July 10, 2001

Mr. Horst Köhler
Managing Director
International Monetary Fund
700 19th Street, N.W.
Washington, D.C. 20431

Dear Mr. Köhler:

The Government of Lesotho entered into a three-year arrangement with the Fund under the Poverty Reduction and Growth Facility in a total amount equivalent to SDR 24.5 million in March 2001. I request that the second disbursement, in the amount of SDR 3.5 million be made available following the successful completion of the first review.

The attached Memorandum on Economic and Financial Policies reviews performance under the program and updates the government's economic objectives and policies for the period through March 2004. The memorandum also outlines the government's action plan for the financial year 2001/02. The Government has prepared and submitted to the IMF and the World Bank an Interim Poverty Reduction Strategy Paper, and is in the process of preparing a full PRSP.

The government requests an increase in performance criterion for the domestic financing requirement of the central government to reflect a revised pattern in external grant and loan flows. It is noted that the domestic financing requirement for the 2001/02 financial year have been revised downward.

In April and early May 2001, there were large capital outflows from the Central Bank of Lesotho that were reversed by mid-June. In view of this volatility, the Government requests a modification in the performance criteria on net international reserves. I also request a change to net domestic assets in view of potential volatility and also the introduction of treasury bills for monetary policy purposes in September 2001. There is no change in the thrust of monetary policy.

The Government through the Central Bank of Lesotho had intended to begin auctioning treasury bills for monetary policy purposes beginning on August 1, 2001. However, it has become necessary to revise the Loans Act before this auction can begin. The Government requests accordingly a modification of the performance criterion on the treasury bill auction start date by extending it by one month to September 1, 2001.

In collaboration with Fund staff, the Government will review the progress in implementing the program every six months. The second review is scheduled to be completed no later than January 31, 2002.

Sincerely yours,

/s/

LESOTHO

I. Introduction

1.  This memorandum updates the Government of Lesotho's Memorandum of Economic and Financial Policies (MEFP) dated February 12, 2001. It reviews performance over the six months to March 2001 and outlines the economic program for the period April 2001-March 2002.

2.  Medium-term economic objectives and policies are unchanged from the detailed description in the February MEFP. Thus, the government aims at economic growth sufficient to raise real per capita income by at least one percent a year and achieve this through market-oriented policies, including macroeconomic stability and good governance. The strategy also includes increased emphasis on education and health. The strategy seeks to restore confidence in the economy, promote domestic and foreign investment, stimulate export growth, and create an environment for the private sector to create jobs. This will be the main vehicle for meaningful poverty reduction in Lesotho.

II. Performance Under the Program

3.  The program promotes macroeconomic stability by limiting the government's access to domestic financing, 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 and data collection.

4.  Lesotho's economy has performed largely as expected over the period under review. Available indicators suggest that GDP growth was about 2½ percent in 2000, but per capita income fell. Consumer price inflation slowed to 6 1/3 percent in the 12 months to April 2001. The external current account deficit narrowed to 18 percent of GDP, and there was a small increase in official reserves during the year. However, official reserves have declined slightly since the beginning of 2001.

5.   Key program objectives for the first review period have been achieved. All quantitative performance criteria for end-March and the structural performance criterion for VAT publicity by April 1, 2001 were met, and a critical mass of structural benchmarks was completed.

Fiscal policies

6.  The government's domestic financing requirement was below the program maximum for the March quarter. For the full 2000/01 financial year this over-performance reflected higher-than-programmed tax collections and below-program total spending. The good performance in tax collection over the year reflected in part ongoing efforts to strengthen tax administration, including progress in clearing tax arrears.

7.  Total spending in 2000/01 was 46 percent of GDP, or 1¾ percent below the program assumption. However, this outcome reflected underspending on capital projects that more than offset above-program recurrent spending. The overrun in recurrent spending mainly reflected an unexpected, one-time transfer of customs collections arrears to SACU and higher-than-anticipated costs of leasing government vehicles following privatization of the vehicle fleet. These overruns more than offset under-spending on elections, the contingency fund, and savings from spending freezes enacted on two occasions during the year. The disappointing below-target capital spending reflected in part delays in donor funding and in project implementation, especially for new projects. Government plans to address underlying weaknesses in both of these areas as summarized in Section III.

Monetary policies

8.  Net foreign and domestic assets of the Central Bank of Lesotho (CBL) were within their respective floor and ceiling targets in March 2001. Interest rates declined during the first four months of 2001. However, lack of financial intermediation remains a serious problem: the ratio of commercial bank loans to deposits averaged less than 15 percent in 2000.

Structural measures

9.   The government successfully observed its structural performance criterion on VAT publicity and a critical mass of structural benchmarks scheduled for completion through April 2001. Intended actions to improve tax administration were largely completed, and the government is committed to maintain momentum in this area. The planned Lesotho Revenue Authority and introduction of the VAT are moving ahead and the government has identified steps to ensure that both can be made operational on schedule.

10.  Measures aimed at strengthening expenditure control and budget management were substantially completed. A working group to improve public sector management has been set up, off-budget spending items have been identified, and considerable progress was made in the computerization of human resources and payroll records in scheduled ministries. However, a timetable to eliminate off-budget items was not drawn up because, in the event, the task was not well defined, and around 10 percent of employee records in the targeted ministries were not computerized because of logistical problems. Budget reports are now being produced, although their timeliness and level of detail could be strengthened. Government plans in these areas are laid out below.

11.  The economic strategy for the financial year centers on sound fiscal and monetary policies, structural measures to make these policies more effective, and measures to promote private sector development.

The 2001/02 budget and supporting measures

12.  Government presented its 2001/02 budget to Parliament in April. It is largely in line with the economic program supported by the IMF. Recurrent spending and tax assumptions are unchanged from the program, while increases in capital spending are to be financed by a higher level of grants. Thus, the projected domestic financing requirement for the year is below the original target. The end-September performance criterion on government domestic financing, however, has been revised relative to the program to reflect new information on the timing of budget flows (Table 1).

13.  The government recognizes that its spending objectives, while feasible, represent several challenges. First, a high degree of discipline will be required to stay within the recurrent spending totals. In particular, some necessary purchases were postponed during last year's spending freezes, and these may put upward pressure on the current budget. Areas of overrun last year, for example car leasing, will need to be monitored carefully to stay within the provisions of the budget. Second, past experience suggests that completing all envisaged capital projects may be difficult because of delays in accessing and using donor funds. In addition, the budget is not expected to be approved by Parliament until June, delaying the start of new projects.

14.  The government intends to enhance budget management to help meet these challenges. A long-term project to improve the efficiency of the public sector, including timely and transparent financial management, is being finalized with the World Bank. The project is expected to begin in early 2002. In the intervening months, the government will strengthen expenditure management by addressing off-budget spending (below-the-line accounts including trading and suspense accounts) and ensuring that autonomous funds such as the Road Fund and the Lesotho Fund for Community Development submit audited accounts to the Ministry of Finance as required by law. These steps will support the government's longer-term objective of moving to a consolidated accounting framework. The Ministries of Finance and Development Planning will also conduct a seminar on the budget process at the ministerial level. It will be coordinated with the kickoff of the 2002/03 budget cycle and is intended to make budget preparation more efficient and timely.

15.  Tax collections in the 2001/02 budget assume that administrative gains last year will be maintained. To reinforce ongoing efforts in this area, the government will emphasize its policy of no tolerance towards tax evasion by reissuing the Ministry of Finance Ten Point Plan to Improve Tax Compliance. The Ministry of Finance will issue a reminder that Circular Number 2 of 2001 on guidelines for tax compliance should be applied in full. Recognizing the importance of monitoring progress, the Sales Tax and Income Tax Commissioners will produce monthly summary reports on tax arrears and third party payment measures. The reports will document deviations from established guidelines on paying taxes due and third party payment measures.

16.  A key objective and performance criterion for end-September 2001 is an operational Lesotho Revenue Authority. The government is committed to the Authority, which, under a Board of Directors, will allow for greater flexibility of operation and lead to efficient and effective tax collection. To this end, the government has appointed an implementation manager and set up a steering committee whose membership includes the Minister of Finance (Chair) and the Governor of the Central Bank of Lesotho. The draft Revenue Authority Bill was approved by Cabinet and its passage by Parliament is expected in July. Terms of service for the director and staff are being worked out. Budget resources for training and other startup expenses are presently available, and a full operational budget will be provided from the contingency fund when the Authority is formed.

17.  The government sees the following steps as necessary for an operational revenue authority:

• Legislation enabling revenue authority passed by parliament

• Board of Directors appointed

• Terms of employment approved for the LRA Commissioner General and staff

• Budget sufficient to cover start-up costs (e.g. office supplies, computer equipment), salary packages consistent with LRA terms of employment, and other operational costs

• Existing staff screened for employment in LRA (e.g., education attainment, past performance, etc)

18.  The government is moving ahead with plans to introduce the VAT on April 1, 2002. It has already begun a publicity campaign and is on track to register traders and install a computer system. A successful VAT will depend critically on effective tax administration at border posts.

Monetary policy

19.  Monetary policy is determined by Lesotho's membership in the Common Monetary Area (CMA) and its fixed exchange rate arrangement. Performance criteria for net international reserves and domestic assets of the central bank have been set within this framework and consistent with the 2001/02 government budget and balance of payments projections. In particular, foreign reserves are programmed to remain above 5 months of imports through March 2002. This level implies that central bank reserves will be in excess of 3 times narrow money.

20.  Over the past several months, commercial banks in Lesotho have increased their foreign asset positions. This appears to reflect the reduction in the Minimum Local Asset Requirement (MLAR) from 60 percent to 40 percent in December 2000 and therefore represents asset rebalancing within the banking sector that is consistent with the CBL's overall strategy to move toward indirect policy instruments. As a result of the asset rebalancing by the commercial banks, net international reserves of the CBL are assumed to decline in the June quarter of 2001, but remain above the program target. However, once the indirect monetary policy implementation program of the central bank gets underway in early September with the new treasury bill auction, net international reserves are expected to return to an upward trend. Progress toward the treasury bill auction has been good, and the bank has requested additional technical assistance from the IMF to address any last minute details.

Development strategy

21.  The government sees private sector development as essential in raising employment and fighting poverty. The government's strategy as outlined above and discussed in the February 12, 2001 MEFP is to provide an environment where Basotho (the people of Lesotho) can reasonably expect to enjoy the profits of their labor and savings. This can best be accomplished through macroeconomic stability, a sound banking sector, an effective legal system, especially in this context pertaining to commercial law and property rights, and good governance including fair tax treatment and an efficient expenditure management system. In addition, the government will, with its development partners, be studying ways to provide physical infrastructure to complement its private sector development strategy.

IV. Program Monitoring

22.  To monitor policy implementation under the program, quantitative and structural performance criteria and benchmarks are set out in Table 1 and 2 of this memorandum.

23.  The Government of Lesotho will keep the IMF informed of the progress in the implementation of its program. In particular, the government will continue to send to the IMF fiscal and monetary data on a monthly basis, and balance of payments data at least on a quarterly basis. It will begin to send domestic and external debt data on a monthly basis beginning in June 2001 and information on monthly treasury bill auctions when they begin. To strengthen financial reporting, the CBL will appoint a private accounting firm to ensure compliance with International Accounting Standards (IAS), and in this connection prepare reconciliation between foreign reserves on the IAS balance sheet and NIR data reported to the IMF. The firm will be appointed before the completion of the second review.

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

Table 1. Lesotho: Quantitative Benchmarks, Performance Criteria and Indicative Targets
June 2001-March 2002
(end of period)
	2001 June		2001 Sept.1			2001 Dec. Indicative	2002 March
	Estimate		Prog.	Rev. Prog.
	(In millions of maloti)
Ceiling on the domestic financing requirement of the Central Government2	76		26	97		122	-86
Ceiling on the stock of net domestic assets of the Central Bank of Lesotho	-2416		-2270	-1937		-2212	-2387
	(In millions of US dollars)
Floor on the stock of net international reserves of the Central Bank of Lesotho3	379		352	312		328	331
Ceiling on the amount of new non- concessional external debt contracted or Guaranteed by the public sector (cumulative from end-November 2000)4,5,6
Maturity of less than one year7	0		0	0		0	0
Maturity of one year or more	0		0	0		0	0
Ceiling on the stock of external payments arrears	0		0	0		0	0
Sources: Finance Ministry, Central Bank of Lesotho, and staff estimates. 1Performance criteria. 2Cumulative from end-March 2001. 3At program exchange rates. 4This performance criterion applies not only to debt as defined in point no. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt, adopted on August 24, 2000, but also to commitments contracted or guaranteed for which value has not been received. A loan is concessional if its grant element is at least 35 percent, calculated using a discount rate based on the ten-year average of OECD commercial interest reference rates (CIRRs) for loans of maturity of greater than 15 years; for loans of maturity of 15 years or less, the discount rate is based on the six-month average of OECD CIRRs. To both the ten-year and six-month averages, the same margin for differing repayment periods would be added (0.75 percent for repayments periods of less than 15 years, 1 percent for 15 to 19 years, 1.15 percent for 20 to 29 years, and 1.25 percent for 30 years or more). 5Excludes borrowing for water transfer operations of the Lesotho Highlands Development Authority. 6Continuous. 7Except for normal short-term import credits and non-resident holdings of treasury bills.

 

Table 2. Lesotho: Structural Benchmarks and Performance Criteria, June 2001- October 2001
Action			Implementation Date
A.	Tax Administration
	1.	Draw public attention to the government's policy of no tolerance towards tax evasion by reissuing the Ministry of Finance's Ten Point Plan to Improve Tax Compliance. The Ministry of Finance will issue a reminder that Circular Number 2 of 2001 on guidelines for tax compliance should be applied in full .	June 30, 2001
	2.	The Sales Tax and Income Tax Commissioners will produce monthly summary reports on tax arrears and third party payment measures 20 days after the end of the-month. The reports will document deviations from legal requirements.*	July 31, 2001
B.	National Revenue Authority
	1.	Lesotho Revenue Authority becomes operational *	September 30, 2001
C.	Value-Added Tax
	1.	Commence registration drive and visits to traders	July 1, 2001
	2.	Complete installation and testing of VIPS computer software	August 31, 2001
D.	Expenditure Control
	1.	Establish a timetable to eliminate off-budget spending (below-the-line accounts) by moving these items into ministry or spending department budgets. Autonomous funds such as the Road Fund and the Lesotho Fund for Community Development will submit audited accounts annually to the Minister of Finance within six months of the end of the financial year.	September 30, 2001
	2.	Complete the public sector fiscal accounts for 2000/01 and submit these to the Auditor General as required by law within six months of the end of the year.	October 30, 2001
	3.	Hold a seminar on the budget process at the ministerial level to coincide with the start of the 2002/03 budget cycle.	September 15, 2001
E.	Financial Sector Reform
	1.	Establish a regular auction mechanism for treasury bills *	September 1, 2001
F.	Statistics Strengthening
	1.	Compile detailed monthly budget execution reports and reports on domestic debt within 30 days of the month's end	June 30, 2001
* Denotes performance criterion.

 

Government of Lesotho
Technical Memorandum of Understanding

July 10, 2001

1. This memorandum sets forth the understandings between the Government of Lesotho and the IMF staff regarding the definitions of the quantitative performance criteria and benchmarks for the arrangement supported under the Poverty Reduction and Growth Facility (PRGF), as well as the respective reporting requirements. These performance criteria and benchmarks are reported in Table 1 of the government's Memorandum on Economic and Financial Policies (MEFP).

2. The test dates for assessing observance of the quantitative targets during the financial year April 2001-March 2002 will be end-June 2001, end-September 2001, end-December 2001, and end-March 2002. The end-September 2001 targets will constitute quantitative performance criteria, and the end-June 2001 and end-December 2001 targets will constitute quantitative benchmarks. In addition, the ceilings on the stock of external payments arrears and new nonconcessional external debt are continuous performance criteria. The second review under the program is scheduled for completion by January 31, 2002. End-March 2002 quantitative performance criteria will be set at the second review.

A. Floor on the Stock of Net International Reserves of the Central Bank of Lesotho

3. Definition: The net international reserves (NIR) are defined as the Central Bank of Lesotho's liquid, convertible foreign assets minus its liquid, convertible foreign liabilities. Pledged or otherwise encumbered assets, including, but not limited to, assets used as collateral or as guarantee for third-party external liabilities are excluded from reserve assets. Reserve assets include cash and balances held with banks, bankers' acceptances, investments, foreign notes and coins held by the Central Bank of Lesotho, Lesotho's reserve position in the Fund, and SDR holdings. Reserve liabilities include nonresident deposits at the Central Bank of Lesotho, use of IMF credit, and any other liabilities of the central bank to non-residents. The stock of NIR at the end of each quarter will be calculated in United States dollars using agreed end-period program exchange rates (maloti per U.S. dollar).

4. Adjustment clause: The program target for the NIR of the Central Bank of Lesotho in any quarter will be adjusted upward by the amount of any advance non-duty receipts from the Southern Africa Customs Union (SACU) in that quarter, where such advance receipts constitute amounts that would otherwise have been received in a subsequent quarter. It will be adjusted for accounting practice changes implemented by the Central Bank of Lesotho that are recommended by the IMF's Statistics Department or are made in response to the IMF safeguard report.

5. Supporting material: The Central Bank of Lesotho will provide data on its NIR and on SACU non-duty receipts on a monthly basis within one week of the end of the month. The NIR data will be provided in a table showing the breakdown of the foreign assets and foreign liabilities of the Central Bank of Lesotho in maloti and in U.S. dollars.

B. Ceiling on the Stock of Net Domestic Assets of the Central Bank of Lesotho

6. Definition: The net domestic assets (NDA) of the Central Bank of Lesotho are defined as the difference between reserve money (currency issued plus total bank deposits at the central bank) and net foreign assets (calculated at program exchange rates as stipulated in paragraph 3). The net foreign assets are defined as foreign assets minus foreign liabilities, and include all foreign claims and liabilities of the Central Bank of Lesotho. The NDA thus include net claims by the Central Bank of Lesotho on the Government (loans and treasury bills purchased less government deposits), claims on banks, and other items net (other assets, other liabilities, and the capital account).

7. Adjustment clause: The program target for the NDA of the Central Bank of Lesotho in any quarter will be adjusted downward by the amount of any advance non-duty receipts from the Southern Africa Customs Union (SACU) in that quarter, where such advance receipts constitute amounts that would otherwise have been received in a subsequent quarter.

8. Supporting material: The Central Bank of Lesotho will provide detailed data on its balance sheet on a monthly basis within 21 days of the end of the month. The Central Bank will also provide on a weekly basis a table of selected monetary indicators covering the major elements of its balance sheet.

C. Ceiling on the Domestic Financing Requirement of the Central Government

9. Definition: The central government includes the central administration and all district administrations. The domestic financing requirement of the central government is defined as net credit to, and other claims on, the government from the banking system (Central Bank of Lesotho and the commercial banks), plus net credit to, and other claims on, the government from the non-bank sector. It will be calculated as the cumulative change from the end-March 2001 stock of net credit to, and other claims on, the government by the banking and nonbanking sectors. Changes in balances held in the privatization account or accounts into which the proceeds from the sale of public enterprises are deposited shall be included in the calculation of the domestic financing requirement, while changes in balances held in any account into which revenues collected by the customs department are held pending their transfer to the SACU revenue pool shall be excluded. The amounts of treasury bills issued or retired by the Central Bank of Lesotho for monetary control purposes, as well as the corresponding changes in the balance of the blocked government account that the Central Bank of Lesotho uses to manage the sale and retirement of treasury bills for monetary control purposes, will be included in net credit to the government.

10. Adjustment clause: The program assumes that customs revenue from the SACU revenue pool will be received as follows: M359.6 million in each quarter in fiscal year 2001/02. The program target for the domestic financing requirement of the central government in any quarter will be adjusted downward by the amount of any excess of customs revenue received over the programmed amount in that quarter, where this excess constitutes advance receipts of amounts that would otherwise have been received in a subsequent quarter.

11. Supporting material: The Central Bank of Lesotho will provide the monetary survey, as well as a table showing the details of all government financing operations from the nonbank public, on a monthly basis and within 30 days of the end of the month. The outstanding balances in the privatization account or accounts, and in the SACU revenue pool account mentioned in paragraph 9, will be separately identified in the monetary survey. The Central Bank will also provide tables showing the details of any monetary operations with treasury bills, including the changes in government deposits stemming from such operations.

D. Ceiling on the Amount of New Non-Concessional External Debt Contracted or Guaranteed by the Public Sector, with Original Maturity of One Year or More

12. Definition: The public sector comprises the central government, the Central Bank of Lesotho, and all enterprises with majority state ownership. A loan is concessional if its grant element is at least 35 percent of the value of the loan, calculated using a discount rate based on commercial interest reference rates (CIRRs) reported by the OECD. For loans of maturity greater than 15 years, the grant element will be based on the ten-year average of OECD CIRRs. For loans of maturity 15 years or less, the grant element will be based on the six-month average of OECD CIRRs. Margins for differing repayment periods would be added to the CIRRs: 0.75 percent for repayment periods of less than 15 years, 1 percent for repayment periods of 15 to 19 years, 1.15 percent for repayment periods of 20 to 29 years, and 1.25 percent for repayment periods of 30 years or more. This performance criterion applies not only to debt as defined in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt, adopted on August 24, 2000, but also to commitments contracted or guaranteed for which value has not been received. Included in this performance criterion are all current liabilities that are created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and that require the public sector (obligor) to make one or more payments in the form of assets (including currency) at some future point(s) in time to discharge principal and/or interest liabilities incurred under the contract. In effect, all instruments that share the characteristics of debt as described above (including loans, suppliers' credits, and leases) will be subject to the ceiling. Borrowing for the water transport operations of the Lesotho Highlands Water Authority and loans under the PRGF will be excluded from this performance criterion. The performance criterion will be evaluated on a continuous basis as the cumulative change in the amount of new nonconcessional debt contracted or guaranteed from end-November 2000.

13. Adjustment clause: None.

14. Supporting material: Details of all new commitments and government guarantees for external borrowing, with detailed explanations, will be provided by the Ministry of Finance on a monthly basis within 30 days of the end of the month.

E. Ceiling on the Amount of New External Debt Contracted or Guaranteed by the Public Sector, with Original Maturity of Less than One Year

15. Definition: The public sector comprises the central government, the Central Bank of Lesotho, and all enterprises with majority state ownership. This performance criterion applies not only to debt as defined in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt, adopted on August 24, 2000, but also to commitments contracted or guaranteed for which value has not been received. Included in this performance criterion are all current liabilities that are created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and that require the public sector (obligor) to make one or more payments in the form of assets (including currency) at some future point(s) in time to discharge principal and/or interest liabilities incurred under the contract. In effect, all instruments that share the characteristics of debt as described above (including loans, suppliers' credits, and leases) will be subject to the ceiling. Treasury bills issued for the purposes of monetary policy operations will also be excluded. Normal short-term import credits, will be excluded from this performance criterion. The performance criterion will be evaluated on a continuous basis as the cumulative change in the amount of new nonconcessional debt contracted or guaranteed from end-March 2001.

16. Adjustment clause: None.

17. Supporting material: Details of all new commitments and government guarantees for external borrowing, with detailed explanations, will be provided by the Ministry of Finance on a monthly basis within 30 days of the end of the month.

F. Ceiling on the Stock of External Payments Arrears

18. Definition: During the period of the arrangement, the stock of external payments arrears of the public sector (central government, Central Bank of Lesotho, and all enterprises with majority state ownership) will remain zero. Arrears on external debt service obligations include any non-payment of interest and/or principal in full and on time falling due to all creditors, including the IMF and the World Bank.

19. Adjustment clause: None.

20. Supporting material: Details of arrears accumulated on interest and principal payments to creditors will be reported within one week from the date of the missed payment.