Lesotho

The global crisis badly affected Lesotho’s economy in 2009 and its outlook for 2010 and beyond. Gross domestic product (GDP) growth fell from 4.4% in 2008 to 1.1% in 2009 as the manufacturing and the mining sectors both shrank. The government estimates that employment in the manufacturing sector declined by 4.1% in 2009. Unemployment also increased because of layoffs in the textile industry and the mining sector in South Africa. The number of migrant mine workers in South Africa declined by 10% in the third quarter of 2009.

The government budget remained in surplus in 2009 for the sixth year running but is expected to be in a deficit of 4.6% of GDP in 2010. This is mainly due to a sharp decline in the South African Customs Union (SACU) revenue pool – made up of South Africa, Lesotho, Botswana, Namibia and Swaziland – which is a major revenue source for Lesotho. The crisis led to lower demand for imported capital and consumer goods, reducing SACU revenues.  

The current account balance declined from a surplus of 3.2% of GDP in 2008 to a 2% deficit in 2009. The crisis also badly hit remittances which fell by 9.6% in 2009. Budget and current account deficits in 2010 raise the risk of debt distress unless fiscal restructuring is pursued. Inflation eased in the last quarter of 2009 thanks to better agricultural production, a stronger currency and generally lower demand for goods and services.  

Shrinking incomes, rising unemployment and a weak overall resource balance threaten to reverse gains from the accelerated growth and macroeconomic stability of recent years. In 2009 per capita GDP declined in absolute terms for the first time in six years, by 1.6%.

Increased growth and lower income inequality helped Lesotho reduce the proportion of the population living below one US dollar (USD) a day from 45.4% in 1999 to 33.1% in 2008. Sustaining this performance would allow Lesotho to meet the UN Millennium Development Goal (MDG) of reducing extreme hunger and poverty by half by 2015. But extreme poverty is estimated to have increased by about 2% in 2009. Rising unemployment and falling household incomes could also affect school attendance rates, according to a recent government survey.  

The government initiated reforms in 2009 to spur short- to medium-term growth and improve the prospect of reaching the MDG and its own Vision 2020 development goals. These include a support strategy for the textile and clothing industry, a private sector development strategy and a domestic resource mobilisation strategy.

Measures for the textile industry range from direct financial support to technical assistance to improve competitiveness. There are plans to create institutional and financial facilities to support export-import businesses for existing and new foreign and local firms. Studies are underway to explore new markets and new products to facilitate exports to southern Africa, the European Union (EU), United States and other regions of the world. The government has sought co-operation with China to increase skills, by working with Chinese textile firms to help increase productivity. The government set aside 600 million Lesotho loti (LSL), equivalent to 79 million US dollars (USD), to provide water supply, roads, factory shells and communications for firms that locate on a new industrial estate set up for manufacturing. 

Efforts will also be made to improve Lesotho’s weakness in attracting investment. Domestic resource mobilisation is also an increasing priority for the government. Reforms are under way to improve tax collection, expand the tax base and increase the tax compliance rate. A large public investment programme should boost economic activity in 2010-11. In the short term, real GDP growth is expected to rise to 2.3% in 2010 and 3.3% in 2011. However a poor export performance could adversely affect the current account balance in 2010 and 2011. 

After several years of strong growth, the economy slowed in 2009 with the international crisis hitting manufacturing, mining and remittances. The decline of real GDP growth from 4.4% in 2008 to 1.1% in 2009 reflected lower textile exports and the closure of two diamond mines in 2008. Rising public investment, particularly the construction of the Polihali Dam, is expected to drive near term growth. The macroeconomic balance in 2010 and 2011 could deteriorate because of the impact of the crisis on revenues and exports that may put pressure on external debt and domestic prices; 

The textile industry, the major source of urban employment, faced drastic declines in US demand that reduced new orders to a trickle. Banks in Asia, notably Hong Kong, Singapore and Taiwan, that used to provide export-import financing and Letters of Credit for textile firms operating in Lesotho could not do so because of the financial crisis. The fall in prices of diamonds, platinum and other minerals in 2008 forced the mining sector in Lesotho and South Africa to scale down operations. Some mines were closed. Despite a rebound in mineral prices in 2009, there has been no recovery in the mining sector.

