aimed particularly at promoting broad-based growth. In this regard, Directors welcomed the authorities’ growth diagnostic study, which would guide the prioritization of efforts to remove constraints to growth. They stressed in particular the importance of land reform, which has the potential to reinvigorate the financial, tourism, and manufacturing sectors, critical for employment creation and sustained poverty reduction.

Directors called on the authorities to accelerate the pace of reforms, supported by the World Bank and the Millennium Challenge Corporation (MCC). Determined efforts to reduce the cost of doing business, improve the investment climate, and increase investment in human and physical capital would help consolidate the recent gains in growth performance and improve competitiveness. Directors welcomed the authorities’ intention to set up a high-level committee that will ensure rapid implementation of these reforms.

Directors encouraged the authorities to adopt a fiscal strategy to mitigate risks from potentially lower SACU revenues, while creating fiscal space for increased social spending and growth-enhancing investment. This includes strengthening non-SACU revenues and tax administration, and containing recurrent spending. Directors also saw the need to accelerate civil service reform and to contain the wage bill, including by linking future increases to performance and to qualified professionals within the health and education sectors.

Directors welcomed the authorities’ intention to improve the process of public expenditure management. They supported the plan to formulate future budgets on the basis of the expected outturn, noting that this would make the budget a more effective tool for public policy, while improving transparency, accountability, and effective use of resources. Directors also underscored the importance of prudent debt policy, including seeking loans on highly concessional terms.

Directors agreed that Lesotho’s monetary and exchange rate regime under the Common Monetary Area helps maintain price stability and facilitates capital and current transactions with the country’s most important economic partner, South Africa. They emphasized, however, that maintaining external sustainability will require enhanced productivity and competitiveness, and pursuit of a prudent fiscal policy.

Directors noted that, while the banking sector has weathered the global financial crisis relatively well, more needs to be done to improve regulatory oversight and increase access to financial services for small- and medium-scale enterprises and the underserved population. In this regard, they welcomed the efforts underway, supported by the MCC and the International Fund for Agricultural Development, to deepen and enhance efficiency of the financial sector.

Directors welcomed the authorities’ recent decision to close the largest Ponzi scheme, and looked forward to an early resolution. They urged that prompt action be taken to address vulnerabilities arising from the weakly supervised nonbank financial institutions, including by expeditiously amending the Financial Institution Act to strengthen the supervisory and regulatory role of the central bank. Directors also supported the planned amendment of the Cooperative Societies Act, which would prohibit deposit mobilization from nonmembers of credit cooperatives. They welcomed the passage of the Anti-Money Laundering Law, and looked forward to the establishment of the Financial Intelligence Unit.