Document of The World Bank FOR OFFICIAL USE ONLY Report No. 73411-LS INTERNATIONAL DEVELOPMENT ASSOCIATION PROGRAM DOCUMENT FOR A PROPOSED GRANT IN THE AMOUNT OF SDR 13.4 MILLION (US$20 MILLION EQUIVALENT) TO THE KINGDOM OF LESOTHO FOR A FIRST GROWTH AND COMPETITIVENESS DEVELOPMENT POLICY GRANT April 29, 2013 Poverty Reduction and Economic Management Botswana, Lesotho, Namibia, South Africa and Swaziland Country Management Unit Africa Region This document is being made publicly available prior to Board consideration. This does not imply a presumed outcome. This document may be updated following Board consideration and the updated document will be made publicly available in accordance with the Association’s policy on Access to Information. Lesotho - Government Fiscal Year April 1 – March 31 Currency Equivalents (Exchange rate effective as of March 28, 2013) Currency unit = Maloti 9.25 = US$1 Weights and Measures Metric System ABBREVIATIONS AND ACRONYMS AfDB African Development Bank AGOA African Growth and Opportunity Act AIDS Acquired Immune Deficiency Syndrome BEDCO Basotho Enterprises Development Corporation BLNS Botswana, Lesotho, Namibia and Swaziland BoS Bureau of Statistics CAS Country Assistance Strategy DFID Department of International Development from United Kingdom DPO Development Policy Operation ECF Extended Credit Facility EU European Union FDI Foreign Direct Investment FIA Financial Institutions Act FIRST Financial Sector Reform and Strengthening Initiative GDP Gross Domestic Product GNI Gross National Income GoL Government of Lesotho GPOBA Global Partnership for Output-Based Aid GTZ German Technical Corporation HBS Household Budget Survey HIV Human Immunodeficiency Virus HMIS Health Management Information Systems HRH Human Resources for Health IBRD International Bank for Reconstruction and Development ICT Information and Communication Technologies IDA International Development Association IFMIS Integrated Financial Management Information System IMF International Monetary Fund LDHS Labor and Demographic Health Survey LNDC Lesotho National Development Corporation LRA Lesotho Revenue Authority MDGs Millennium Development Goals M&E Monitoring and Evaluation MDP Ministry of Development Planning MoF Ministry of Finance MoH Ministry of Health MoSD Ministry of Social Development MTEF Medium-Term Expenditure Framework NISSA National Information System for Social Assistance NPAB National Planning Advisory Board NSDP National Strategic Development Plan OBFC One Stop Business Facilitation Center PAF Performance Assessment Framework PEFA Public Expenditure and Financial Accountability PMT Proxy Means Test PPAD Procurement Policy and Advice Division PPP Public/Private Partnerships PSCEDP Private Sector Competitiveness and Economic Diversification Project PFM Public Finance Management PRS Poverty Reduction Strategy R&D Research and Development SACU Southern African Customs Union SADC Southern African Development Community SME Small and Medium Size Enterprises TVET Technical and Vocational Education Training Vice President: Makhtar Diop Country Director: Asad Alam Sector Director: Marcelo Giugale Sector Manager: John Panzer Lead Economist/Sector Leader Sandeep Mahajan Task Team Leader: Christian Y. Gonzalez Amador KINGDOM OF LESOTHO DEVELOPMENT POLICY GRANT TABLE OF CONTENTS I. INTRODUCTION ........................................................................................................................................ 1 II. COUNTRY CONTEXT ................................................................................................................................... 1 A. Economic Poverty, and Social Context ................................................................................................. 1 B. Political Context ................................................................................................................................... 5 C. Recent Economic Developments ........................................................................................................... 5 D. Macroeconomic Outlook ...................................................................................................................... 8 III. THE GOVERNMENT’S PROGRAM ........................................................................................................ 10 IV. BANK SUPPORT TO THE GOVERNMENT’S PROGRAM .................................................................. 11 A. Link to Country Assistance Strategy ................................................................................................... 11 B. Relationship to Other Bank Operations .............................................................................................. 11 C. Collaboration with the IMF and Other Donors .................................................................................. 12 D. Lessons Learned ................................................................................................................................. 13 E. Analytical Underpinnings ................................................................................................................... 13 V. THE PROPOSED OPERATION ................................................................................................................. 15 A. Operation Description ........................................................................................................................ 15 B. Policy Areas ........................................................................................................................................ 15 VI. OPERATION IMPLEMENTATION .......................................................................................................... 28 A. Poverty and Social Impact .................................................................................................................. 28 B. Environmental Aspects ....................................................................................................................... 29 C. Consultation and Participation .......................................................................................................... 29 D. Implementation, Monitoring, and Evaluation ..................................................................................... 30 E. Fiduciary Arrangements ..................................................................................................................... 31 F. Disbursement and Audit ..................................................................................................................... 33 G. Risks and Risk Mitigation ................................................................................................................... 34 ANNEXES ............................................................................................................................................................ 36 Annex 1: Letter of Development Policy ........................................................................................................ 36 Annex 2: Policy Matrix ................................................................................................................................ 48 Annex 3: Fund Relations Note...................................................................................................................... 53 Annex 4: Consultations ................................................................................................................................ 55 Annex 5: Country at a Glance ...................................................................................................................... 56 Annex 6: Fiscal Sustainability Analysis ....................................................................................................... 59 Annex 7: Map of Lesotho ............................................................................................................................. 64 This DPO was prepared by an IDA team led by Christian Y Gonzalez Amador (AFTP1) and included Macmillan Anyanwu, Senior Operations Officer (AFMLS); Carolina Biagini, Consultant AFTP1); Carlos Cavalcanti (Senior Economist, PRMED); Melis U. Guyen, Senior Social Protection Specialist (AFTSP); Fernando G. Im, Economist (AFTP1); Jose C. Janeiro, Senior Finance Officer (CTRLA); Melanie Jaya, Program Assistant (AFCS1); Austin Kilroy, Young Professional (AFTFE); Smita Kuriakose, Economist (AFTFE); Christine Makori, Counsel (LEGAM); Catherine Kadennyeka Masinde, Principal Operations Officer (IFC); Emma Mistiaen, Operations Officer (AFTSP); Tandile Msiwa, Financial Management Specialist (AFTME); Keneuoe Mofolo, Program Assistant (AFMLS); Chaba Mokuku, Project Manager (AFTFE); Phindile Ngwenya, Research Analyst (AFTP1); Pedro Olinto, Senior Economist (LCSPP); Andrew Osei Asibey, Senior Monitoring and Evaluation Specialist (AFTDE); Marco Scuriati, Senior Operations Officer (AFCS1); John Sikazwe, Procurement Specialist (AFTPE); Pablo Suarez Becerra, Consultant (PRMPR); and Gert Van der Linde, Lead Financial Management Specialist (AFTFM). The team is grateful for the close collaboration of the Government of Lesotho during the preparation of the grant. Asad Alam (AFCS1), Sandeep Mahajan (AFTP 1) and John Panzer (AFTP1) provided internal quality oversight. The peer reviewers were Rashmi Shankar, Lead Economist (ECSP1); David Gould, Lead Economist (SARCE); and Thomas Kenyon, Senior Private Sector Development Specialist (LCSPF). . GRANT AND PROGRAM SUMMARY KINGDOM OF LESOTHO DEVELOPMENT POLICY GRANT Recipient Kingdom of Lesotho Implementing Ministry of Finance Agency Financing Data IDA Grant Amount: SDR13.4 million (US$20 million equivalent). Terms: Service charge fee of 0.75 percent. Operation Type First in a series of three programmatic single-tranche Development Policy Operations (DPO). Main Policy Areas This DPO is designed to support Government reforms to: (i) improve private sector competitiveness, through implementing key investment climate reforms; (ii) improve the sustainability and efficiency of public spending, through fiscal consolidation and public financial management and public procurement system reforms; and (iii) improve social protection and monitoring systems, through improving the targeting of social safety net programs and strengthening the statistical system. Key Outcome Indicators Baseline 2016 Indicators (2015) (2012) Number of days to register a firm. 40 7 Number of days required to obtain manufacturing 1-5 3 and trading licenses. Number of months delay in publishing the audit 18 (avg) 0 reports on public accounts. Number of households in NISSA reached through 6,920 25,000 the Childs Grant Programme. Percentage of the population issued with national 0 100% ID card. Program The operation’s development objective is to assist the Government in Development implementing a reform program aimed at promoting growth, Objective(s) and competitiveness and public sector efficiency. The DPO supports progress Contribution to towards the Country Assistance Strategy objectives of fiscal adjustment CAS and public sector efficiency and enhanced competitiveness and diversification. i Risks and Risk The achievement of the development objective is subject to three main Mitigation risks: • On the institutional side, the main risk stems from the weak capacity of Government institutions to implement the reform program. To reduce this risk, the Bank is working with other donors to support the Government’s reform program through technical assistance and ongoing operations. • On the political side, the main risk derives from the new Government’s unproven capacity to muster broad consensus and be able to approve and complete the implementation of the politically difficult aspects of the reform program. The new administration is faced with the challenge of managing a complex multi-party coalition government. This arrangement could limit the Government’s ability to build consensus around reforms that are critical for the sustenance of economic growth and its capacity to mobilize enough political support to implement its programs could be impaired. The new Prime Minister has re-affirmed the Government’s commitment to the strategic objectives of the NSDP and his resolve to improve communication between the Government and citizens, and implement key reforms that will help to mitigate the risks associated with weak institutions and poor governance in the country. The Bank prepared a set of policy notes on the major reform areas that was delivered to the new Government. The Bank will continue to foster policy dialogue using its analytical works, investment operations, and coordination with other development partners. • On the economic front, the main risk centers on the possibility of further worsening of the global economic environment. Under this scenario, the country’s shock-absorption capacity could face important limitations, particularly in applying effective countercyclical macroeconomic policies and suitable social safety nets. To reduce this risk, the Government has become much more cautious, focusing on fiscal consolidation to build fiscal space and on building international reserves to protect the peg of the maloti with the rand, reforms currently supported under an IMF Extended Credit Facility Program. Operation ID P128573 ii IDA PROGRAM DOCUMENT FOR A PROPOSED DEVELOPMENT POLICY GRANT TO THE KINGDOM OF LESOTHO I. INTRODUCTION 1. This program document proposes the First Growth and Competitiveness Development Policy Grant (DPO 1) in the amount of US$20 million equivalent to the Kingdom of Lesotho. The proposed operation is the first in a series of three single-tranche operations envisaged in the Country Assistance Strategy covering FY2010-2014, discussed by the Board in July 2010. This series builds on the achievement and lessons of the preceding Poverty Reduction Strategy Credit series and aims to consolidate reforms supported by previous operations. This operation is closely aligned with other Bank operations such as the ongoing Private Sector Competitiveness Loan (P088544), Technical Assistance to the National Information System for Social Assistance (NISSA) (P132159), and the Lesotho Public Financial Management Reform Support Program (P143197), currently under preparation. The design and implementation of the series is benefiting from close collaboration with Lesotho’s development partners and other stakeholders. 2. The proposed series is designed to assist the Government in implementing a reform program aimed at promoting growth, competitiveness and public sector efficiency. Specifically, the operation supports three areas that are central to the reform program: (i) improve private sector competitiveness, through implementing key investment climate reforms; (ii) improve the sustainability and efficiency of public spending, through fiscal consolidation and public financial management and public procurement system reforms; and (iii) improve social protection and monitoring systems, through improving the targeting of social safety net programs and strengthening the statistical system. The operation supports three strategic goals of the National Strategic Development Plan (NSDP): (i) pursue high, shared and employment creating economic growth; (ii) improve health, combat HIV and AIDS and reduce (social) vulnerability; and (iii) promote peace and democratic governance and build effective institutions. It also contributes to the CAS’s two pillars: (i) fiscal adjustment and public-sector efficiency; and (ii) competitiveness and diversification. The proposed DPO series is fully aligned with the Bank’s Africa Region Strategy. The reforms supported by this operation are expected to have no negative impacts on poverty and inequality (see section VI). II. COUNTRY CONTEXT A. Economic Poverty, and Social Context 3. Lesotho is a lower middle-income country with per capita gross national income of US$1,210. 1 It is small, mostly mountainous and largely rural country of about 2 million people completely surrounded by South Africa. Lesotho has an open economy traditionally centered on trade. Its main exports are textiles, water, and diamonds. Lesotho’s main trading partners are the United States and South Africa. It is a member of the Southern African Customs Union (SACU) and the Southern African Development Community (SADC) and, as 1 2011 Atlas GNI per capita. 1 a member of the Common Monetary Area (CMA); its currency is pegged to the South African rand. 4. Lesotho has undergone changes adjusting to new realities and shocks over the past two decades. The economy has grown at an annual rate of 3 percent in per capita terms (Figure 1)—modest for its income level but comparable to the rest of the SACU region, the African continent, and small states. 2 The economy has been able to adapt itself to new realities and has taken advantage of new growth opportunities. The changes have involved shifts from subsistence agriculture and remittances toward mining, water exports, manufacturing exports, and services. Figure 1. Trends in GDP growth 1200 8 GNI Per capita 7 1000 6 GNI Per Capita ( constant 2004 800 5 Real GDP Growth 600 4 3 400 2 200 1 0 0 FY99/00 FY00/01 FY01/02 FY02/03 FY03/04 FY04/05 FY05/06 FY06/07 FY07/08 FY08/09 FY09/10 FY10/11 Source: BoS and Staff Estimates Figure 2.Trends in Sectoral Distribution of GDP Source: BoS and Staff Estimates 2 Small states are defined as sovereign countries with a population of 2 million or less. Favaro, Edgardo M., (2008), Small States, Smart Solutions, World Bank Press, Washington D.C. 2 5. Agriculture’s contribution to GDP has declined significantly over the past three decades (Figure 2). It declined from 21.4 percent in 1982 to 7.8 percent in 2011. About three quarters of the population live in rural areas, where three out of every four people are engaged in farming, herding, or both. The sector has been losing competitiveness, and the value of agricultural exports has declined over the past three decades. Over the same period, a large structural food deficit has emerged, with domestic cereal production now covering only about 30 percent of annual consumption requirements of an estimated 360,000 tons. As a result, Lesotho is heavily reliant on food imports. 