Services have increasingly dominated economic activity in Lesotho, contributing close to 60% of GDP in the last five years (Figure 2). In 2009, 77% of GDP growth came from the services sector (Figure 3). Agriculture grew at a modest rate in 2009 due partly to improved weather conditions. But a series of setbacks in past years and the rapidly growing manufacturing sector means the relative importance of agriculture in overall growth has diminished. The modest growth in the agriculture sector could not make up for the impact of the fall in manufacturing activity on the overall economy. Growth in non-textile manufacturing was robust in 2009 however. Manufacturing of food products grew at 4.8% and other products, including electronic products and appliances grew at 20%, providing a moderate cushioning against the impact of the global crisis on the sector. These positive developments could be attributed partly to a government diversification drive adopted in response to the global crisis.

The construction sector, after troubles in 2000, had recovered recently and grown at a rate of 5% since 2007. It maintained growth close to 5.5% in 2009 and contributed 15.5% of overall GDP growth. However, construction growth may fall in coming years if public investment is affected by grim revenue prospects and recovery is slow.

Growth in private consumption spending fell significantly in 2009 (Table 2), probably due to the 9% fall in remittances and rising unemployment. In 2003, remittances accounted for close to 11% of household income. This fell to 5% in 2009. Weak growth, rising unemployment in manufacturing and large lay-offs by South African mines are expected to push a large number of people into poverty, which then undermines development efforts by the government. Preliminary National Statistical Bureau estimates suggest that unemployment could rise from 21% in 2008 to 23% in 2009 due to setbacks in the manufacturing and mining sectors. The Lesotho government had put in place fiscal stimulus measures to help families affected by unemployment. In 2009, the government allocated M112 million (about USD 14.8 million) for the Integrated Watershed Management Project which uses the jobless workers to rehabilitate severely eroded land. A further M50 million (USD 6.6 million) was allocated to local infrastructure projects, again using the unemployed.

Lesotho needs strong broad-based growth to reduce poverty and inequality on a sustainable basis. Past growth largely came from sectors that had a limited impact on employment. Agriculture, the mainstay for most of the population, performed dismally in the last decade. The government has a medium term strategy to diversify activity in agriculture, tourism and manufacturing to boost growth and employment. The plan to support small scale enterprises and microfinance activities could encourage sustainable and broad-based growth. Strong government effort is required to reduce infrastructure constraints, improve legal and regulatory bodies, invest in education and health to increase productivity, and facilitate private investment. 

The government budget is driven largely by the revenue from the SACU customs pool, creating strong links between budget balance and the performance of the South African economy, the largest in the five-nation group. SACU makes a substantial contribution to government revenue, reaching a peak of 60% of total revenue in fiscal 2006/07, but declining since then. It is expected that in fiscal 2009/10 the budget balance could experience a deficit for the first time in five years mainly because of sharp decline in SACU revenue – from falling imports into the region -- and lower revenue mobilization from the domestic economy. This will limit the government’s ability to stimulate the economy, while attempts to increase spending through borrowing could hurt the current account balance and possibly official reserves. In the near-term it will be difficult for the government to sustain growth and attain macroeconomic stability.

The the share of government expenditure as a percentage of GDP has increased by more than 10 percentage points in the past decade. In a 2009/2010 budget proposal, overall government spending is expected to rise in the next two years, despite falling revenues, raising the prospect of debt distress. In the past, government spending tracked revenue prospects. A pro-cyclical fiscal policy may not be helpful in the longer term as it could undermine the role of fiscal policy in promoting growth and ensuring overall price stability (Table 3). In a budget speech to parliament in February, 2010 the finance minister emphasized that dependence on SACU revenues has made planning more uncertain. He signalled the ministry’s commitment to determine the government budget on the basis of  revenue from domestic resources.

The budget is allocated according to priorities fixed in its national development strategy. In 2009/10, total spending allocated to education, health and economic affairs was close to 47% which helped efforts to reach universal primary education, reduce child and maternal mortality and improve overall welfare. The decline in 2009/10 SACU revenue fast tracked the government’s commitment to improve the effectiveness and efficiency of public spending through its Public Sector Improvement and Reform Program (PSIRP), which has three core components: improving financial management, decentralizing public services and reforming public services management. The government also plans to increase the administrative capacity to speedily disburse and allocate funds. In 2009/10, only 70% of the capital budget was fully utilized. Part of the reform aims to tighten project preparation and approval procedures to ensure projects are ready for implementation as soon as the finance is appropriated.

Lesotho maintains a fixed exchange rate system under the Common Monetary Area (CMA) shared with Namibia, South Africa and Swaziland. The local currency – the loti – is pegged to the South Africa rand. This has made Lesotho’s monetary sector susceptible to changes in South Africa’s monetary policy, notably on inflation, real exchange and interest rates. In 2009, the prime lending rates by commercial banks declined from 16.58 per cent in September 2008 to 12.17 per cent in September 2009 due to a fall in the yield rates on South African treasury bills.

The currency peg is maintained by holding foreign currency reserves, the adequacy of which is ensured through the setting a minimum target. The target – 120% of narrow money -- was changed from USD 500 million in January 2009 to USD 700 million in the last quarter. Open market operations entailing the sale of government securities (91, 182, 273 and 375-days treasury bills) are undertaken fortnightly to manage liquidity in the banking sector, ensuring the central bank official reserves target is met and interest rates move in line with comparable rates in other CMA  countries.

In 2009, reserves were generally maintained at comfortable levels above the target minimum. This was influenced by a strong current account driven by customs receipts, resilient exports and subdued government foreign currency expenditure. Interest rates moved in line with the rest of the region, mainly downward as South African monetary authorities responded to slowing inflation and weakening economic activity. The 91-day Treasury bill rate fell from 10.03% at the beginning of the year to 6.7% at the end of 2009.

Inflation fell in the last quarter of 2009, declining from a peak of 16% in 2008 to about 4% in 2009.  The decrease was driven mainly by lower food and utilities prices. Since August 2009, Lesotho’s inflation rate has been lower than South Africa’s which stood at 6.1% in the same period. Lesotho’s inflation rate fell within the South African target band of 3%-6% in the last two months of the third quarter. This was particularly important for the poor in light of declining incomes and employment in 2009. Food price inflation reached a high of 25% in 2002 due to a poor harvest and a 36% fall in the South African Rand during the period. 

Lower export receipts and remittances hit the current account balance, which declined from a surplus of  3.2% of GDP in 2008 to a deficit of 2% in 2009. However, capital inflows are expected to fully offset the current account deficit and facilitate a build-up in gross international reserves to a level of USD 1.1 billion at the end of 2009 (equal to 7 months’ imports of goods and services), twice the target set by the Central Bank of Lesotho (CBL) to ensure the stability of the exchange rate pegged to the South African Rand.

Exports declined partly due to the impact of the global crisis on manufacturing sector that forced the closure of textile factories and a decline in mining, particularly for diamond exporters. The 2009 trade balance deficit showed a significant increase compared to 2008 despite a contraction in imports. Some improvement is expected in 2010.

Textiles, a key export and source of employment, critically need reform to stay competitive and profitable. The sector faces strong competition in the US market even if existing preferences under the US African Growth and Opportunity Act (AGOA) are extended beyond its expiry in 2015. The government produced a support strategy policy document in 2009 which recommends giving working capital at highly concessional interest rates; export insurance guarantees, which would reduce the risk premium charged by specialist agencies; capital equipment grants to help technological upgrades; improving worker education, subsidising utility costs, supporting brand building and expanding one-stop exporter assistance, especially for non-residents. The plan to work with Chinese textile firms to transfer technology and technical skills needs to be fully implemented. This will help reduce costs and enhance efficiency. It is also government policy to diversify manufacturing by introducing new lines of products. The Philips multinational has built a new plant built to produce energy saving bulbs in Lesotho.

External debt stock as a percentage of GDP has declined substantially since 2000. In 2009, total public debt stood at 43.8% of GDP, below the 60% threshold set by the Southern African Development Community (SADC) for macroeconomic convergence targets. Debt service ratio also remained within the sustainability threshold at 2.6% (Figure 6). External debt constituted a greater percentage of overall debt stock. The ratio of external debt to total debt was 88.5% while the ratio of domestic debt to total debt was 11.5% in 2009 (Figure 7). 

The Lesotho government recognises that sustainable growth needs a vibrant private sector. In 2009, Lesotho was classified as the least business friendly country in the southern African region, ranking 130 out of 181 in the World Bank Doing Business survey. The SACU average ranking was 65 and South Africa was 34^th. The poor investment climate has deteriorated. Lesotho’s laws and regulations are time consuming and expensive for businesses. In 2009, Lesotho ranked 155^th for granting permits and facilitating title deeds, core elements for promoting the private sector. It would take about 40 days to start a new business and 101 days to register a property. It takes close to two years to enforce contracts in courts and resolve business license issues. Businesses spend more than 300 hours, more than 40 working, paying taxes.

To improve the investment climate, the government initiated a strategy for 2010-2012, which once approved will be run by the Private Sector Development Division under the ministry of finance.

The reform envisages changing business policies and bringing in procedures to promote entrepreneurship, savings and investment. The strategy focuses on reforming the legal framework for business, establishing a one stop business facilitation centre, reducing time-consuming tax payment procedures, and proposing solutions to unblock government reforms. The strategy also seeks ways to encourage small scale enterprises. According to a survey completed in 2009, close to 65% of small scale enterprises are in retail and services activities. Encouraging them to participate in more productive sectors, such as manufacturing, agro-processing and commercial farms is an objective of the strategy, which also seeks to put the focus on skill development for small scale enterprises, market access and finance. 

Lesotho has four commercial banks, three of which are owned by South African banks. The four are in a strong financial position despite the global financial crisis. All meet the prudential requirements of bank supervision. In 2009, Post-bank was issued a full licence to engage in normal banking activities. This could improve credit extension to the private sector, which has been low at around 30% of private sector deposits since the privatisation and closure of state owned banks 10 years ago.

The financial system faces several challenges, such as a lack of competition. The margin between lending and deposit rates (about 9%) is quite high by regional standards, mainly because of difficulties entering the banking business. The banking sector faces structural bottlenecks that have to be addressed. Efforts are underway to revise the 1998 Financial Investment Act. Reforms are expected on licences for new banks, improving the collection of credit histories of potential borrowers through a Credit Bureau (where a borrower’s history can be centralised for easy access by all banks), streamlining title deeds that are often used to guarantee loans, improving bank supervision procedures and automating several banking activities. Debates on transaction costs charged by commercial banks continue in the region. Studies undertaken in Lesotho showed that transactions costs charged by banks in Lesotho subsidised the poor, with charges on services used mostly by small depositors relatively low compared with charges on more sophisticated services. Generally, charges in Lesotho were not found to be significantly higher than in South Africa and other countries in the region. However, a 2009 study on banking charges in South Africa concluded that charges were high compared to international levels, implying that high banking costs are a regional problem.

Notable developments expected to take place in 2010 include broadening the securities market where the central bank plans to introduce multiple treasury bill products and a new bond market for long term investment. To further enhance private participation in the financial market, regulatory frameworks and supervision guidelines are being developed to introduce secondary security markets.

A large illicit pyramid scheme wiped out the savings of thousands of people in 2009. The central bank is seeking the liquidation of the scheme and distribution of remaining funds and assets to investors. In December 2009, the central bank distributed to investors funds held by a closed institution which was taking deposits without a proper licence. Investors would only receive a part of the funds they originally put in the institution.

The Lesotho government pursued efforts to resolve infrastructure impediments, particularly in utilities. Lesotho experienced acute power shortages in 2008 due to a regional supply deficiency. Power generating infrastructure is ageing, there has been inadequate investment in new power stations and demand in South Africa is increasing. Lesotho’s own ‘Muela hydropower station, built as part of the Lesotho Highland Water project in the late 1990s, does not meet domestic demand especially during the peak winter months of June and July. Plans are underway to increase the capacity of the station during the construction of the Polihali Dam as part of the Highlands project. Construction of the dam is expected to commence in 2011 for a cost of LSL 7.3 billion (USD 950 million), and will be used to increase water supply to South Africa and increase hydropower generation capacity. A feasibility study on the power generation expansion is being carried out.

A USD 4.3 million contract was signed in June 2009 for the design and supervision of the construction of Metolong dam. The dam is to supply water for domestic and industrial purposes in the lowlands of Lesotho including the capital, Maseru, which experiences periodic water shortages due to increased demand. The project costs a total of USD 280 million and is financed by a consortium of donors. The government built new access roads in major urban centers and two bridges aimed at linking the mountainous Qach’a Nek with Semonkong, cutting the driving distance to the important South African port of Durban.

The proximity to South Africa should be an opportunity for Lesotho to boost its economy and narrow the income gap with its neighbour. With appropriate structural and institutional reform, Lesotho could attract investment from South Africa given its low wage rate and relatively cheaper utilities. Banking reforms and efforts to promote the private sector could bear fruit if implemented properly. 

Tax revenue has grown considerably over the last ten years mainly as a result of the establishment of the Lesotho Revenue Authority in 2003, that improved revenue mobilization, and growing revenue from the SACU pool. The government budget recorded a surplus for the last six years, though a deficit is expected in 2010 and 2011 mainly due to the impact of the global crisis.

The contribution of tax revenue to total revenue increased from 75% in 2000 to 91% in 2009 while that of non-tax revenue diminished. Tax revenue is dominated by indirect taxes, the bulk coming from custom duties (64%) followed by Value Added Tax (13 per cent). The share of income tax declined steadily from 18% in 2000 to 13% in 2009. One of the main reasons was that while customs revenue grew at an annual rate of 2 5% in the last six years, tax revenue grew at only 5%.

The revenue authority is an autonomous body which assesses and collects revenue and is responsible for administration and enforcement of laws on revenue matters.  The authority is managed by an independent board and is accountable to parliament. It incorporates the functions of the old Income Tax, Customs and Excise and Sales Tax departments.

The authority implements three tax codes: the Income Tax Act of 1993, the Customs and Excise Act of 1982 and the VAT Act of 2001. Income tax covers corporate tax, advance corporate tax (tax on dividends received by shareholders), Pay as You Earn tax (tax paid by employers for employees) and others. The income tax rate is revised periodically by parliament taking into consideration income growth, inflation and other factors. Generally, individual incomes are grouped into three categories with thresholds revised by parliament. For 2009, for instance, incomes less than LSL 22 728, or about USD 2 950, per year were exempt from income tax. For income above this threshold, the first bracket pays 22% and the last bracket about 35%. There is room for the revenue authority to maneuver reforms around the top income tax band to raise more revenue and to make the system more equitable by introducing more income bands. Custom tax rates vary depending on the quantity and type of goods entering or leaving Lesotho. Currently the VAT rate is 14% or 15% depending on the commodity.

The share of tax revenue in GDP is high by world standards and has grown considerably from 36% in 2000 to 57% in 2009, though the bulk of the revenue came from the SACU revenue pool. Still, the government has been able to mobilize revenue close to 30% of GDP from domestic sources in the last decade, above the Sub Saharan average of about 21%. However this effort needs to be revamped to offset the substantial decline of revenue from the SACU pool (Figure 8).

The Ministry of Finance, Economic Development and Planning (MFED) is formulates and supervises tax policies. The revenue authority implements policy and has a consulting role. Tax collection has stayed within 2.5% of total revenue collected. While there is room for improvement, the threshold is within acceptable international norms.

One of the challenges faced by the revenue authority is the prospect of declining SACU revenue, which has prompted the agency to develop reforms to mobilize resources from domestic sources. Some of the measures the authority intends to implement include: improving revenue collection procedures, identifying new sources of tax revenue (expand the tax base), increasing public tax compliance and reducing corruption. A major challenge for the government is to diversify the tax base, reduce corruption at collection points and educate the public on the civic duty to comply with tax obligations. The revenue authority has had some success. The number of registered business tax payers increased substantially from 2 955 in 2003/04 to 31 762 in 2008/09. In 2009, the authority received technical assistance to help build capacity and improve operational efficiency which helped the agency to adapt international best practices to local circumstances.

The share of development aid as a percentage of GDP has declined considerably over the years, bottoming out in 2008 at about 2%, though it is expected to rise slightly in 2009 and 2010. The bulk of official development assistance in recent years has been in the form of budget support mainly from the European Union. Specialist aid has focused on natural resource use, in particular renewable energy, studies on water management, rehabilitation and restoration of wetland areas etc. In 2009, the share of natural resource management in total aid was about 37% and projected to rise to 50% in 2011. The next most favored sector is health which received close to 13% of the total aid in 2009 and is expected to double its share in 2010 and 2011. Education receives about 10% of total aid and this is expected to remain unchanged in the near-term. The government expects total grants to increase by 36% in 2010 in nominal terms and shrink substantially in 2011 as projects are completed. It is vital for the government to mobilize international resources to weather the difficult times ahead through enhanced coordination and policy harmonisation with key bilateral and multilateral donors. 

Lesotho is a constitutional monarchy under King Letsie III, with a Senate and a National Assembly elected under a mixed first past the post and proportional representation system. The Lesotho Congress for Democracy (LCD) under the leadership of Prime Minister Bethuel Pakalitha Mosisili won a parliamentary majority in a 2007 election. The result was contested by opposition parties. The SADC carried out mediation efforts through the former Botswana president Ketumile Masire, but progress was sluggish in 2009. In April 2009, a group of men later named as South African and Mozambican citizens tried to enter the state house by force in an apparent attempt to assassinate the prime minister. The action failed, but a number of people died. Survivors of the shootout fled, but were arrested in neighbouring South Africa. Suspects appeared before courts in South Africa and Lesotho. 

Lesotho has one of the highest rates of extreme poverty and low human development in Sub Saharan Africa. The last decade has seen some progress in reducing hunger and malnutrition. The proportion of the population that lived with less than one US dollar a day declined from 45% in 1999 to 33% in 2008. However, human development progress has been badly hit by the HIV/AIDs pandemic. The country’s ranking in the United Nations Development Programme’s Human Development Index in 2008 was 156 out of 186. Progress towards achieving UN Millennium Development Goals (MDGs) has been encouraging in the areas of universal primary education, and to a certain extent of child and maternal mortality.

The financial crisis is likely to erode some of the gains Lesotho made with MDGs. A labour force survey conducted in 2008 reported that the unemployment rate was 21% and expected to rise in 2009 by two percentage points. Declining incomes, rising unemployment and limited social security provisions are expected to increase the proportion of people living in extreme poverty by about two percentage points in 2009.

The government provides free primary education and partial funding for secondary education. Net enrollment in primary education has increased from 57.7% in 1999 to about 84% in 2009. There has also been improvement in education quality, with a considerable decline in the teacher-pupil ratio during this period. However challenges remain. According to a study by the National Statistical Bureau and Ministry of Education, there is an increase in repeat and drop out rates especially among children in rural areas. Parents find it expensive to keep children in school. The expected withdrawal of World Food Programme (WFP) support for primary school feeding programmes may worsen attendance rates. The government may have to provide resources to continue the programme. This may be difficult with declining government revenues in the near term. 

Modest progress has been made in the last decade to reduce child mortality. From 2000 to 2007, child mortality declined at an annual rate of 3% while for infant mortality the figure was 2%. This trend however will not reach the goal of reducing child mortality by one third by 2015. The same applies to maternal mortality. Lesotho needs to double its effort to be on track towards to achieving health MDGs. HIV/AIDs plays a significant role derailing efforts to improve health indicators.

The 24% prevalence rate of HIV/AIDs in Lesotho is the third highest in the world. The US-funded Millennium Challenge Account helps to build health centres. The first of the 150 clinics will open in 2010. The centres should give greater access to anti-retroviral treatment. Work on a replacement for Queen Elizabeth II Hospital should be finished in 2011.