Staff Reporter
The International Monetary Fund (IMF) has issued a stark recommendation for Lesotho to promptly approve two key tax policy bills and a tax administration bill to address widespread deficiencies in the country’s tax system.
This urgent call was part of the IMF’s staff concluding statement of the 2024 Article IV Mission, published on Wednesday this week.
The IMF’s assessment comes at a critical juncture for Lesotho. It highlights the establishment of a new Tax Policy Unit and the hiring of key staff as positive steps forward. However, these measures alone are not enough to remedy the systemic issues plaguing the country’s tax administration.
“With help from the IMF, the unit’s ability to accurately forecast revenue and improve tax-system design should be strengthened,” the statement emphasised.
The IMF’s report underscores the necessity for a phased reform strategy to tackle the weaknesses identified in core tax administration functions. This strategy should align with the findings of the IMF’s 2023 Tax Administration Diagnostic Assessment Tool (TADAT) assessment, which pinpointed critical areas requiring immediate attention.
“Prompt approval of the two tax policy bills and tax administration bill could help address identified deficiencies in many areas,” the statement read.
The IMF’s critical assessment of Lesotho’s economic trajectory also underscored significant challenges facing the country’s government-driven economic model.
The preliminary findings of the IMF’s 2024 Article IV Mission, led by Andrew Tiffin, reveal that while Lesotho’s near-term economic outlook has improved modestly, underlying structural issues continue to impede sustainable growth.
The IMF mission, which concluded its meetings in Maseru on June 14, 2024, provided a comprehensive analysis of Lesotho’s economic state. Real Gross Domestic Product (GDP) growth is expected to reach 2.7 percent in the financial year 2024/2025, up from 2.2 percent the previous year.
This growth is largely driven by strong construction activity, particularly from the Phase II of the Lesotho Highlands Water Project (LHWP-II), the construction of Polihali Dam in Mokhotlong. However, despite these positive developments, the country’s economic model is struggling to meet its growth and development goals.
“Lesotho’s government-driven economic model is not delivering the expected outcomes,” said Andrew Tiffin. “Despite a fiscal surplus and strengthened reserves, the country faces significant challenges in achieving sustainable, inclusive growth.”
Economic Context and Outlook
The IMF noted that prudent government spending during financial year 2023/2024 resulted in a fiscal surplus, strengthening reserves, supporting the currency peg, and enhancing long-term fiscal sustainability.
Inflation has also eased, with headline inflation down to 7.1 percent in April from a peak of 8.2 percent in January 2024. However, this positive development is overshadowed by a decline in competitiveness in the apparel sector and lower diamond prices, which have depressed exports.
“Inflation is easing, with headline inflation down to 7.1 percent in April from a peak of 8.2 percent in January 2024,” Tiffin stated. “However, the country’s reliance on exogenous factors such as higher regional food prices and transportation costs poses ongoing risks.”
Lesotho’s fiscal balance showed a notable surplus in 2023/2024, with South African Customs Union (SACU) transfers exceeding expectations by more than 10 percent of GDP.
Despite these windfall inflows, recurrent spending declined as a proportion of GDP, owing to a moratorium on public sector hiring and the adoption of the new Public Procurement Act. This marks a significant shift from previous patterns where windfall SACU transfers often led to procyclical and unsustainable increases in spending.
“The net impact has been a fiscal surplus of 6.1 percent of GDP in FY23/24, which has helped lift gross international reserves to 4½ months of imports, strengthening the peg and reducing Lesotho’s public debt to 61.5 percent of GDP from 64.5 percent in FY22/23,” Tiffin highlighted.
Strategic Management of New Revenue Streams
Looking ahead, the IMF emphasized the need for strategic management of new revenue streams, particularly increased water royalties from South Africa starting in 2024. “The main task will be to ensure that these funds are saved wisely and spent strategically, with an emphasis on high-quality investment projects,” said Tiffin. “This, combined with broad-ranging structural reforms, should help improve prospects for green, job-rich, sustainable, and inclusive private sector-led growth.”
Another year of windfall SACU transfers will bolster fiscal and external balances in FY24/25, but these transfers are expected to fall sharply starting in FY25/26. Helping fill the gap, however, are the recently renegotiated water royalty rates under the Treaty with South Africa on the LHWP-II, projected to contribute significantly to Lesotho’s revenue.
“Total royalties are projected at around 6½ percent of GDP in FY24/25, rising to over 12½ percent of GDP in FY25/26, and then settling at around 9½ percent of GDP over the medium term,” Tiffin explained.
As an immediate priority, the IMF stressed the importance of rebuilding Lesotho’s external buffers. “A large part of Lesotho’s macroeconomic stability depends on the exchange rate peg against the Rand,” Tiffin stated. “The credibility of the peg depends on the country’s stock of international reserves. In a global economy characterized by larger and more frequent shocks, there is ample room to strengthen further Lesotho’s reserve buffer.”
The IMF also recommended boosting resilience by reducing Lesotho’s public liabilities. Public debt has trended steadily upward, rising sharply during the COVID pandemic. The IMF’s Debt Sustainability Analysis suggests that although the risk of debt distress is still “moderate,” there is little scope to absorb any further shocks.
“Lesotho’s improved fiscal situation will naturally allow the authorities to scale back new borrowing, but to build increased resilience against future shocks, the authorities should also consider retiring existing debt more rapidly,” Tiffin advised. “As a priority, the authorities should at minimum clear domestic arrears (1 percent of GDP) as soon as possible.”
Ensuring that new revenues result in greater savings will require continued fiscal prudence.
The IMF highlighted several key areas for attention:
- Contain the Wage Bill: Lesotho’s wage bill (as a share of GDP) is the highest among SACU members and triple the sub-Saharan African average. Reducing the wage bill was a key recommendation of last year’s Article IV consultation. The government has made critical steps in this direction, but continued efforts are needed.
“This effort should continue, with a continued moratorium on hiring, streamlining of the establishment list, and regular reviews of the compensation system,” Tiffin emphasized. “Ultimately, the main objective is a fair and performance-based public employment system that rewards higher productivity and ensures better delivery of public services.”
- Improve Tax Policy Design and Strengthen Tax Administration: The Tax Policy Unit has been established, and key staff are being hired. With help from the IMF, the unit’s ability to accurately forecast revenue and improve tax-system design should be strengthened.
“Prompt approval of the two tax policy bills and tax administration bill could help address identified deficiencies in many areas,” Tiffin noted.
- Improve Efficiency of Social Spending: Social spending in Lesotho is several times that of neighbouring countries as a share of GDP but is dominated by poorly targeted schemes.
“The introduction of means testing or the more effective recovery of loans would free resources for other more effective social support initiatives,” Tiffin suggested. “A better-targeted safety net will be critical to build resilience to climate-related shocks and food insecurity.”
Enhancing Public Financial Management
The IMF stressed the need for enhanced Public Financial Management (PFM) to prevent the wastage of new revenues. “Budget preparation and execution must be strengthened to enhance budget credibility,” Tiffin asserted. “This requires improved expenditure control through better collaboration between departments, monitoring and identification of misappropriated funds, and regular and timely audits.”
To build further trust in PFM, the IMF recommended strengthening internal controls within the integrated financial management system (IFMIS) and ensuring comprehensive analysis and management of fiscal risks.
“Pending PFM legislation should be passed as soon as possible, including the Public Financial Management and Accountability Bill, the Public Debt Management Bill, and secondary legislation to implement the 2023 Public Procurement Act,” Tiffin emphasized.
Building Prosperity for Tomorrow
Beyond building buffers, the IMF called for the quick establishment of a well-governed savings framework (stabilization fund). “The main aim of this framework would be to accumulate savings to ensure a stable source of government funding going forward,” Tiffin explained. “A stabilization fund should be anchored by a clear and credible fiscal rule, set within a firm legal framework.”
Improved public investment management is also needed to increase the quality of capital spending. “Before Lesotho’s savings are allocated for investment or infrastructure projects, sufficient controls should be put in place to ensure that this investment represents value for money,” Tiffin noted.
To ensure sustainable and job-rich growth, public investment must be accompanied by broad structural reforms. “Better service delivery and higher-quality investment will be helpful, but the prevailing government-led growth model has struggled to deliver high-quality growth,” Tiffin stated.
Unlocking Private Sector Potential
The IMF outlined several steps to unlock the potential of the private sector:
- Developing a National Strategy for Financial Inclusion: Access to finance remains a key challenge, particularly for small and informal firms. A broad financial inclusion strategy to better coordinate efforts, including a renewed focus on digital financial services, should be a priority.
- Providing a Stable and Well-Regulated Business Environment: Needed reforms include measures to reduce the cost of doing business, a reduction in the stake of large state-owned enterprises in businesses and utility companies, and efforts to boost broader private investor confidence.
- Mitigating Corruption and Strengthening the Rule of Law: “Recent fraud cases and growing arrears point to underlying vulnerabilities in payment and procurement processes within government,” Tiffin warned. “Strengthening key bodies such as the Office of the Auditor General and the Directorate on Corruption and Economic Offences (DCEO) would also send a strong signal of the government’s resolve.”