6. The manufacturing sector’s contribution to GDP declined from about 20 percent in 2006 to 11 percent in 2011—the result of stagnation in the textile and apparel sector after the global economic crisis, competition from low-cost Asian producers, and the rapid growth in other sectors, notably mining. 3 The main growth engine before 2007 was manufacturing exports, mostly from the textile and apparel industry, since then diamond production is becoming an important source of Lesotho’s growth, accounting for nearly 7 percent of GDP in FY2010/11, up from 0.5 percent in the early 2000s (Figure 2). 4 However, the diamond sector is capital intensive and does not contribute significantly to total employment. It currently employs around 2,000 workers. 5 7. Water is an important contributor to Lesotho's economy and central to long- term prospects for the accelerated and sustainable growth of a greener economy. The combination of high altitude, abundant water, and proximity to major demand centers in South Africa provides Lesotho profitable opportunities. Lesotho currently generates an average of US$20 million a year in royalties from the Lesotho Highlands Water Project (LHWP). These revenues have contributed to poverty reduction measures and investments aimed at addressing national water supply demands. 8. The country now finds itself at a crossroads, requiring new growth engines, a more streamlined role for the state, and the need for a dynamic private sector to seize opportunities in the Southern African market. Public spending grew from 45 percent of GDP in FY2004/05 to about 62 percent in FY2011/12, one of the highest ratios in the world. This level is unsustainable, and public spending can no longer be relied upon to drive growth. 6 The effectiveness of public spending has also been low, weakening its effect on growth and social outcomes. 7 The fiscal consolidation needed to strengthen fiscal and external sustainability would weigh on future growth, especially if not matched by greater effectiveness of spending and service delivery institutions. Now, the impetus for growth has to come from the private sector, which at the moment is small and weak, having insufficiently absorbed the benefits of the past decade’s large FDI inflows and public expenditure programs. In addition, Lesotho will need to sustain and attract new FDI –in particular, investment coming from new sources (such as South Africa), flowing into new sectors (with emphasis on low-skill production), and putting a greater focus on the South African market. 3GoL, 2011. 4 The policy and institutional environment of the mining sector in Lesotho is weak. The Bank and IMF are providing technical assistance to the Government in developing a new mining code. 5 IMF Staff Report for 2012 Article IV consultations. 6 Lesotho Public Expenditure Review 2012 (Report No. 71973-LS). 7 Lesotho Public Expenditure Review 2012 (Report No. 71973-LS). 3 9. Economic growth has not been adequately inclusive, resulting in high concentration of poverty in rural areas, persistent high levels of inequality, and widespread unemployment. Unemployment stood at 24 percent in 2008, among the highest in the world. Only 230,000 of the 608,000 employed people engage in formal wage employment. The rest are in informal activities, and they are often paid in-kind. Preliminary Government’s estimates based on the 2010/11 Household Budget survey show that the national poverty head count rate stood at 57.1 percent and the Gini Coefficient based on consumption stood at about 0.53 (Table 1). Both these figures are virtually the same as those obtained in the 2002/2003 Household Budget survey. However, by comparing the 2002/03 figures with those from 2010/11, poverty has decreased in urban areas while poverty has increased in rural areas (see Table 1). Poverty is concentrated in rural areas that, despite poor soil quality and rainfall, remain home to about three quarters of the population, indicating underutilization and misallocation of labor resources. The critical challenges of inclusive growth, a sustainable and effective public sector, and access to quality service delivery define Lesotho’s core development agenda. A necessary condition to achieve inclusive growth is job creation, particularly in low-skilled sectors. Table 1: Selected Social Indicators 2010 (or latest 1995 2000 available) National headcount poverty ratio (% of population) 56.6* 57.1** National headcount poverty ratio- urban (% of population) 39* 36.6** National headcount poverty ratio- rural (% of population) 60.9* 61.8** Gini coefficient 0.51* 0.53** Primary school enrollment (% net) 68 76 73.4 Secondary school enrollment (% gross) 30 30 46 Life expectancy at birth (years) 56.9 47.6 46.7 Under-5 mortality rate (per 1,000 live births) 99.4 126.8 85 Maternal mortality rate ( modeled per 100,000 live births) 340 470 530 Prevalence of HIV (% of population ages 15-49) 14.3 24.5 23.6 *Information from 2002/03 HIES **Preliminary Government estimate based on the 2010/11 HIES Source: World Bank World Development Indicators 10. Gender equality continues to be a challenge although the Government is beginning to make inroads. According to the Gender Equality Index (HDR 2011), Lesotho had a score of 0.532, ranking 108th out of 187 countries. Women have long been disadvantaged by cultural traditions, even though they play a vital role in the economy. The Legal Capacity of Married Persons Act of 2006 (the Act) repealed many discriminatory provisions in the formal legal system and represents a crucial improvement in women’s legal position. Once the Act’s provisions are fully implemented, women will be able to access credit, improve land tenure, invest money, engage in entrepreneurial activities, and become the sole guardians of their children. The NSDP lays out the strategy to fully implement the Act. 4 11. Much of the expansion of Government spending over the past decade has been directed toward the social sectors, but Lesotho’s social outcomes have not improved significantly. Lesotho spends close to 30 percent of GDP, or more than half the Government’s budget, in three social sectors: education, health, and social protection. Deep- rooted inefficiencies in social spending have reduced the expenditures’ effectiveness. The country's health systems have been overwhelmed by HIV/AIDS, with the adult prevalence rate climbing to the world’s third highest at 23.6 percent. However, overall coverage of key HIV/AIDS interventions has improved, including Prevention of Mother to Child Transmission (PMTCT) and Anti-Retroviral Treatment (ART). 8 Maternal mortality is among the highest in Sub-Saharan Africa, and infant mortality has also increased in recent years. 9 In the education sector, learning outcomes and coverage have improved, but quality remains low at the primary level. In terms of social protection, Lesotho spends close to 9 percent of GDP on social transfers and most of them do not target the poor. B. Political Context 12. Lesotho has undergone a major political transformation over the past decades. After nearly forty years of turbulent political history, stability was restored in 1998. The country witnessed a peaceful transition of power from former Prime Minister Pakalitha Mosisili to the new Prime Minister Mr. Thomas Thabane, who was sworn in on June 8, 2012. He leads a coalition government formed by the three major opposition parties – All Basotho Convention (ABC), Lesotho Congress for Democracy (LCD), and Basotho National Party (BNP), who controls 71 out of the 120 parliamentary seats. The Government embraced the NSDP, which was prepared by the previous administration, and incorporated some additional strategic actions to reflect the Coalition Manifesto. The reform program supported by the DPO series is envisioned in the NSDP. C. Recent Economic Developments 13. Economic growth remained resilient in the face of the global financial crisis. GDP grew 4.7 percent in FY2009/10, 6.8 percent in FY2010/11 and 5.4 percent in FY 2011/12, driven mainly by public investment. However, textile and diamond exports fell significantly as did employment in these sectors from FY2008/09 to FY2009/10. Remittances from mine workers working in South Africa also declined. As a result of a very sharp decline in SACU transfers, the fiscal balance deteriorated from 8.2 percent of GDP in FY2008/09 to - 10.3 percent of GDP in FY2011/12, and the current account also worsened significantly. The fiscal balance is expected to be 4.8 percent of GDP in FY2012/13. A key factor would be an expected doubling of SACU receipts, partly as compensation for underpayments in previous years. In addition, the Government under-executed capital spending. International reserves are projected to increase to 3.9 months of imports by the end of March 2013, having fallen from 5.3 months of imports in FY2009/10 to 3.4 months in FY2011/12. 8 Through the HIV and AIDS Technical Assistance Project (P107375), the Bank has continued to support the Government’s efforts to build the capacity of ministries, departments, and agencies (MDAs) and civil society organizations (CSOs) to implement the Second HIV/AIDS National Strategic Plan in a coordinated manner. 9 The Maternal and Newborn Health Performance Based Financing project (P114859), expected to be presented to the Board on April 2013, will support the Government’s efforts to improve maternal and infant mortality rates. 5 14. The growth outlook for FY2012/13 has weakened owing to slower growth in textile and agriculture production. External balances however are expected to improve. Growth of the textile industry slowed down owing to the uncertainty of the renewal of the African Growth and Opportunity Act (AGOA), prior to the decision for the extension in August 2012.Furthermore, a major drought in 2012reduced crop production by over 70 percent. 15. The volatility of SACU transfers has made budget management challenging. SACU transfers declined from 36 percent of GDP in FY2008/09 to 15.8 percent in 2010/11, and 14.6 percent in 2011/12, before increasing to 28.9 percent in 2012/13, a magnitude of change that would overwhelm any fiscal system. Public expenditures had previously increased about 19 percentage points of GDP between FY2005/06 and FY2009/10 as SACU transfers had risen at a rapid pace. Maintaining medium-term fiscal balance depends on careful management of these revenue and expenditure lines. 16. In response to the fiscal pressures and volatility of SACU transfers, the Government has embarked on an ambitious fiscal consolidation program. In 2010, the Government adopted a medium-term macroeconomic program supported by an IMF ECF to strengthen fiscal and external sustainability. 10 At the heart of this program is a phased reduction in recurrent spending over the medium-term, deemed necessary to reduce reliance on volatile SACU revenues and strengthen fiscal sustainability. Key reforms included: (i) containing expenditures to levels consistent with revenue flows, while safeguarding social spending for the poor and vulnerable groups; (ii) further strengthening of public expenditure and financial management; (iii) improving the business climate to facilitate private-sector development; and (iv) strengthening the financial sector’s regulatory framework and deepening financial intermediation. The program put a floor on spending on priority social programs. Finally, the ECF arrangement incorporated measures to strengthen revenue administration. The ECF program remains on track; with the next final review scheduled for May 2013. 17. Arresting the trend of increasing government spending is necessary to ensure macroeconomic sustainability and stability. In this context, government salaries represent a key challenge. Lesotho’s wage bill stands at about 19.3 percent of GDP and is one of the highest in the world. The Government recognizes the importance of bringing down the wage bill and moderating future wage increases. The Government has a three stage strategy to bring down the wage bill. In the first stage, the Government is undertaking a payroll audit to get a proper head count and deal with ghost worker issues. In the second stage, the Government will undertake a study to review the civil service structure to determine the appropriate staff complement for efficient and effective delivery of government development programs. Finally, the last stage will focus on outsourcing some Government activities. 10 The IMF Board approved a three-year ECF arrangement for SDR41.88 million (120 percent of quota), against the backdrop of a sharp fall in SACU transfers. On April 9, 2012, the Board approved an augmentation of access equal to 25 percent of quota, which has led to a total access of SDR50.6 million (145 percent of quota) to cushion the impact of the 2010- 11 flood damage and high international commodity prices. 6 Table 2. Selected Economic Indicators, FY2009/10-FY2015/16 2009/10 2010/11 2011/12 2012/13p 2013/14p 2014/2015p 2015/16p National Income and Prices Annual Percent Change Real GDP Growth 4.7 6.8 5.4 3.6 4.4 4.2 4.0 GDP at market prices (USD Million) 1,935.5 2,317.2 2,533.1 2,434.0 2,567.4 2,730.8 2,943.4 CPI Inflation 5.9 3.4 6.2 5.6 6.2 5.9 5.8 Government finances Percent of GDP unless otherwise indicated Total Revenues 62.4 51.3 50.9 65.5 61.2 54.1 50.7 Tax Revenues 21.3 21.0 22.7 23.5 24.5 24.7 24.6 Grants 3.0 7.2 7.6 8.2 6.8 2.1 1.9 Non Tax Revenues 5.2 7.4 6.0 4.9 4.5 5.4 5.0 SACU 32.9 15.8 14.6 28.9 25.4 21.9 19.2 Total Expenditures 66.3 56.2 61.1 60.7 59.2 52.4 47.7 Expense 55.5 44.7 45.9 45.0 44.1 40.9 38.7 o/w Compensation of employees 21.0 19.2 19.3 19.3 19.4 18.7 17.9 o/w Interest Payments 0.8 0.6 0.7 0.8 1.0 0.9 0.8 o/w Grants 6.6 4.2 5.1 4.3 3.4 3.1 2.9 o/w Social benefits 3.7 3.6 3.1 3.0 3.1 3.0 3.0 Non-financial assets 1/ 10.8 11.5 15.2 15.7 15.1 11.5 9.0 Overall Fiscal Balance (3.9) (4.9) (10.3) 4.8 2.0 1.6 3.0 Core SACU fiscal balance 2/ (20.0) (4.9) (7.8) (5.1) (4.3) (2.2) (0.1) Public Sector Debt 37.0 34.4 37.8 43.1 41.3 40.8 37.9 Recurrent Expenditure 47.7 38.3 39.6 39.0 39.0 37.4 35.4 Capital Expenditure 18.6 18.0 21.5 21.7 20.2 15.1 12.3 External Sector Current Account (% of GDP) (3.1) (14.5) (24.2) (10.6) (14.1) (13.0) (5.3) Foreign Direct Investment (US Million) 109.0 120.0 137.0 201.0 273.0 258.0 185.0 Gross International Reserves (US Million) 1,105 961 858 970 1,145 1,151 1,192 In months of imports 5.3 3.8 3.4 3.9 4.6 4.8 4.9 Source: MoF, IMF and Staff Estimates p/ Projections. 1/ It is defined as the difference between purchases of fixed assets and sales of fixed assets (IMF GFSM 2001). Non-financial assets include fixed assets inventories, valuables and non-produced assets. 2/ The core SACU fiscal balance is defined as the fiscal balance excluding the volatile component of SACU revenues and foreign-financed project loans. The volatile component of SACU revenues is defined as total SACU revenues minus a core component equivalent to 15 percent of GDP, which is the lowest annual SACU receipt in the past two decades (IMF ECF Fourth Review Report). 18. Much of the expansion of Government spending over the past decade was directed toward public investment, particularly in the social sectors. Capital expenditures increased from 8.7 percent of GDP in FY2000/01 to 18.6 percent of GDP in FY2009/10, while recurrent expenditures increased from 35 percent of GDP to 47.7 percent of GDP. However, the economy grew on average 4.1 percent per year while annual gross investment was on average 32.2 percent of GDP, suggesting poor productivity of investment, including public projects. 11 Improving the quality of public investment is paramount. 19. While Lesotho has relatively high and active use of banking services, local SMEs in general lack adequate access to finance and credit. The ability of the banking sector to mobilize savings and deposits is good. M2 as share of GDP stood at 38 percent in 2010, high compared to peer countries. Among the adult population, 58 percent have access to formal financial services (80 percent use transaction and savings services), and 23 percent access informal services. The ratio of private-sector credit to GDP—a key indicator for the strength 11 The ICOR in 2001-2010 was 7.9; in 2004-2010, it was 6.3, suggesting an improvement of investment productivity over the past six years. However, Lesotho’s Incremental Capital-Output Ratio (ICOR) still trailed other small states and developing countries in Sub-Saharan Africa. 7 of financial sector performance—has grown at close to 20 percent in recent years. However, its level remains significantly below the sub-Saharan Africa average of 58 percent. Access to credit is a particular challenge for households and SMEs. The 2011 Finscope survey found that only 9.8 percent of the banked population accessed credit. Credit is largely provided through microfinance lenders and informal mechanisms rather than formal financial institutions. 20. Efforts are underway to strengthen oversight of non-bank financial institutions (NBFIs), but this reform agenda is still unfinished. According to the latest IMF Article IV staff report (March 2012), a key challenge for the financial sector going forward relates to its proper regulation and supervision. According to the report, Lesotho’s banking sector has been well regulated and supervised, but NBFIs are generally not comprehensively supervised. In addition, no framework exists for the microfinance institutions that could offer their much- needed services to enhance poor households' access to financial services. The IMF and the Financial Sector Reform and Strengthening Initiative (FIRST) are supporting work on pensions, insurance, and NBFI regulation; it needs to be taken forward. Effective implementation of the new Financial Institutions Act (FIA) will help reduce financial sector risks by covering NBFIs under the Central Bank of Lesotho. The Bank and the IMF are supporting the authorities in developing a financial sector development strategy. D. Macroeconomic Outlook 21. Lesotho’s medium-term outlook envisions a moderation in real GDP growth with significant downside risks. Real GDP growth is expected to remain slightly above 4 percent over the next 3 years (Table 2), which is a significant slowdown from growth in recent years. The planned fiscal consolidation drive and relatively weak growth prospects in South Africa would be the key factor driving this growth moderation in Lesotho. The government is undertaking a number of important structural reforms (many of which would be supported by the DPO series) and public investments in critical infrastructures to stimulate private sector investment and accelerate trend growth. However, the impact of these measures will only be felt with a lag. Trend growth is expected to pick up to 5 percent as a result of higher water- export revenues from the Lesotho Highland Water Project Phase 2 (LHWP II), and improvements in the overall investment climate. 22. The main risks arise from the uncertain global and regional outlook that could negatively affect SACU revenues and external demand for Lesotho’s exports, mainly diamonds and textiles. 12 Diamond production is expected to reach about 18 percent of GDP in FY 2015/16 as a result of new investments, up from about 11 percent of GDP in FY2011/12. However, this projection is subject to risks from slowdowns in global demand. 23. Inflation be will moderate over the medium term, with prospects closely tied to inflation in South Africa. Monetary policy will remain focused on supporting the currency peg between the loti and the rand. 12 SACU revenues and remittances are highly correlated with South Africa’s business conditions, and a downturn in the South African economy could have a negative impact on both fiscal and external balances. 8 24. The current account deficit is expected to widen over the next two years but then narrow in the medium term. In FY2013/14, the current account deficit is expected to widen to 14.1 percent of GDP, up from 10.6 percent of GDP in FY2012/13, owing to the onset of LHWP II and investments in mining. In the medium term, however, the current account will narrow as import growth slows and exports of textiles and diamonds pick up. 25. Effective fiscal management will be crucial for macroeconomic sustainability and stability. Three areas of fiscal management will be particularly important: (i) maintaining the wage bill within projected bounds; (ii) enhancing the efficiency of public expenditures; and (iii) managing the volatility of SACU revenues. The Government is committed to reforms in each of these priority areas. 26. The Government remains committed to the IMF ECF program aimed at achieving fiscal and external sustainability over the medium term. In light of the current uncertainty surrounding global economic outlook, the Government continues on its fiscal- adjustment process and considers it critical to accumulate adequate levels of international reserves to better manage potential shocks by raising reserves to above five months of imports in the medium term. The Fifth Review under the Extended Credit Facility and Request for extension of the arrangement is scheduled to be discussed by the IMF Board in early May, 2013. If the extension is approved, the current arrangement will be extended to September 2013. 13 27. The Government’s commitment to fiscal consolidation over the medium term involves reductions in current spending (the wage bill and spending on goods and services in particular), enhancing domestic revenue collection, improving spending quality, and strengthening cash management. As a result of these measures the overall fiscal balance will remain above 2 percentage points of GDP in the medium run. 28. A public debt simulation suggests that Lesotho’s public debt is on a sustainable trajectory (see Annex 6). Under the baseline scenario, the public debt-to-GDP ratio will gradually decline from an estimated 43.1 percent in FY2012/13 to about 32.5 percent at the end of FY2017/18. A stronger fiscal adjustment would lead to a sharper reduction in the public debt ratio. Under a scenario of simultaneous shocks in which GDP growth, the primary balance, and real interest rates are affected, the projected debt ratio would reach 46.3 percent in FY2017/18 or 13.8 percentage points higher than under the baseline scenario. This shock is projected to place the public debt ratio on an upward trend until FY2015/16, and only slowly stabilizing thereafter. Under these simulations, the risk of debt distress remains moderate. To ensure sound debt management, the Government plans to formulate a broader debt management reform plan with the Bank’s assistance. 29. In sum, the macroeconomic policy framework is deemed adequate for this proposed Development Policy Grant. The risk of debt distress is found under the Bank’s fiscal simulations to remain moderate. The planned fiscal consolidation outlook is appropriate to rebuild the international reserve buffer in the medium term, while safeguarding priority social and growth-promoting capital spending. The implementation of structural reforms 13 Currently, the IMF ECF program will end on June 2013. 9 aimed at improving business climate will be critical to maintain a favorable growth trend over the long run. III. THE GOVERNMENT’S PROGRAM 30. Lesotho’s NSDP serves as an implementation strategy for the National Vision 2020. The NSDP serves as the Poverty Reduction Strategy Paper (PRSP) and is the second PRSP that the Government has produced. The National Vision document states these broad goals: “By the year 2020, Lesotho shall be a stable democracy, a united and prosperous nation at peace with itself and its neighbors. It shall have a healthy and well-developed human resource base. Its economy will be strong, its environment well managed, and its technology well established.� To achieve these ends, the NSDP seeks to: (i) pursue economic growth that is high, shared, and job-creating; (ii) develop priority infrastructure; (iii) enhance the country’s skills base, technology adoption, and foundations for innovation; (iv) improve health, combat HIV/AIDS and reduce (social) vulnerability; (v) reverse environmental degradation and adapt to climate change; and (vi) promote peace and democratic governance and build effective institutions. 31. The NSDP recognizes the significant challenges Lesotho faces in reducing poverty and making growth more broad-based. It takes explicit note of the role high inequality and slow employment growth have played in making growth less inclusive and the inability of recent growth drivers (mining and construction) to noticeably change the situation. The plan also identifies the major non-economic sources of vulnerability: the spread of HIV/AIDS and climate change/natural disasters. 32. Pursue economic growth that is high, shared, and job-creating. The NSDP seeks to establish the pre-conditions for high, sustainable, and private sector-led economic growth and faster job creation. The plan’s targets include long-term GDP growth of 5 percent per year and creation of 50,000 private-sector jobs. Keys to achieving these goals are improving the investment climate and facilitating external trade. The proposed operation supports the Government’s strategy through: (i) streamlining procedures for getting construction permits, and (ii) streamlining the process required obtaining manufacturing and trading licenses. 33. Promote peace and democratic governance and build effective institutions. The NSDP seeks to enhance the public sector’s effectiveness and efficiency in delivering services, improving public financial management, and maintaining the rule of law. The proposed operation supports a key element of this initiative—the strengthening of statistics, policy development, planning, procurement, and public expenditure and financial management. 34. Improve health, combat HIV/AIDS, and reduce (social) vulnerability. In terms of reducing social vulnerability, the NSDP seeks to consolidate social-protection programs and improve their efficiency and coverage. The proposed operation supports key elements of this pillar. These include: (i) establishing a central registry system and improving management information systems; and (ii) evaluating and consolidating some existing social-protection programs. 10 IV. BANK SUPPORT TO THE GOVERNMENT’S PROGRAM A. Link to Country Assistance Strategy 35. The proposed operation is an integral part of the Bank's assistance to Lesotho as outlined in the Country Assistance Strategy (CAS). On July 2, 2010, the Board discussed the current CAS, which covers a four-year period (FY2010-14). It was developed within the context of the Government's strategy for growth and sustainable development, expressed in National Vision 2020 and its Interim National Development Framework. The CAS is built around three broad areas of engagement: (i) fiscal adjustment and public-sector efficiency; (ii) human development and service delivery; and (iii) competitiveness and diversification. The proposed operation supports reforms in two of these areas. B. Relationship to Other Bank Operations 36. The Bank has a relatively small portfolio in Lesotho, with an IDA allocation of about US$30 million a year in FY2010-14. The proposed operation complements and reinforces several current and planned investment projects in Lesotho. These include the Private Sector Competitiveness and Economic Diversification (PSCED, P088544) Project, Integrated Transport Project (P075566), Water Sector Improvement Project (P108143), and the Smallholder Agriculture Development Program (P119432). They are all geared towards creating an enabling environment for broad-based growth and improving infrastructure and access to basic services. The proposed operational so complements ongoing projects to improve access to service delivery and social transfers. 37. This proposed operation is closely linked to the Lesotho Private Sector Competitiveness and Economic Diversification Project(P088544, US$8.10 million), the principal instrument to support private-sector development. The project supports the Government on a range on issues that help: (i) improve the business environment and access to infrastructure and basic services; (ii) develop the financial system and promote access to finance; (iii) promote creation of a strong, dynamic, competitive and innovative private sector; (iv) and promote the priority sectors, broadening entrepreneurship and creating jobs in such sectors as agriculture, tourism, and manufacturing. While this operation is scheduled to close on June 30, 2013, a follow-up PSC II Project is envisioned that would continue supporting the Government by providing capacity-building technical assistance to foster greater private-sector development. The reforms supported by this operation address some of the barriers being incurred by both foreign and domestic investors. Lowering these barriers would help make the regulatory environment more conducive for new businesses, including those in such priority sectors as tourism and manufacturing. 38. The IFC acts as the Government's lead transaction advisor on four on-going PPP projects. 14 These mandates were signed in February and March 2012. These operations include: (i) developing a PPP project at 170 public-health facilities, which will address facilities management and information communication technology, including internet connectivity and telemedicine services; (ii) designing and developing health-care waste management PPP projects at facilities in three districts (Leribe, Berea, and Maseru) as pilots 14 Although the number of PPP projects in Lesotho has increased in recent years, there is a need to have an overall PPP framework in place. 11 for implementation of the Health Care Waste Management Strategic Plan, prepared in 2010; (iii) developing a tourism PPP program that focuses on five tourism PPP projects, creates a PPP framework for Lesotho’s tourism sector, and streamlines the tourism licensing process; and (iv) undertaking a feasibility study of two wind energy sites and, if feasible, packaging them as PPPs for development and financing by a private operator. The IFC has also partnered with a local organization—the Small, Micro and Medium Enterprise (SMME) Support Network—to deliver training and advisory services to local businesses and entrepreneurs. 39. Finally, the proposed operation is closely linked with the Lesotho Public Financial Management Reform Support Project (P1431971), currently under preparation. The project supports the implementation of the Government’s PFM action plan in collaboration with the EU and the AfDB. This project focuses on re-engineering the IFMIS, including linking it to the country’s payroll management system, and strengthening the public procurement system. C. Collaboration with the IMF and Other Donors 40. Maintenance of sound macroeconomic management will be a precondition for implementation of this operation. Lesotho has been under an ECF arrangement with the IMF since June 2010, and the coordination between Bank and IMF teams is strong, and both teams have been jointly assisting the authorities in various key structural reforms (e.g. PFM, financial sector strategy). IMF is currently conducting a stability assessment of the banking sector in Lesotho to evaluate macro-economic linkages, financial soundness, the implementation of Basel Core Principles for banking supervision, contingency planning and crisis management. According to the IMF, Lesotho has been performing well under the arrangement, and as at end of September 2012 performance criteria for the fifth ECF review were met. 41. The proposed operation is being prepared within the joint framework of budget support developed under Government leadership supported by the EU and IDA. AfDB, WHO, UNICEF, UNAIDS, Irish Aid, and GTZ are not at present providing direct budget support, but they have been participants in the process. 42. In May 2006, the development partners established the budget support program’s guiding principles. It was agreed that a nationally owned PRS and an associated common performance assessment framework would provide the basis for budget support. It was also recognized that the program should align itself with the budget timetable and MTEF process and should address the need to ensure predictability in disbursements. The program should also aim for a judicious balance between realism and ambition in the results indicators that serve as the basis for disbursements. The Government welcomed this approach, noting the importance of budget support in securing the still fragile reform agenda while cautioning against the use of unrealistic results indicators. The donors are supporting Lesotho in implementing its development programs by providing financial and technical support in a coordinated manner. Annual joint reviews are planned, with the most recent one conducted in February 2013. In the last review, the targets for 12 of 20 indicators were fully met, while three were partly met. The Joint Budget Support Review meeting concluded satisfactorily, and the next one is scheduled for early February 2014. 12 D. Lessons Learned 43. Four main lessons from the previous Poverty Reduction Support Credit series (FY2008-11) have been incorporated into the design of this DPO. These operations were rated moderately satisfactory. The lessons are: 44. Ownership of reforms is critical for a successful outcome. The satisfactory outcome of previous lending operations is largely a consequence of exclusively supporting Government-led initiatives. A continued technical and policy dialogue with the authorities and their technical team was important in maintaining the country’s ownership and commitment. 45. Strong analytical underpinnings and links to Bank investment lending provide the foundation for a well-designed operation. The key pieces of Economic and Sector Work (ESW) and the Public Expenditure and Financial Accountability (PEFA) Reports not only contributed to the design of previous lending operations, but also helped shape the Government’s reform efforts and supported a fruitful policy dialogue. 46. Effective donor coordination during project preparation and implementation is important. To avoid conflicting policy advice and provide a stronger voice in the policy dialogue with the Government, it was important to coordinate with the AfDB, IMF, EU, and other donors during program preparation and implementation. 47. Strong links to other Bank technical capacity and investment operations is critical for the program’s implementation. In past operations, the prior actions that were not linked with any other Bank operation resulted in poor program outcomes. In a country with weak institutional capacity, the prior actions must be supported by a capacity building operation. Therefore, this operation is being supported by Bank investment operations, trust funds, and technical assistance operations. E. Analytical Underpinnings 48. The design of the proposed operation is backed by solid analytical work conducted by the Bank, IMF, and others. The substantial body of analytical work has provided the basis for an in-depth dialogue with the Government and has supported the design of the DPO. Table 3 shows the links between the components included in the DPO and the recommendations from recent analytical work. Table 3: Links Between the DPO and Prior Analytical Work Analytical Reports – Findings and Recommendations Links to DPO Prior Actions I. Improving Private Sector Competitiveness Selected Policy Notes (WB 2012) The Government through its Ministry of Trade and The report recommends: “To further reduce the time to register a business, it is necessary Industry, Cooperatives and to fully implement the Companies Act of 2010 and the amended Trading Enterprises Marketing, submitted the Regulations. In addition, it is important to approve and implement the Industrial Licensing Industrial Licensing Bill 2012 Bill, which will eliminate the requirement for approval of manufacturing licenses by the to its Parliament. 13 Pioneer Industrial Board, which meets only once every two weeks, and adds an unnecessary layer to the process.� II. Improving the Sustainability and Efficiency of Public Spending Selected Policy Notes (WB 2012) The Government has, through: (a) its Ministry of The report recommends continuing with the implementation of the PFM Action Plan. Finance, submitted the revised Fiscal Year (“FY�) 2009/10 public accounts to the Office of the Auditor General; and (b) its Office of the Auditor General, published the audit report on the FY2008/09 public accounts. Selected Policy Notes (WB 2012) The Government has, through its Ministry of Finance, The report recommends: “Government urgently needs to set up the Procurement Tribunal established the Procurement to provide the private sector with recourse to an independent complaint-handling process.� Tribunal and appointed its members. Public Expenditure Review (WB 2012) The Government has, through its Ministry of Finance, The report recommends: “Monitoring is also severely hindered by weaknesses in Lesotho's established the Public financial reporting and procurement systems. The limited availability of budget information Procurement Tribunal and constrains oversight by the legislature, civil society, and the media.� appointed its members. III. Improving Social Protection and Monitoring Systems Lesotho: A Safety Net to Protect Extreme Poor and Build Human Capital (WB 2013) The report recommends: “Lesotho implements a number of social transfer programs, but these are not well coordinated and there is a need to better define the overall priorities and objectives of the safety net.� Specific actions should include: “Establish a national safety net strategy for the next 5-10 years that spells out the The Government has, through country’s broad poverty reduction objectives, desired target groups and coverage, and its Ministry of Social program choices. Development, developed and adopted the National Eliminate any duplication of coverage—for example, between the OAP, the CGP, and PA, Information System for Social and the creation of an integrated beneficiary register. Assistance (“NISSA�) and is piloting said NISSA through Establish a central body with policy oversight and expenditure planning authority over the Child Grants Programme. all transfer programs. -Continue a gradual expansion of the NISSA once a clear vision for the system has been developed and careful consideration has been made as to how the expansion would/should take place. The system should also be continuously monitored to determine whether it is in fact an effective way to improve coordination and targeting.� Selected Policy Notes (WB 2012) The Government has, through its Ministry of Development The report recommends strengthening data quality by accelerating implementation of the Planning, submitted to the National Strategy for the Development of Statistic as outlined in the NSDP. Ministry of Finance a FY 2013/14 Budget Framework Paper for the Bureau of Statistics. 14 Lesotho: Sharing Growth by Reducing Inequality and Vulnerability: Choices for Change. A The Government has, through Poverty, Gender, and Social Assessment (WB 2010) its Ministry of Development Planning, submitted to the The report recommends: “Lesotho’s fight against poverty and exclusion is hampered by a Ministry of Finance a FY lack of adequate quality data or disaggregated data on household demographics, assets, 2013/14 Budget Framework livelihoods, earnings and income, shocks, such as deaths or other major life events access Paper for the Bureau of to services, and social indicators. As a result, the impact of growth and public policy is hard Statistics. to identify.� V. THE PROPOSED OPERATION A. Operation Description 49. To continue its transformation to a prosperous, economically diverse middle income country, Lesotho will need to foster private sector-led growth, strengthen the sustainability and effectiveness of the public sector, and improve the reach and quality of public services for the poorest households. Continued improvement in the business environment will be essential for attracting new FDI, most profitably targeted at the South African market. FDI will also be important for reaping the benefits of Lesotho’s abundant water resources, which demands sustained investment in water infrastructure. At the same time, fiscal consolidation and stabilization are urgent priorities that call for:(i) prudent management of SACU transfers; (ii) stricter control over the wage bill; and (iii) streamlined and more effective public spending that is tightly aligned with the development priorities laid out in the Government's NSDP. Carried out in tandem with strengthening of service delivery institutions, this will bolster pro-poor social-sector programs; other countries have achieved social outcomes that are similar to or better than Lesotho’s with fewer public resources. 50. The proposed operation supports the Government’s efforts targeted to achieve this transformation, with emphasis on: (i) investment climate reforms; (ii) fiscal reforms; and (iii) improved monitoring of the economy and well-being and citizen empowerment. B. Policy Areas Policy Area 1: Improving Private-Sector Competitiveness 51. Moving towards a more dynamic growth environment will depend on Lesotho’s ability to sustain and attract new FDI—in particular, investment coming from new sources (such as South Africa), flowing into new sectors (with emphasis on low-skill production), and putting a far greater focus on the South African market (Policy Notes 2012). To take advantage of this potential, Lesotho would need to address some of these bottlenecks for attracting investors and complement it with top trade facilitation which is needed for these potential exports. Focus on these sources of competitiveness is all the more important given that some of the key policies to improve competitiveness are not under the Government’s direct control, such as: (i) exchange rate policy, which is determined by the Maloti’s peg to the Rand; and (ii) trade policy, which is decided at the SACU level. 52. Lesotho’s private-sector growth is hindered by a number of factors. The NSDP acknowledges an “uncompetitive business environment� as one of the most binding constraints on the growth of private enterprises, adversely affecting both foreign investment 15 and the growth of local SMEs. A number of factors that hinder private-sector growth remain at almost every stage of business—accessing land, obtaining construction permits, engaging in cross-border trade with South Africa, and accessing finance. For example, it may take more than two years for a foreigner to establish a firm in Lesotho; it takes less than a year in such countries as South Africa, Rwanda, and Vietnam. Improving the overall business environment will be essential to attracting new FDI, promoting domestic private-sector growth and creating new jobs. 53. In the past few years, the Government has made some progress in implementing reforms to alleviate constraints on the private sector. The Companies Act of 2010 was a step forward in reducing the number of procedures to register a new firm; it was supported by PRSC III and the Private Sector Competitiveness and Economic Diversification Project (PSCEDP). The Trading Enterprises Regulations of 1999 were amended in December 2011 to make it easier to obtain trade licenses through the establishment of a One Stop Business Facilitation Center (OBFC). The revised law also replaced prior inspections with post inspections for selected businesses with low health and environmental risks. Both these reforms were supported by the PSCEDP. The OBFC brings several functions under one roof. These include issuance of trading enterprise licenses, industrial licenses, work permits, and import permits/rebates and export visas (a restricted list of products still requires approval from various ministries). 54. The process for getting a permit to start a business in Lesotho will be further streamlined. The Ministry of Trade and Industry, Cooperatives and Marketing, has submitted the Industrial Licensing Bill 2012 to Parliament. 15 The Bank’s PSCEDP provided technical assistance in the preparation of the Industrial Licensing Bill. Its purpose is to facilitate and promote industrial development and small, micro, and medium enterprises (SMMES) through a new regulatory regime that is simple, short, and cost effective. Licensing powers will be vested in the Director of Industry, making processing shorter and simple. Currently, the Pioneer Industrial Board must approve manufacturing licenses. The board meets once every two weeks, adding an unnecessary layer to the process. The Industrial Licensing Bill eliminates Pioneer Industrial Board approval, reducing the number of days required to obtain manufacturing licenses. This is the prior action for this operation. This measure will cut the process of registering a firm by about 14 days (baseline 2012=40 days to register a firm). The Companies Act of 2010and amendments to the Trading Enterprise Regulations were a step forward in reducing the number of procedures to register a new firm. Companies Act implementation should be continued and the law should be further rolled out into the districts. Roll out of the OBFC to Maputsoe is a proposed trigger for the second DPO of this programmatic series. In addition, the Government will enact the Business Registry Bill, which amends the Trading Enterprise Regulations to require pre-inspection for enterprises on the negative list. 16 This is a trigger for the third DPO. DPO 1 Prior Action #1: The Government through its Ministry of Trade and Industry, Cooperatives and Marketing, submitted the Industrial Licensing Bill 2012 to its Parliament. DPO 2 Indicative Trigger #1: The Government, through its Ministry of Trade and Industry, Cooperatives and Marketing, issued the regulations to implement the Industrial Licensing Bill and rolls out OBFC services in Maputsoe. 15 The submission to Parliament of the Industrial Licensing Bill is also structural benchmark of the IMF’s ECF program. 16 The negative list is comprised by firms that pose high health and environmental risk. 16 DPO 3 Indicative Trigger #1: The Government, through its Ministry of Trade and Industry, Cooperatives and Marketing, submitted to its Parliament, the Business Registration Bill. Expected Results at the End of the Program: • Number of days required to register a firm: 7 (Baseline 2012=40 days). • Number of days required to obtain manufacturing and trading licenses: 3 (Baseline 2012=1-5 days). 55. The Government is committed to further improving access by investors (including foreigners) to land by strengthening the enforcement of contracts. Subleasing is now possible under the amended Land Act of 2010, but there should be greater dissemination of these changes along with information on procedures required to obtain subleases. The process could help facilitate private provisioning of factory shells currently in short supply. The Land Act of 2010 gives specific rights to lessees but not to sub-lessees. The Millennium Challenge Corporation’s compact has been supporting the Government’s efforts in land reform. The Government will amend the Land Act of 2010 to facilitate the use of subleases by giving specific rights to sublessees. In particular, the amendments will have specific clauses that give rights to sub-lessees to provide them greater certainty and security in occupational rights. These amendments are being reviewed and will be submitted by the end of the year. The submission is an indicative trigger for the second DPO of this programmatic series. The authorities have also drafted a sectional title bill, which will allow citizens to sell or transfer a section of their property with an accompanying title for ownership. The Government is likely to submit this bill to Parliament next year. The submission to Parliament of the Sectional Titles Bill is an indicative trigger for the third DPO for this programmatic series. 56. The Government is taking measures to reduce the number of days to obtain a construction permit. According to the World Bank (2012), dealing with constructions permits requires 11 procedures, takes 330 days, and costs 950 percent of per capita income. 17 There has been some easing in these regulations over the past few years, but they remain well above the Sub-Saharan Africa averages. This operation aims at streamlining the entire process at two stages—obtaining an environmental impact assessment and obtaining a permit from the Maseru City Council (MCC). The Government will issue regulations and guidelines to require environmental impact assessments only for construction projects in industries with high environmental risks. Currently, obtaining an environmental impact assessment takes 25 days. To streamline the process, the Government will issue regulations and guidelines to require environmental impact assessments only for construction projects for industries that pose high environmental risk, rather than for all construction projects. This would be in line with international best practice where Environmental Impact Assessments are conducted using a risk-based approach. The measure will cut 25 days off the process of obtaining construction permits for majority of firms. 57. In addition, the Government will introduce streamlined procedures to better integrate approvals from the various utility bodies prior to obtaining building permits from the Maseru City Council. Obtaining a permit from Maseru City Council (MCC) takes 65 17 The 330 days to obtain a construction permit might change. According to the 2013 Doing Business indicators, it takes 180 days to request and obtain a telecommunications connection. The team found that there was no requirement for approval of the building permit by the telecommunications company. The team will liaise with the Doing Business team to clarify the discrepancies with the information in the DB report. 17 days. 18 To speed up the process, Lesotho will develop an automated system for the permits. Other measures contributing to the lengthy process of obtaining construction permits are under the control of various subnational government levels and subject to delays attributable to utility companies. Going forward, better integrating approvals from the various utility bodies will help reduce the number of days required to obtaining a building permit from the MCC. Both of these proposed changes will bring down the number of days required to obtain a construction permit—the indicator for this subcomponent. These actions are indicative triggers for the next DPOs. DPO 2 Indicative Trigger #2: The Government through the Lesotho Land Authority Administration has submitted to its Parliament amendments to the Land Act of 2010 to facilitate the use of sub-leases. In particular, the amendments will define the rights of a sub-lessee. DPO 2 Indicative Trigger #3: The Government through the Ministry of Tourism, Environment and Culture has issued regulations and guidelines to require environmental impact assessments only for construction projects in industries with high environmental risks. DPO 3 Indicative Trigger #2: The Government through the Lesotho Land Authority Administration has submitted to its Parliament the Sectional Titles Bill. DPO 3 Indicative Trigger #3: The Government introduces streamlined procedures to better integrate approvals from the various utility bodies prior to obtaining building permits from the Maseru City Council. Expected Results at the End of the Program: • Sub leases have increased (number of sub leases per year)= 64 (Baseline 2012= 8). • Number of days to obtain a construction permit: 240 days (Baseline 2012= 330 days). 58. Trading across borders has improved, and further reforms are being prepared. Time to import has been reduced from 49 days in 2007 to 35 days in 2012, and the number of procedures has been cut from eight in 2007 to seven in 2012. Meanwhile, costs to import a standard container rose from $1,210 in 2007 to $1,945 in 2012.19 Time to export has been reduced from 44 days in 2007 to 31 days in 2012. Despite the improvements, Basotho producers and consumers still pay high trade transactions costs. 59. To improve cross-border trading, the Government has drafted a Customs Modernization Strategy. It provides a robust framework for coordinating and aligning customs-related activities, including coordination of border institutions. In addition, the strategy led to the Customs Modernization Programme (CMP) Phase 1 Report, which promotes practical collaboration among border agencies. The CMP’s strategic objective is to streamline processes and procedures towards reduction and minimization of the burden on business and public in meeting revenue payment, border management, and security provisions. Also, one of the LRA customs strategy objectives is to lead in the development and introduction of an integrated border management approach that meets international 18 World Bank 2012. 19 To make the data comparable across economies, Doing Business Indicators uses several assumptions about business and traded goods. The business: (i) is of medium size and employs 60 people; (ii) is located in the periurban area of the economy‘s largest business city; and (iii) is a private, limited liability company, domestically owned, formally registered and operating under commercial laws and regulations of the economy. The traded goods: (i) are not hazardous and do not include military items; (ii)do not require refrigeration or any other special environment; (iii) do not require any special phytosanitary or environmental safety standards other than accepted international standards; (iv) are one of the economy‘s leading export or import products; and (v) are transported in a dry-cargo, 20-foot full container load. 18 standards. The Lesotho Revenue Authority (“LRA�) Customs Modernization Programme Steering Committee approved the LRA Customs Modernization Programme Phase 1 and will enforce its implementation in the project’s timeline. It was composed of the Commissioner of Customs and Excise (as chair) and representatives from LRA ICT, LRA Policy and Strategy, LRA Enforcement, LRA Legal, LRA Human Resources, a private-sector representative (nominated by the Business Forum), and representatives of border agencies—Home Affairs, Health, Agriculture, Industry, Trade, Marketing and Cooperatives, and Tourism. The Bank is providing technical assistance in the design and implementation of the Customs Modernization Program through the Lesotho-RSA Customs Collaboration Trust Fund (P125780).The CMP Phase 1 Report includes planning for the consolidation of a range of customs projects under one program, a planned study of the LRA project management and implementation approach for customs initiatives, and a number of key projects to reach customs reforms objectives, including a Trade Information Portal, adoption of standard operating procedures at the border, a pilot preferred-trader scheme, and an education program for internal and external stakeholders on the new customs strategy. 60. The Government is working toward continued improvement in cross-border trading. The Government will create a pilot for the Preferred Traders Program by June 2013. The program’s objectives are facilitating legitimate trade by reducing inspection cost and enhancing traders’ compliance. The pilot will offer certain benefits to some traders deemed knowledgeable and compliant to customs rules and regulations. One of such benefits will be minimal inspections on entry. Completion of the pilot will signify progress on developing a common risk analysis for border traffic, covering several border agencies. The Preferred Trader’s program is part of the CMP. An Integrated Border Management Strategy would be an apex document that embodies the collaboration between all relevant border agencies and plans for consolidation of border processes and procedures. This trigger forms a natural continuation of the CMP and would signify wider progress on customs reform. DPO 2 Indicative Trigger #4: The Government has completed the Preferred Trader Program Pilot and reported on recommendations for implementation of the full scheme. DPO 3 Indicative Trigger #4: The Government started to roll out the Preferred Trader program and has adopted an Integrated Border Management Strategy. Expected Results at the End of the Program: • Import clearance (days): 1 day (Baseline 2012 =4.5 days). • Export clearance (days): 1 day (Baseline 2012 = 4.7 days). Policy Area 2: Improving the Sustainability and Efficiency of Public Spending 61. Lesotho has focused its PFM reform on the areas of significant weakness and has reported progress since reforms began. A Public Expenditure and Financial Accountability (PEFA) Report, completed in late 2012, notes that progress is clearly being made, although at a slow pace. Previously identified and longstanding weaknesses persist in budget execution, the internal control framework, financial reporting, and auditing. The operation focuses on key reforms in these areas. 62. Strengthening the effectiveness of public spending and the accountability framework is at the core of fiscal consolidation. The MoF has developed a detailed PFM 19 Action Plan in close collaboration with development partners. The plan seeks to develop more effective PFM systems, including improvements in planning, budgeting, budget execution, procurement, accounting, reporting, audit, and oversight. Sustained implementation of the plan is critical over the medium term for improved governance in Lesotho. The PFM Action Plan includes activities to fully control and commit the budget through IFMIS, an important step in resolving current expenditure arrears, preventing future ones, and improving oversight of aggregate fiscal risk from other public sector entities. 63. Development partners and the PRSC series supported the IFMIS to address financial control and reporting weaknesses. A well-functioning financial-management system is among the basics that underpin capacity to achieve the PFM objectives of strategic allocation of resources, fiscal discipline, efficient and economical service delivery, and transparency and accountability. Introduction of the IFMIS in April 2009 marked a critical milestone in the Government’s PFM reform program. The system has become the basis for maintaining government accounts since FY2009/10. There remain significant implementation challenges: (i) insufficient training and preparation for users; (ii) monthly government financial statements are now readily available; however they are not yet timely and fully reconciled with the bank accounts. A process is underway to ensure all transactions will be conducted within the system, supported by timely bank account reconciliation. The EU recently supported an independent IFMIS quality assurance. 64. Progress has been made toward improving financial reporting. Public Accounts for 2005, 2006, 2007, and 2008 have been audited and submitted to Parliament. A Statement of Financial Affairs as of March 31, 2008, which deals with the period for which no accounts are available (1996-2001), has been prepared and submitted to Parliament. This affects the opening balances in the public accounts of 2009 and those to be recorded in the IFMIS for 2010 onward. The IFMIS went live on April 1, 2009, but no financial statements have as yet been completed for FY2009/10 and FY2010/11. However, the process of correcting data problems—transactions not captured or partly entered and outstanding bank reconciliations— is underway. The Government submitted the FY2009/10 financial statements for audit about a year ago, which was a prior action for PRSC 3. Due to IFMIS data problems, it had to be revised. In December 2012, the Ministry of Finance submitted a revised FY2009/10 financial statement (Public Accounts) to the office of the Auditor General. In addition, the Office of the Auditor General published its audit report on the FY2008/09 Public Account, which Parliament tabled in February 2013.These measures are prior actions of this DPO. 65. The Government plans to take steps to improve the availability and reliability of financial information. In particular, Government through its Ministry of Finance will implement an annual mid-term budget review and fiscal reports. The annual mid-term budget review will allow the Government to examine the budget’s execution rates and will allow them to set more credible expenditures limits for the next budget. In addition, it will help the Ministry of Finance for an early support from the line ministries on the overall budget. To support implementation of the Public Financial Management and Accountability Act of 2011, regulations are required to detail the responsibilities, procedures, controls, and systems covering all stages of the budget cycle. At a minimum, this will include budget preparation, budget execution (including procurement), internal controls, internal audit, and cash management, accounting, and reporting. The Government has drafted the regulations detailing responsibilities, procedures, controls and systems covering all stages of the budget 20 cycle (as outlined in the PFM Act of 2011) and will issue them in the coming months. The Office of the Auditor General will publish their audit reports on the FY2009/10, FY2010/11 and FY2011/12 Public Accounts. Reconciled quarterly expenditure reports produced from IFMIS will be used to monitor budgetary targets. A necessary condition to meet these triggers is that the IFMIS produces reliable budget expenditure data. Strengthening of the IFMIS will be supported by the Bank’s proposed Public Financial Management Reform Support Project. 66. Recognizing that having a public service able to deliver government programs and services effectively is essential, the Government is undertaken a study to review the civil service structure to determine the appropriate staff complement for efficient and effective delivery of government development programs. As a first step, the Government is undertaken a payroll audit of its employees. The Government has requested Bank support to prepare this study. Based on this study, the Government will prepare an action plan with specific measures on civil service reform. Both of these measures are triggers for the next DPOs. DPO 1 Prior Action #2: The Government has, through: (a) its Ministry of Finance, submitted the revised Fiscal Year (“FY�) 2009/10 public accounts to the Office of the Auditor General; and (b) its Office of the Auditor General, published the audit report on the FY2008/09 public accounts. DPO 2 Indicative Trigger #5: The Government through the Office of the Auditor General publishes the audit report on the FY2009/10 public accounts. DPO 2 Indicative Trigger #6: The Government through its Ministry of Finance issued the regulations detailing responsibilities, procedures, controls and systems covering all stages of the budget cycle (as outlined in the PFM Act of 2011) and developed training needed to implement them. DPO 2 Indicative Trigger # 7: The Government through its Ministry of Public Service has reconciled the establishment list with the payroll in at least one ministry. DPO 3 Indicative Trigger#5: The Government through the Office of the Auditor General publishes the audit reports on the FY2010/11 and FY2011/12 public accounts. DPO 3 Indicative Trigger # 6: The Government has taken actions to implement the recommendations of the Audit Report to the Fy2008/09 public accounts. DPO 3 Indicative Trigger#7: Reconciled quarterly expenditure reports are produced from IFMIS to monitor budgetary targets. DPO 3 Indicative Trigger # 8: The Government through its Ministry of Finance implements an annual mid- term budget review and fiscal reports. DPO 3 Indicative Trigger #9: The Government through its Ministry of Public Service has: i) reconciled the establishment list with the payroll in at least two additional ministries; and ii) adopted an action plan based on a study on civil service restructuring. Expected Results at the End of the Program: • No delays in the publication of the audit reports on the public accounts. • Timely and reliable budget expenditure data from the IFMIS. 67. Although several reforms have been introduced, the public procurement system remains weak, understaffed, and poorly regulated at ministry and district levels. A new public procurement regulation took effect in 2007, and it has been under review since 2010 to remove inconsistencies, provide more clarity on its application, and introduce additional 21 procurement methods. 20 Capacity building of procurement staff also began under the Irish Aid-supported Chartered Institute of Purchasing and Supply (CIPS) program at the Lesotho Institute of Development and Management (IDM). As part of the reforms, a Procurement Tribunal was created under the Public Financial Management and Accountability Act of 2011 (PFMA 2011).Despite these positive developments, several challenges stand in the way of a transparent, efficient, economic, and competitive public procurement system that delivers value for money and fosters the development of local enterprises. The challenges include: (i) a decentralized procurement system not fully staffed in almost all line ministries and districts; (ii) staff with limited (and in some cases unacceptable) academic qualifications and little experience in public procurement, coupled with a CIPS training program that appears ineffective in building public procurement skills; (iii) weak regulatory oversight and audit and ineffective capacity-building by Procurement Policy and Advice Division (PPAD); (iv) procurement structures at national, ministry, and district levels that do not offer competitive salaries and grades to attract and retain skilled and experienced staff; (v) a Public Procurement Tribunal that exists in law but has not yet been set up; (vi) negative public perception of procurement as having limited competition, inadequate information, and lengthy payment arrangements, prone to corruption and detrimental to the interests of the private sector (GoL, 2008c). 68. Establishing an improved complaint mechanism was one of key recommendations of the Bank’s 2008 Country Procurement Assessment Review (CPAR). PFMA 2011 provides for creation of a Public Procurement Tribunal of six independent members, appointed by the Minister of Finance. Its role is to hear appeals against decisions of the Advisory Division under the Public Procurement Regulations of 2007, which were supported by the PRSC series. The Government has, through its Ministry of Finance, established the Public Procurement Tribunal and appointed its members. By setting up the tribunal, the Government will provide the private sector with the comfort of an independent complaint-handling process. Under the PFM Action Plan, donors will provide technical support for the establishment of the Procurement Tribunal. 69. The Government plans to take steps to strengthen further the public procurement system. The PPAD will publicize all tenders and contracts awarded above M100,000 on the web and in other media. Finally, the Ministry of Finance will monitor the waivers allowing non-competitive bidding. These measures are indicative triggers for the next DPOs. DPO 1 Prior Action # 3: The Government has, through its Ministry of Finance, established the Public Procurement Tribunal and appointed its members. DPO 2 Indicative Trigger # 8: The Government through its Ministry of Finance publicizes all tenders and contracts awarded above M100,000 on the web and in printed media. DPO 3 Indicative Trigger # 10: The Government through its Ministry of Finance monitors the waivers that allow non-competitive bidding. Expected Results at the End of the Program: • Number of waivers allowing non-competitive bidding approved: 30 (Baseline 2012=79). • Number of waivers allowing non-competitive bidding not approved= 70 (Baseline 2012=40). 20 The 2007 procurement regulation created the Procurement Policy and Advice Division (PPAD) to spearhead procurement reform and provide the needed regulatory function. The regulation also created procuring units in each entity. 22 Policy Area 3: Improving Social Protection and Monitoring Systems I. Strengthening Social Protection 70. Lesotho’s spending on social transfer programs is relatively high, but targeting is weak, resulting in poor outcomes in terms of social protection for the poor and vulnerable. The total spent on safety-net programs amounts to 4.6 percent of GDP—higher than many countries in the region. When all transfers are included, spending increases to 9 percent of GDP. Safety-net programs are spread across a range of programs, including school feeding, public-assistance grants, nutrition programs, and old-age pensions. 71. Social protection transfers reach only a small share of the poor and do not seem well targeted to reach the poorest households. The vast majority of existing transfer programs covers no more than a small percentage of the population – or even of the very poor. Based on rough assumptions regarding the incidence of benefits, only the School Feeding Program reaches a significant share of the poorest (estimated at a bit less than a quarter); while the old age pension, child grants, and nutrition support program each reach about 5 percent (one-twentieth) of the poorest. The other programs reach only a very small proportion of the poorest – typically around 1 percent. An absence of data on the incidence of any of the programs makes it impossible to conclude how well they are targeted; however, a priori it would appear that the existing package of benefits is not well-targeted (in particular, the old-age pension program, agricultural subsidies, and the school-feeding program). 21 72. No overall policy or institutional framework coordinates transfers programs. Currently, the sector has no clear objectives. The legal framework is scattered, making it difficult to focus on specific objectives. As a result, overlaps and duplication almost certainly exist, with some of the poor receiving benefits from multiple programs. The lack of a coordinating framework and agency further limits the impact of social transfers. 73. Administration of social transfer programs is weak and needs to be modernized. Benefits administration is hampered by weak capacity, information systems, and oversight and control. Lesotho currently lacks an automated national registry of applicants and beneficiaries, and benefit management is largely paper-based at the local level. The lack of an operational management information system leads to ineffective monitoring and evaluation of social policy, inefficiencies in eligibility determination, and delivery of benefits with high transactions costs. 74. A separate Ministry of Social Development was recently created, demonstrating growing emphasis on social protection in Lesotho. Before the establishment of the new ministry in June 2012, the Department of Social Welfare in the Ministry of Health and Social Welfare was leading the social-protection agenda. Moving forward, the new ministry is expected to take the lead on the social protection agenda. Its creation demonstrates the growing emphasis on social protection and might provide an important opportunity to establish a coordinating body for social safety net interventions. Currently, this ministry is implementing the Child Grants Programme (CGP), Nutrition for Malnourished and Other 21 Although it is worth mentioning that some of the safety net programs were not designed to be targeted, but are implemented universally. 23 Vulnerable Groups, and the Public Assistance Programs. However, other ministries are implementing most of the larger transfer programs—the old-age pension by the MoF’s Pensions Unit, the school feeding program and the OVC bursary scheme by the Ministry of Education and Training, and the fertilizer voucher and subsidy schemes by the Ministry of Agriculture and Food Security. Other safety-net related programs are implemented by the Ministry of Public Works and Transport, the Ministry of Forestry and Land Reclamation, and the Ministry of Local Government and Chieftainship. Finally, the Government has drafted a National Social Development Policy (NDP), considered an overarching document that provides a framework for addressing human needs in a developmental and holistic manner, with a view to improve the quality of life for all Basotho. 75. The Government has taken steps to improve the effectiveness of safety nets by better targeting of social programs. The Government has created a platform for a National Information System for Social Assistance (NISSA), with the vision to have this as a national registry for households receiving payments through transfer programs. This is an important step toward a more efficient safety net, but it is important to recognize that the NISSA should be expanded in a sustainable manner, ensuring that its processes and procedures are logistically and financially feasible in the long run. The system was designed to cover several key social protection programs, including the Child Grants Programme (CGP), the Old Age Pension Program, the Public Assistance Program, and the OVC Bursary Program. Initially, NISSA was launched as a pilot for the CGP, supported by the EU and UNICEF. NISSA reached 6,920 households through the CGP pilot, which has been finalized. 22 NISSA’s current database contains around 40,000 households in five of the country’s 10 districts—Leribe, Berea, Maseru, Mafeteng, and Qacha’s Nek. Lesotho spends about US$2.2 million annually in the CGP, which represents about 0.1 percent of GDP. The CGP is a non-conditional social cash transfer program, providing support to very poor and vulnerable households caring for Orphans and Vulnerable Children (OVC). The CGP targets poor households caring for OVC. 23 This is done through a fairly sophisticated process, including a census-style interview to collect data from all households within a given community, feeding into NISSA and thereafter categorizing households using a Proxy Means Test (PMT) formula. The PMT uses different variables to determine the poverty status of a household and has been developed to enable social assistance programs to more efficiently reach the poorest of the eligible households. The selection is further validated through the community and once the PMT and community both verify a household as eligible only then are they included in the program. 76. The Government intends to develop a Social Protection Strategy to lay out the overall objectives of the Social Protection programs. An inter-ministerial committee will be convened to steer the development of the Social Protection Strategy, building on the National Social Development Policy. The strategy will spell out clear, unambiguous objectives for the social programs. 77. The Government will continue expanding NISSA coverage to increase harmonization between programs. In the short to medium run, the Government plans to 22 About 3,300 additional households are being covered by the CGP but they are not currently registered in NISSA. It is expected that by end of June 2013 these households will be included in NISSA. 23 According to the Operations Manual, the CGP is targeted to poor households with children. The target group will include poor households caring for orphans, including single orphans, double orphans and child headed households. The target group will also include poor households caring for children who are not orphans, but who are vulnerable by virtue of their poverty status. 24 cover up to about 25,000 households eligible for the CGP, which is a trigger for the next DPOs. The EU and UNICEF are supporting the CGP expansion, including the NISSA enlargement. The Bank is providing technical assistance to the Government in developing a road map for NISSA expansion. The technical assistance aims to ensure that NISSA expansion is consistent with the Government’s vision for social protection and supports developing a road map for expansion, indicating how NISSA would form the basis for targeting related safety net programs. Important issues in the discussions under this technical assistance include the institutional framework within which NISSA will operate; the Government’s vision for NISSA; and the feasibility and sustainability of a proposed expansion. The Ministry of Social Development also plans to include the Public Assistance Program in NISSA, and other ministries have expressed interest in including their social programs in NISSA. These are important steps to increase harmonization of social safety net programs. Finally, the Government is committed to exploring ways in how to link NISSA to the National ID System. The development of a solid beneficiary identification is important when implementing safety net programs to distinguish program beneficiaries from non- beneficiaries. A functioning identification system enables adequate tracking of beneficiaries throughout key program processes (including e.g. registration, payment and recertification). This promotes efficiency within a program, and improves program governance by reducing duplication errors, fraud, and overlapping benefits. Although there may be initial investment costs to expand the NISSA it is envisioned that the increased harmonization of programs would lead to more efficient programs administration and in the long run it is expected that the safety net would more efficiently reach the targeted population. DPO 1 Prior Action # 4: The Government has, through its Ministry of Social Development, developed and adopted the National Information System for Social Assistance (“NISSA�) and is piloting said NISSA through the Child Grants Programme. DPO 2 Indicative Trigger # 9: The Government through its Ministry of Social Development, increase the coverage of the NISSA reached through the Childs Grants Programme by an additional 5,000 households. DPO 3 Indicative Trigger # 11: The Government through its Ministry of Social Development has extended the Childs Grants Programme by an additional 5,000 households and has rolled out the NISSA to include the Public Assistance Program. Expected Results at the End of the Program: • Number of households in NISSA reached through the Childs Grant Programme= 25,000 (Baseline 2012= 6,920 households). II. Improving Data and Information Monitoring Systems. 78. Government decision-making is hampered by the lack of accurate and timely information. Data from household surveys, ministries, public service delivery units, and public-sector spending reports are sporadic and vary in quality, imposing constraints on the ability of decision-makers to assess alternative policies and make informed decisions. As a result, decisions regarding the allocation of scarce resources and options for reforming and improving public services often lack a sound analytical foundation and program evaluation is at best difficult. The Government recognizes this weakness. It has taken measures to grant autonomy to the Bureau of Statistics (BoS), which will help enhance its effectiveness in managing and coordinating the country’s statistical activities. 25 79. The Government has taken the first steps toward giving administrative autonomy to the Bureau of Statistics (BoS). The Government has, through its Ministry of Development Planning, submitted to the Ministry of Finance a FY 2013/14 Budget Framework Paper (BFP) for the Bureau of Statistics and allocated resources to activities leading to its administrative autonomy. The BFP calls for: (i) reviewing the Statistics Council’s terms of reference to ensure the body’s appropriateness and relevance for governing an autonomous BoS; (ii) amending the Statistics Act 2001 to grant the BoS operational autonomy to enhance its effectiveness in managing and coordinating the country’s statistical activities; and (iii) reviewing and aligning all relevant laws of other agencies to make them consistent with the amended Statistics Act. 80. Giving administrative autonomy to the BoS will be essential to improving the quality of statistics. Currently, line ministries’ own rules govern their statistics, and the ministries lack both the expertise to analyze data and the discipline of Statistical Information Management Systems. Autonomy will not only give access to more resources but it will also provide the BoS with the leverage to manage and coordinate the National Statistical System. The National Statistical System will ensure: (i) coordinated statistics production; (ii) harmonized methods, standards, classification, concepts and definitions; and (iii) the availability of technical assistance to the line ministries that produce statistics. It will be necessary to change the BoS’ organizational structure to take into account these additional functions. The EU and the Bank have been supporting the BoS’ implementation of the National Strategy for the Development of Statistics (NSDS), which envisions the BoS as an autonomous agency. 81. The Government is taking important steps to improve the quality of its statistics. The Government will submit to Parliament amendments to the Statistics Act of 2001, which will grant autonomy to the BoS. In addition, the BoS had drafted a definitions and concepts manual, which harmonized concepts and definitions with international standards. This draft was scheduled to be discussed internally by all the relevant stakeholders by the end of May 2013 and published thereafter. Finally, the BoS is adopting the 2008 System of National Accounts methodology and is moving toward quarterly national accounts. All of these actions are triggers for the next DPOs. DPO 1 Prior Action # 5: The Government has, through its Ministry of Development Planning, submitted to the Ministry of Finance a FY 2013/14 Budget Framework Paper for the Bureau of Statistics. DPO 2 Indicative Trigger #10: The Government through the Bureau of Statistics has published the Definitions and Concepts Manual and has adopted the 2008 System of National Accounts methodology. DPO 3 Indicative Trigger # 12: The Government, through the Ministry of Development Planning, has submitted to its Parliament amendments to the Statistics Act of 2001 that grants autonomy to the BoS. Expected Results at the End of the Program: • BoS proclaimed autonomous agency. • Line ministries use harmonized concepts and definitions. 82. Lesotho does not have a national ID. Currently, the only formal ID is the national passport, available only to a small number of people. The establishment of a national ID system will help improve targeting of service delivery and social transfers, fight fraud, and improve financial services access. In addition, it will help the Government establish the Credit 26 Bureau. The national ID system will be linked to the National Voter’s Registry, the Credit Bureau, the Social Grants Database (NISSA), and the Health Services Database. 83. The Government is working toward establishing a national ID system. The Government has prepared the population registry database and has setup 10 fixed-location registry centers in district capitals and acquired 12 mobile registry centers. The Government will launch the national ID system in early September 2013, and it expects to cover 10 percent of the population by the end of this year. This action is an indicative trigger for the next DPO. The Government will acquire an additional 33 mobile registry centers with the goal of reaching full coverage by 2016. DPO 2 Indicative Trigger # 11: The Government through its Ministry of Home Affairs has rolled out the National ID and covers at least 10 percent of the population. DPO 3 Indicative Trigger #13: The National ID System covers at least 50 percent of the population. Expected Results at the End of the Program: • All the population issued with National ID card. Overall Operation’s Design and Conditionality Principles 84. The proposed operation’s design takes into account good-practice principles on conditionality. These include strong country ownership through close cooperation and technical assistance, close coordination with other development partners (especially the EU and IMF), alignment of the operation with the Government’s reform timetable, and selection of critical structural reforms that will yield medium- to long-term benefits (Box 1). Box 1: Good Practice Principles on Conditionality Principle 1: Reinforce country ownership. • The operation is closely aligned with the Government’s NSDP. • It is accompanied by a program of technical assistance, supporting the Government in the design and implementation of reforms. Principle 2: Agree upfront with the Government and other financing partners on a clear division of labor. • The operation’s policy matrix was developed in close cooperation with the Government and jointly accepted by other key development partners, especially the EU, AfDB, and the IMF. • All donors involved in budget support meet regularly and closely coordinate their support. Principle 3: Customize the components and structure of the operation to country circumstances. • The timing of the operation is aligned with the Government’s reform timetable and financing needs. Principle 4: Choose only actions critical to achieving results as conditions for disbursement. • Three prior actions were selected based on their structural nature and importance for improving the overall business environment. In addition, one trigger was selected to ensure fiscal sustainability. Principle 5: Conduct transparent progress reviews conducive to predictable and performance-based financial support. • In response to the Government’s request, the operation’s timetable would allow for disbursement in CY2013 to help meet the Government’s financing needs. • The operation’s outcome indicators will be jointly monitored by the Government and the Bank. 27 VI. OPERATION IMPLEMENTATION A. Poverty and Social Impact 85. The policy actions supported by this proposed operation are not expected to have any significant negative poverty and social impacts. Actions under Policy Area I, Improving Private Sector Competitiveness, are likely to boost private-sector investment and growth on the medium and long run. This is likely to accelerate poverty reduction. Eiefert (2009) shows in cross-country study that a 10 day reduction in the time to start a business is associated with a 0.3 percentage point increase in the investment rate and a 0.36 percent increase in GDP growth rate. Olinto, Saavedra and Ibarra (2013) estimate the growth elasticity of poverty reduction at 4.5 percent for a country with a poverty rate of 60 percent. Therefore, the investment climate reforms supported by this operation will have an impact on poverty reduction on the medium to the long run. 86. Policy actions under Policy Area II could help reduce poverty. Fiscal consolidation reforms will generate the fiscal space needed to protect the social safety net program in case of an external shock. The financial management reforms will allow the Government to have a better control and management of its resources. Potential savings in the management of the resources could be used improve and expand services in rural areas where poverty is concentrated. 87. Policy actions under Policy Area III are likely to help reduce inequality. Figure 3 shows that the current social assistance programs in the country do not seem to be well targeted. There are more households who reported social assistance as a main income source receiving social assistance in the top two quintiles of the income distribution than there is in the first quintile. Overall, very few households in Lesotho who reported social assistance as a main source of income receive social assistance benefits. Thus, policies to improve the targeting, effectiveness, and efficiency of Lesotho’s social safety net are likely to reduce inequality and help accelerate poverty reduction in the medium run. Figure 3: The incidence of social assistance benefits by income quintile Source: CMS/HBS 2010 88. Consolidating some programs and improving their targeting could help reduce poverty. Redirecting the expenditures on social safety net programs to targeted cash transfer 28 (CCT) programs could reduce Lesotho’s current poverty rate and inequality. As indicated in Figure 4, if all social assistance programs were consolidated into a single CCT program that employs the proxy-means testing method currently employed in the Child Support Programme, the incidence of the social assistance would improve dramatically. Depending on the selection criterion chosen, we would have up to approximately two thirds of individuals in the first two quintiles of the income distribution receiving benefits (instead of only 5 to 6 percent who are currently receiving benefits). Figure 4: The incidence of a Hypothetical CCT by quintile of income distribution if targeted via Proxy-Means Testing Source: CMS/HBS 2010 B. Environmental Aspects 89. The policy actions supported by the proposed operation are not likely to produce significant impacts on the environment, forests, or other natural resources. The investment climate reforms are not likely to have a significant negative effect on the environment. Although the reforms do promote establishment of new firms in Lesotho, strict environmental regulations are in place to mitigate any potential environment degradation. The policies aimed at improving the effectiveness of public spending are not likely to have a positive or negative effect on the environment. Finally, social protection reforms are not likely to have a negative effect on the environment. The Department of Environment formerly known as the National Environment Secretariat (NES) was established in April 1994 and is currently under the Ministry of Tourism, Environment and Culture. The Department of Environment is the lead agency for environmental management and promotes socio-economic and environmental sustainable development. C. Consultation and Participation 90. The Development Policy Operation-supported reform program is envisioned in the NSDP. The strategy was prepared in a participatory process. The former Ministry of Finance and Development Planning (MFDP) prepared the report with assistance from line ministries and development partners. Civil society contributed mainly through cluster groups configured around the NSDP’s strategic pillars. The clusters reviewed the work of the MFDP and the line ministries’ technical teams. The NSDP secretariat consolidated the inputs from 29 the clusters and other stakeholders and prepared a revised document that was adopted by the Cabinet. Thereafter, the Government held consultations at the district level. Lesotho’s development partners were supportive throughout the process, providing technical and financial support. The published NSDP reflects the major issues raised during this process. Furthermore, few additions were made in the strategic actions to reflect the Coalition Manifesto, and the NSDP was presented to the new Cabinet and approved in December 2012. 91. The Government held the fifth Annual Joint Donor Budget Support Review from February 12-14, 2013 in Maseru. Different stakeholders participated, including ministers, principal secretaries of the ministries, directors of Government departments, government officials, members of Parliament, civil society representatives, ambassadors, and officials from development partners the EU, AfDB, WB, IMF, Irish AID, WHO, USAIDS, and UNICEF. The ministries made their presentations and highlighted reforms to be undertaken in the form of achievements and challenges met on the set targets for 2012 and 2013. The principal secretaries chaired the presentations, with the assistance of the department directors. It was an interactive session with open and candid discussions. 92. The Bank presented the reform package supported by this DPO in each session of the fifth Annual Joint Donor Budget Support Review. No negative reactions were received. Participants voiced particularly strong support for reforms in the following areas: public financial management, social protection, private sector competitiveness, and quality of statistics. D. Implementation, Monitoring, and Evaluation 93. The institutional arrangements for implementing the proposed operation fall within the framework of the Joint Budget Support (JBS) structure. The proposed arrangements seek to ensure oversight and buy-in at the political level. A dedicated team of officials from the National Monitoring and Evaluation System (NMES), housed in the MDP, will monitor progress in implementing the overall budget support program. At the ministerial level, dedicated teams of relevant officials responsible for implementation and monitoring of activities 24 will track Performance Assessment Framework (PAF) activities and collect data to verify achievement of PAF indicators and report to the JBS secretariat. The secretariat is headed by the MoF’s principal secretary and will report quarterly to the Improvement and Reform Steering Committee (IRSC). Development partners’ representatives are members of the IRSC, ensuring that they are also aware of implementation progress made between the annual joint reviews. The chairperson of the IRSC will, in turn, report, through the Minister of Finance to the Budget Committee. The MoF’s principal secretary will submit the PAF progress report to the Committee of Principal Secretaries, which is responsible for delivering on these indicators. This will be the forum for initial discussions toward the required remedial actions where problems exist. The MoF’s principal secretary will also pursue these discussions bilaterally with relevant ministries/agencies for implementation of required actions. Briefings to development partners considering budget support will be provided at regular intervals. 24 These teams are from within the ministries responsible for implementation of the PAF activities. 30 94. The PAF will be the basis for the program’s monitoring and evaluation. An annual progress report submitted by the end of January each year will be followed by a joint annual review, based on the PAF, to analyze progress towards agreed targets. The main objective is to come to a joint view on performance, which will serve as the basis for commitments for the next fiscal year. Some DPO indicators differ from those on the PAF, but most of the areas supported by the DPO are monitored through the PAF. Table 4. Prior Actions and Related Operations Supporting its Implementation DPO 1 Prior Action Operation supporting implementation The Government through its Ministry of Trade and Private Sector Competitiveness Loan (P088544). Industry, Cooperatives and Marketing, submitted the Private Sector Competitiveness Loan II (under Industrial Licensing Bill 2012 to its Parliament. preparation). The Government has, through: (a) its Ministry of Lesotho Public Financial Management Reform Finance, submitted the revised Fiscal Year (“FY�) Support Program (P143197, currently under 2009/10 public accounts to the Office of the Auditor preparation). General; and (b) its Office of the Auditor General, published the audit report on the FY2008/09 public EU Budget Support Operation and Capacity Building accounts. Operation (under preparation). The Government has, through its Ministry of Finance, Lesotho Public Financial Management Reform established the Procurement Tribunal and appointed its Support Program (P143197, currently under members. preparation). AfDB Capacity Building Operation (under preparation). The Government has, through its Ministry of Social Technical Assistance to the National Information Development, developed and adopted the National System for Social Assistance (NISSA) (P132159). Information System for Social Assistance (“NISSA�) and is piloting said NISSA through the Child Grants EU and UNICEF operations. Programme. The Government has, through its Ministry of Development Planning, submitted to the Ministry of Finance a FY 2013/14 Budget Framework Paper for First Growth and Competitiveness DPO. the Bureau of Statistics. E. Fiduciary Arrangements 95. The recipient is the Kingdom of Lesotho. The grant is for an amount of 13.4 million SDR (US$20 million equivalent). The closing date for the grant is June 30, 2014. 96. The Public Expenditure and Financial Accountability (PEFA, 2012) report identified a number of strengths and weaknesses of Lesotho’s public financial management (PFM) systems. The PEFA findings confirm that PFM reform in Lesotho to date has been mixed. Most notably, progress has been made in budgeting and macroeconomic forecasting and in the introduction of a new PFM legal framework. In other areas, significant work remains to be done; overall, insufficient attention and resources have been allocated to identifying and resolving bottlenecks. Box 3 summarizes the performance assessment for the key dimensions of budget execution, accounting and reporting, and external scrutiny and audit. The Government publishes in a timely manner, on the Ministry of Finance’s website, both the budget as approved by Parliament as well as the budget proposal. In February 2013, the Government published the FY2012/13 budget proposal in a timely manner on the Government’s portal website: http://www.gov.ls and in printed media. 31 97. The Government and its development partners have committed to a new phase of PFM reforms and have been working together, through the PFM Improvement and Reform Steering Committee (IRSC), on creating a new PFM Action Plan. So far, the approach has involved the Bank, EU, AfDB, and the IMF supporting the Government in developing a future program based on the needed improvements identified in the 2009 (and now 2012) PEFA assessments. The final PFM Action Plan was approved by the IRSC at its March 2013 meeting. 98. About US$20 million has been committed to the implementation of the PFM Action Plan. At present, funding is expected from the EU (approximately 8 million euros, or US$10 million at December 2012 exchange rates), the World Bank (US$5 million) and the AfDB (US$4.2 million). The IMF will provide technical assistance to the Government, in various areas including cash management and budget preparation. The Bank will primarily focus on improving the treasury management function (including IFMIS) and procurement. The Government and its development partners provisionally agreed to these arrangements because of the Bank’s relative strengths and the links to triggers under the DPO series. PFM assistance, however, is subject to further review and discussion among all parties if the available funding from the Bank proves insufficient. 99. The PFM system and planned reforms in the PFM Action Plan provide a sufficient fiduciary basis for the operation. Progress achieved since the inception of PFM reforms as far back as 2006 include: (i) introduction of a level 1 MTEF; (ii) introduction of budget framework papers and program budgeting; (iii) catching up with the public accounts backlog to 2010; (iv) implementation of a new IFMIS; (v) strengthening of internal audit; (vi) setting up of a procurement tribunal; and (vii) launching a PFM professionalization initiative. These actions provide evidence of the Government’s commitment to address its PFM challenges. The recent process to develop, design, and fund a new PFM Action Plan, which now awaits implementation, amounts to further testimony to this commitment. Box 2: Extracts from Draft PEFA Report on Lesotho September 2012 Budget Execution (executive summary paragraph 9) Although there is no systematic forecasting and monitoring of cash flows, spending authorities have had reasonable assurance that cash will be available to meet any commitments within available budgetary provision. The quarterly releases of funds have thus not operated as a constraint on the undertaking of commitments. Payroll controls are weak, and the situation has been made worse by the decentralization of responsibility for controls and reconciliations to the line Ministries. The Procurement Regulations (currently under review) are generally consistent with good international practice, but responsibility for procurement rests with each Ministry, and there is no systematic collection of information which would demonstrate their compliance. The IFMIS includes a commitment control which prevents payment without a purchase order having been introduced into the system. A reasonable set of internal financial controls (the 1973 Finance Regulations, shortly to be replaced by the new draft Treasury Regulations) is in place, but audit reports suggest that they are widely disregarded. Internal audit is improving its coverage and range of work, but needs substantial further development to match best international practice. Accounting and Financial Reporting (executive summary paragraph 10) This was an area of particular concern in the 2009 assessment, and remains so, despite (or because of) the introduction of IFMIS. There is widespread failure to undertake bank reconciliations and to clear suspense accounts and advances. Although IFMIS should make possible the flexible and timely generation of accurate in- year budget execution reports, problems remain in the operation of the system and its interfaces with other databases which cast doubt on the accuracy of the information produced. The most recent published annual financial statements (for 2007-08) were again heavily criticized by the Auditor General, and there is no reason to 32 expect any improvement for 2008-09 for which the audit report has been awaiting tabling in Parliament by the Minister of Finance since March 2012. There is a three year backlog in the production of consolidated financial statements and no statements have been submitted for audit within 15 months of the end of the financial year for many years. No comprehensive information is collected on the resources received (in cash or kind) by service delivery units in any major sector. One good area is that public debt is efficiently managed and records are up-to- date, reliable and reconciled. External Scrutiny and Audit (executive summary paragraph 11) The Office of the Auditor General (OAG) undertakes financial, compliance and performance audits and aims to comply with international standards. But its resources are limited, and it is still treated as a government department, reporting to Parliament through the Ministry of Finance. The new audit law to strengthen the independence of OAG which was foreshadowed in the 2009 assessment has still not been put before Parliament. The delay in the preparation of the government’s financial statements, and thus in the presentation to Parliament of the annual audit reports, deprives audit work of much of its force: findings and recommendations are outdated by the time they are published. OAG’s practice of not publishing any results from current inspection activity until they can be mentioned in an annual audit report on the year in question enables MDAs to ignore their work in the knowledge that there is little risk of public pressure to take remedial action. OAG has begun to undertake performance audits, but the main focus seems still to be on compliance failures rather than on assessing the impact on the efficiency and effectiveness of public services. Parliamentary scrutiny of the annual budget may be seen as adequate, given the limitations of the Westminster model which enables the executive to maintain tight control over the details of budget proposals. Some progress was made during the 2007-12 Parliament in strengthening the work of the Public Accounts Committee (PAC), which with the assistance of OAG was becoming more effective in questioning Chief Accounting Officers (CAOs, i.e. Principal Secretaries of Ministries) about findings in OAG reports. But there is no evidence of PAC reports having much impact on government practices. 100. Fiduciary control weaknesses identified in the 2010 IMF Safeguard Assessment of the Central Bank of Lesotho (CBL) shows improvement in the updated 2012 assessment. The CBL’s 2011 Annual Financial Statements also received an unqualified audit endorsement. F. Disbursement and Audit 101. The proposed operation would consist of a single tranche of SDR 13.4 million (US$20 million equivalent) disbursed against satisfactory implementation of the development policy program. The operation would follow IDA’s disbursement procedures for development policy operations and would not be linked to specific expenditures. Once the Financing Agreement becomes effective and upon receipt of a withdrawal application, the IDA will deposit the proceeds of the grant into an account designated by the Government at the CBL—provided the IDA is satisfied with the program being carried out by the Government and with the appropriateness of the country’s macroeconomic policy framework. The deposit will be part of the country’s foreign exchange reserves. The Government will credit the local currency equivalent in the budget management system using the prevailing exchange rate. As a due diligence measure, the Government will provide IDA with confirmation that the amount of the grant proceeds have been accounted for in the country’s budget management system, with an indication of the exchange rate applied and the date of transfer. The confirmation will be expected within 30 days of disbursement. If the proceeds of the grant are used for excluded expenditures as defined in the Financing Agreement, the IDA will require a direct refund of an amount equal to payment, promptly upon notice from IDA. Amounts refunded to the Bank upon such request shall be cancelled. No dedicated account is required. 33 102. Auditing requirements. The budgeted public expenditures partly financed by the loti equivalent of the grant are subject to external audit by the Auditor-General under the normal auditing arrangements applicable to the Government. The IDA will have access to these audit reports. G. Risks and Risk Mitigation 103. The DPO is subject to three main risks: institutional, political, and economic. 104. On the institutional side, the main risk stems from the weak capacity of Government institutions to implement the reform program. To reduce this risk, the Bank is working with other donors to support the Government’s reform program through technical assistance and ongoing operations. In particular, the Private Sector Competitiveness Loan and the Lesotho-RSA Customs Collaboration Trust Fund are supporting technical assistance in implementing reforms aimed at improving private sector competitiveness, and the Technical Assistance to the National Information System for Social Assistance is supporting reforms aimed to strengthen the social safety net. A proposed Public Financial Management Reform Support Project by the Bank aims to provide technical assistance for implementing reforms in public financial management and public procurement. 105. On the political side, the main risk derives from the Government's ability to approve and complete implementation of the reform program, particularly the private sector competitiveness reforms and fiscal consolidation reforms. The new administration is faced with the challenge of managing a complex multi-party coalition government. This arrangement could limit the Government’s ability to build consensus around reforms that are critical for the sustenance of economic growth and its capacity to mobilize enough political support to implement its programs could be impaired. The new Prime Minister has re- affirmed the Government’s commitment to the strategic objectives of the NSDP and his resolve to improve communication between the Government and citizens, and implement key reforms that will help to mitigate the risks associated with weak institutions and poor governance in the country. The Bank prepared a set of policy notes on the major reform areas that was delivered to the new Government. The Bank will continue to foster policy dialogue using its analytical works, investment operations, and coordination with other development partners. 25 106. On the economic front, the main risk centers on the possibility of another global recession. Under this scenario, Lesotho’s shock-absorption capacity could face important limitations because of much reduced fiscal space, particularly in applying effective countercyclical macroeconomic policies and suitable social safety nets. For Lesotho, the main transmission channels are likely to be the same as they were in the 2008 crisis. First, the United States and South Africa are Lesotho’s largest trade markets, and exports fell significantly. Second, workers’ remittances from abroad amount about 30 percent of GDP, and 90 percent of them originated in South Africa. Like exports, they declined. Third, official development assistance was limited. Fourth, SACU revenue fell significantly. To reduce this risk, the Government has been committed to maintaining macroeconomic stability and preparing for future shocks by strengthening international reserve buffer through fiscal 25 This will include exploring the possibility of mobilizing resources from the Global Partnership for Enhanced Social Accountability (GPESA) to strengthen the capacity of relevant CSOs e.g. NGOs and media etc. 34 consolidation efforts. Currently, the country is under an IMF Extended Credit Facility Program. Predictable and timely budget support will also help mitigate the risk. It will be backed by analytical support and policy dialogue through the DPO series and from other development partners, including the IMF, to aid the Government’s ongoing medium-term fiscal consolidation. 35 ANNEXES Annex 1: Letter of Development Policy 36 37 38 39 40 41 42 43 44 45 46 47 Annex 2: Policy Matrix Medium-term Policy Actions Outcome Objectives Indicators DPO 1 Triggers for DPO 2 Indicative Triggers Baseline 2016 Responsible (Prior Actions ) (Nov. 2013) for DPO 3 (2012) Entity (March 2013) (Nov. 2014) I. Improve Private The Government The Government Sub leases 8 64 Land Sector through the Lesotho through the Lesotho have Administratio Competitiveness Land Authority Land Authority increased n Authority Administration has Administration has (number of submitted to its submitted to its sub leases Parliament Parliament the per year). amendments to the Sectional Titles Bill. Land Act of 2010 to facilitate the use of sub-leases. In particular, the amendments will define the rights of a sub-lessee. The Government The Government Number of 330 240 Ministry of through the Ministry introduces streamlined days to Local of Tourism, procedures to better obtain a Government Environment and integrate approvals construction and Culture has issued from the various permit. Chieftainship regulations and utility bodies prior to Affairs, guidelines to require obtaining building Ministry of environmental permits from the Tourism, impact assessments Maseru City Council. Environment only for and Culture, construction projects and Maseru in industries with City Council high environmental risks. 48 Medium-term Policy Actions Outcome Objectives Indicators DPO 1 Triggers for DPO 2 Indicative Triggers Baseline 2016 Responsible (Prior Actions ) (Nov. 2013) for DPO 3 (2012) Entity (March 2013) (Nov. 2014) The Government, Number of 40 7 Ministry of The Government, through its Ministry of days to Trade and The Government through its Ministry Trade and Industry, register a Industry, through its of Trade and Cooperatives and firm Cooperatives Ministry of Trade Industry, Marketing, submitted and and Industry, Cooperatives and to its Parliament the Number of 1-5 3 Marketing. Cooperatives and Marketing, issued Business Registration days Marketing, the regulations to Bill. required to submitted the implement the obtain Industrial Industrial Licensing manufacturi Licensing Bill 2012 Bill and rolled out ng and to its Parliament. OBFC services in trading Status: Complete. Maputsoe. licenses. Import The Government The Government clearance 4.5 1 Lesotho through its Lesotho started to roll out the (days). Revenue Revenue Authority Preferred Trader Authority has completed the Program and has Preferred Trader adopted an Integrated Export Program Pilot and Border Management clearance 4.7 1 reported on Strategy. (days). recommendations for implementation of the full scheme. 49 Medium-term Policy Actions Outcome Objectives Indicators DPO 1 Triggers for DPO 2 Indicative Triggers Baseline 2016 Responsible (Prior Actions ) (Nov. 2013) for DPO 3 (2012) Entity (March 2013) (Nov. 2014) II. Improve The Government The Government Ministry of Sustainability and through its Ministry through its Ministry of Public Service Efficiency of Public of Public Service Public Service has: i) Spending has reconciled the reconciled the establishment list establishment list with with the payroll in at the payroll in at least least one ministry. two additional ministries; and ii) adopted an action plan based on a study on civil service restructuring. The Government The Government The Government Number of 18 0 Ministry of has, through: (a) through the Office through the Office of months (average) Finance its Ministry of of the Auditor the Auditor General delay in Finance, submitted General publishes publishes the audit publishing the revised Fiscal the audit report on reports on the the audit Year (“FY�) the FY2009/10 FY2010/11 and reports on 2009/10 public public accounts. FY2011/12 public public accounts to the accounts. accounts. Office of the Auditor General; The Government The Government has and (b) its Office of through its Ministry taken actions to the Auditor of Finance has implement the General, published issued the recommendations of the audit report on regulations detailing the Audit Report to the FY2008/09 responsibilities, the Fy2008/09 public public accounts. procedures, controls accounts. and systems Status: Complete covering all stages Reconciled quarterly Timely and No 0 Ministry of of the budget cycle expenditure reports reliable reconciled Finance (as outlined in the are produced from budget quarterly PFM Act of 2011) IFMIS to monitor expenditure expenditur and developed budgetary targets. data from e reports training needed to the IFMIS from 50 Medium-term Policy Actions Outcome Objectives Indicators DPO 1 Triggers for DPO 2 Indicative Triggers Baseline 2016 Responsible (Prior Actions ) (Nov. 2013) for DPO 3 (2012) Entity (March 2013) (Nov. 2014) implement them. IFMIS The Government Medium No Annual Ministry of implements an annual term budget Medium Cycle Finance mid-term budget policy term {Institutio review. statement budget nalized} and a policy medium statement term fiscal and a framework medium approved by term fiscal Cabinet. framework presented to Cabinet. The Government The Government The Government Number of 79 30 Ministry of has, through its through its Ministry through its Ministry of waivers Finance Ministry of of Finance Finance monitors the allowing Finance, publicizes all waivers that allow non- established the tenders and non-competitive competitive Public contracts awarded bidding. bidding Procurement above M100,000 on approved. Tribunal and the web and in appointed its printed media. Number of members. waivers Status: Complete. allowing 23 70 Ministry of non- Finance competitive bidding not approved. III. Improved The Government The Government The Government Number of 6,920 25,000 Ministry of monitoring and has, through its through its Ministry through its Ministry of households Social citizen Ministry of Social of Social Social Development in NISSA Development empowerment to Development, Development, has extended the reached improve access to developed and increase the Childs Grants through the service delivery and adopted the coverage of the Programme by an Childs 51 Medium-term Policy Actions Outcome Objectives Indicators DPO 1 Triggers for DPO 2 Indicative Triggers Baseline 2016 Responsible (Prior Actions ) (Nov. 2013) for DPO 3 (2012) Entity (March 2013) (Nov. 2014) social transfers. National NISSA reached additional 5,000 Grant Information through the Childs households and has Program System for Social Grants Programme rolled out the NISSA Assistance by an additional to include the Public (“NISSA�) and is 5,000 households. Assistance Program. piloting said NISSA through the Child Grants Programme. Status: Complete The Government The Government The Government, Number of 0 14 Bureau of has, through its through the Bureau through the Ministry line Statistics Ministry of of Statistics has of Development ministries Development published the Planning, has using Planning, Definitions and submitted to its harmonized submitted to the Concepts Manual Parliament concepts or Ministry of and has adopted the amendments to the definitions. Finance a FY 2008 System of Statistics Act of 2001 2013/14 Budget National Accounts that grants autonomy Framework Paper methodology. to the BoS. for the Bureau of Statistics. Status: Complete. The Government The National ID Percentage 0 100% Ministry of through its Ministry System covers at least of the Home Affairs of Home Affairs has 50 percent of the population rolled out the population. issued with National ID and National ID covers at least 10 card. percent of the population. 52 Annex 3: Fund Relations Note IMF Executive Board Completes Fourth Review Under Extended Credit Facility Arrangement for the Kingdom of Lesotho, and Approves US$ 8.7 Million Disbursement Press Release No. 12/462 November 27, 2012 The Executive Board of the International Monetary Fund (IMF) today completed the fourth review of the Kingdom of Lesotho's economic performance under a program supported by the Extended Credit Facility (ECF) arrangement. In completing the review, the Board also approved a waiver for the missed continuous cumulative quantitative performance criterion on new nonconcessional external debt contracted or guaranteed by the public sector. The Board's decision will enable an immediate disbursement of an amount equivalent to SDR 5.68 million (US$8.7 million), bringing total disbursements under the arrangement to an amount equivalent to SDR 39.245 million (US$60.2). The three-year ECF arrangement for the Kingdom of Lesotho in an amount of SDR 41.9 million (120 percent of quota) was approved by the IMF’s Executive Board on June 2, 2010 (see Press Release No. 10/224). On April 9 2012, the Board approved an augmentation of access equal to 25 percent of quota, which has led to a total access of SDR 50.605 million (145 percent of quota) in order to cushion the impact of the 2010–11 flood damage and high international commodity prices. Following the Executive Board’s discussion on Lesotho, Mr. Min Zhu, Deputy Managing Director and Acting Chair, issued the following statement: “Lesotho has maintained robust growth despite adverse weather shocks while inflation continues to moderate, partly reflecting easing in international commodity prices. Though international reserves fell as a result of adverse exogenous shocks, strong fiscal adjustment efforts have been made to restore fiscal and external sustainability. Additional donor assistance is being sought to address the weather-related shocks and cushion their impact on the balance of payments. “The 2012/13 budget is appropriately targeted at further increasing the surplus, largely through enhanced tax collection. Further efforts are needed to improve public financial management, while safeguarding critical social and development spending. Considering downside risks associated with the global and regional economic outlook, and given the desirability of maintaining the exchange rate peg, the fiscal consolidation path should be maintained to rebuild international reserves. “The authorities have made further progress in implementing structural reforms to support private sector–led growth and economic diversification, through enacting the new Companies Act and finalizing the Industrial Licensing Bill. These reforms will help to further improve the business climate and boost external competitiveness. 53 “Steps are being taken to develop a sound financial sector. Key measures include adopting regulations for the new Financial Institutions Act, reinforcing the supervisory role of the central bank, and broadening access to financial services. With technical assistance from the Fund and the World Bank, the Central Bank of Lesotho plans to formulate a financial sector development strategy. “Inaccurate data on public sector new nonconcessional external debt, provided for the previous reviews under the ECF arrangement, resulted in noncomplying disbursements. In view of the authorities’ corrective actions taken and planned to strengthen debt management and monitoring, the Board decided to waive the nonobservance of the performance criterion that gave rise to the noncomplying disbursements,� Mr. Zhu added. Contact: Jiro Honda Tel.: (202) 623 4284. 54 Annex 4: Consultations 1. The fifth Joint Annual Review of PAF for General Budget Support was held on 12-14 February, 2013 in Maseru. Participants from different stakeholders included ministers, principal secretaries of the ministries, directors of government departments, government officials, members of Parliament, civil society representatives, ambassadors, and officials from development partners the EU, AfDB, WB, IMF, Irish AID, WHO, USAIDS, and UNICEF. The ministries made their presentations and highlighted reforms to be undertaken in form of achievements and challenges met on the targets set for 2012 and 2013. The principal secretaries chaired the presentation, with the assistance of the directors. It was an interactive session with open and candid discussions. 2. Most of the reforms discussed during the consultations were accepted and in line with Government and development partner milestones. Development partners felt that progress has been slow in the implementation of the PFM reforms. However, all development partners accepted the reforms supported by the DPO. The Government is finalizing a PFM reform action plan, and it will request technical assistance for its implementation from the Bank, EU, IMF, and AfDB. The Bank will provide technical assistance to the new Public Financial Management Reform Support Program (P143197). Progress in implementing the reform package supported by the DPO will depend on timely implementation of the Government’s PFM action plan. 3. The Government mentioned that NISSA marks a great achievement to improve the targeting of social programs. NISSA is a database containing information on about 40,000 households. By using a proxy means test formula, it categorizes these households into five poverty rankings. The Government requested support of all stakeholders so that all social programs could be integrated into the NISSA. Currently, only the Child’s Grant Program is included in NISSA. Development partners and members of civil society strongly supported this initiative. 4. Development partners and civil society supported the Government’s reforms aimed at improving private-sector competitiveness. During the meeting, the group discussed the possibility of including the number of days to obtain a construction permit as a PAF indicator. The Government will consult internally and will get back to the development partners. Finally, none of the stakeholders had an issue with the reforms to the BoS. 55 Annex 5: Country at a Glance Lesotho at a glance 4/24/13 Sub- Lower Key Development Indicators Saharan middle Age distribution, 2010 Lesotho Africa income (2012) Male Female Population, mid-year (millions) 2.2 853 2,519 75-79 Surface area (thousand sq. km) 30 24,243 23,579 60-64 Population growth (%) 1.1 2.5 1.5 45-49 Urban population (% of total population) 27 37 39 30-34 GNI (Atlas method, US$ billions) 2.7 1,004 4,078 15-19 GNI per capita (Atlas method, US$) 1,210 1,176 1,619 GNI per capita (PPP, international $) 1,970 2,148 3,632 0-4 10 5 0 5 10 GDP growth (%) 4.0 4.8 6.9 percent of total population GDP per capita growth (%) 2.9 2.3 5.3 (most recent estimate, 2005–2011) Poverty headcount ratio at $1.25 a day (PPP, %) 43 48 .. Under-5 mortality rate (per 1,000) Poverty headcount ratio at $2.00 a day (PPP, %) 62 69 .. Life expectancy at birth (years) 47 54 65 200 Infant mortality (per 1,000 live births) 65 76 50 180 Child malnutrition (% of children under 5) 17 22 25 160 140 120 Adult literacy, male (% of ages 15 and older) 83 71 80 100 Adult literacy, female (% of ages 15 and older) 95 54 62 80 Gross primary enrollment, male (% of age group) 104 104 110 60 Gross primary enrollment, female (% of age group) 102 95 104 40 20 0 Access to an improved water source (% of population) 85 61 87 1990 1995 2000 2010 Access to improved sanitation facilities (% of population) 29 31 47 L eso tho Su b- Sah a ran Africa a Net Aid Flows 1980 1990 2000 2012 (US$ millions) Net ODA and official aid 93 139 37 257 Growth of GDP and GDP per capita (%) