Lesotho—Letter of Intent, Memorandum of Economic and Financial Policies, and Technical Memorandum of Understanding

September 5, 2002

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

Dear Mr. Köhler:

The Fund approved a three-year arrangement under the Poverty Reduction and Growth Facility for Lesotho in a total amount equivalent to SDR 24.5 million in March 2001. I request that the fourth disbursement, in the amount of SDR 3.5 million, be made available following the successful completion of the third 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 2003. The memorandum also outlines the Government's action plan for the financial-year 2002/03, including famine relief. The Government has prepared and submitted to the IMF and the World Bank a preparation status report on the poverty reduction strategy paper, and is preparing a full PRSP.

The Government requests waivers for the nonobservance of the quantitative performance criterion on the ceiling on the domestic financing requirement of the Central Government for end-March 2002 and of the structural performance criterion relating to the Accountant General position, which was not filled by end-July2002. The quantitative limit was not observed mainly because of disbursement delays on the part of the European Union and the Rand Monetary Compensation Fund. These funds were received after March 31, 2002. The Accountant General position was not filled because the nominated candidate was unable to accept our offer because of a change in family obligations.

In collaboration with Fund staff, the government will review the progress in implementing the program every six months. The fourth review is scheduled to be completed no later than January 31, 2003, and the fifth review no later than August 15, 2003.

Sincerely yours,

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, 2002/031
	June	September	December	March		Full year
	Maloti2					Grain3
Relief program
Unsifted maize meal, beans, and oil
Food aid for the most vulnerable	20	79	165	237		90,000
Subsidy for general population	0	29	58	87		110,000
Supplementary food for children under 5 years	0	13	27	40
Operating costs	0	3	6	9
Total Requirement	20	124	256	373		200,000
Less:
Donor support in kind	0	52	104	155		59,000
Financial commitments and pledges	0	46	90	136
Commitments	0	19	37	56
Pledges	0	27	53	80
Total donor support	0	98	194	291
GoL commitment	20	27	62	82
IMF augmentation
Other donor support
Financing gap	0	-0	0	-0
Source: Ministry of Finance. 1Fiscal year begins April. 2Millions of maloti. 3Metric tons.

Table 2. Lesotho: Quantitative Benchmarks and Performance Criteria, June 2002–June 2003
	2002					2003
	June	Sep.1		Dec.		Mar.1	June
	Est.	Prog.	Rev. Prog.	Prog.		Prog.	Prog.
	(In millions of maloti)
Ceiling on the domestic financing requirement of the central government2	41	63	125	213		130	10
Ceiling on the stock of net domestic assets of the Central Bank of Lesotho	–3486	–3488	–3427	–3346		–3341	–3335
		(In millions of U.S. dollars)
Floor on the stock of net international reserves of the Central Bank of Lesotho3	363	363	360	352		352	352
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	0
Maturity of one year or more	0	0	0	0		0	0
Ceiling on the stock of external payments arrears6	0	0	0	0		0	0
Sources: Ministry of Finance; Central Bank of Lesotho; and staff estimates. 1Performance criteria. 2June, September, December 2002, and March 2003 are cumulative from end-March 2002. June 2003 is cumulative from March 2003. September program at M 63 million has been corrected for an error. In Table 1 of the MEFP in the March 2002 Staff Report, it was incorrectly stated as M -64 million due to an arithmetic error in Table 4. 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 repayment 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 performance criterion. 7Except for normal short-term import credits and nonresident holdings of treasury bills.

Table 3. Lesotho: Structural Benchmarks and Performance Criteria, July 2002– March 2003
Action	Implementation Date
A. Lesotho Revenue Authority, VAT, and supporting measures
1. LRA becomes operational. * 2. Re-commence VAT registration drive and visits to traders. 3. Introduce VAT	December 31, 2002 March 1, 2003 June 30, 2003
B. Financial Management
1. Construct the government's balance sheet as of March 31, 2002 comprising all government accounts and below the line financial assets and liabilities.*	December 31, 2002
2. Begin the recruitment process for an Accountant General.	September 30, 2002
3. Complete a timed action plan to strengthen financial management based on the recommendations of the IMF and EU technical assistance reports.*	October 31, 2002
4. Begin phase one of the study into an integrated financial management system for government. This will entail identifying requirements, evaluating current resources, and making recommendations on closing the resource gap.*	October 31, 2002
5. Improve expenditure management and tracking through the following: (i) Implement the routine practice by which all payments are backed by a payment voucher. All vouchers are to be batched and sent to Treasury for processing on the days designated by Treasury for each ministry. (ii) Banks will continue to make payments only on instruction from Treasury. (iii) The Debt Office will continue to pre-authorize payment orders under signature of the Accountant General.*	November 30, 2002
6. Put in place top management of the Treasury Department including acting Accountant General and his/her expert advisor and at least two Deputy Accountants General. Recruit and have in place technical experts to assist deputies.**	February 28, 2003
C. Other measures
1. Work with the private sector to establish a credit bureau. 2. Begin to publish Central Bank of Lesotho macroeconomic projections.	January 31 , 2003 January 31, 2003
* Performance criterion for the fifth disbursement. ** Performance criterion for the sixth disbursement.

Government of Lesotho

Technical Memorandum of Understanding

September 5, 2002

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 three-year 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 2 of the government's Memorandum on Economic and Financial Policies (MEFP).

2.  The remaining test dates for assessing observance of quantitative targets during the financial year April 2002-March 2003 will be end-September 2002, end-December 2002, and end-March 2003. The end-September 2002 and end-March 2003 targets will constitute quantitative performance criteria, the end-December 2002 and end-June 2003 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 third review under the program is scheduled for completion by September 20, 2002. End-September 2003 quantitative performance criteria for the financial year April 2003-March 2004 will be set at the fourth 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 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 is defined in U.S. dollars and will be calculated using the agreed cross exchange rates.¹

4.   Adjustment clause: The program target for the NIR of the Central Bank of Lesotho in any quarter will be adjusted downward (upward) by the shortfall (surplus) in donor support for famine relief shown in Table 1 of the MEFP. It will be adjusted downward (upward) by the amount that the grain requirement is less than (greater than) that shown in Table 1 of the MEFP. The adjustment will be converted into U.S. dollars at the market exchange rate.

5.   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.

6.   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 currency breakdown of the reserve assets and reserve liabilities of the Central Bank of Lesotho and converted into U.S. dollars and in maloti at program exchange rates stipulated in paragraph 3.

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

7.   Definition: The net domestic assets (NDA) of the Central Bank of Lesotho are defined as the difference between reserve money (currency in circulation 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. Foreign assets and liabilities at the end of each quarter will be calculated in U.S. dollars using the agreed cross exchange rates stipulated in paragraph 3 converted into maloti using the U.S. dollar-loti exchange rate (also stipulated in paragraph 3). 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).

8.   Adjustment clause: The program target for the NDA of the Central Bank of Lesotho in any quarter will be adjusted upward (downward) by the shortfall (surplus) in donor support for famine relief shown in Table 1 of the MEFP. It will be adjusted upward (downward) by the amount that the grain requirement is less than (greater than) that shown in Table 1.

9.   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.

10.   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

11.   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 end-March 2002 in fiscal year 2002/03 and as the cumulative change from end-March 2003 in fiscal year 2003/04, 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. Changes in government liabilities stemming from the issue or retirement of treasury bills and bonds due to the recapitalization of the Old Lesotho Bank 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.

12.   Adjustment clause: The program target for the domestic financing requirement of the central government will be adjusted upward (downward) by the shortfall (surplus) in donor support for famine relief shown in Table 1. It will be adjusted upward (downward) by the amount that the grain requirement is less than (greater than) that shown in Table 1.

13.   Adjustment clause: The program assumes that customs revenue from the SACU revenue pool will be received as follows: M367.5 million in each quarter in fiscal year 2002/03. 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. External debt service, amortization, and disbursements will be calculated at program exchange rates.

14.   Supporting material: The Central Bank of Lesotho will provide the monetary survey and other monthly monetary statistics, 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, as well as details of any monetary operations with treasury bills, including the changes in government deposits stemming from such operations will be separately identified as memorandum items in the monetary survey. The Central Bank will also provide a table showing the details of government debt by type and holder. The Ministry of Finance will provide detailed monthly budget operations and tax arrears reports.

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

15.   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 arrangement 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.

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.

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

18.   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.

19.   Adjustment clause: None.

20.   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

21.   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 continually 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.

22.   Adjustment clause: None.

23.   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.

Lesotho's Three-Year Arrangement
under the PRGF Facility:

Timetable and Modalities for the Reporting Requirements Outlined in the Technical Memorandum of Understanding

The table below specifies the timetable and other modalities for data reporting with a view to ensuring a smooth flow of timely and comprehensive data needed in monitoring Lesotho Three-Year Arrangement under the PRGF. If possible, all data should be transmitted to the IMF via email. In the event that a data transmission is delayed more than 5 business days, an explanation for the delay, together with the expected transmission date of the late data should be communicated to the IMF.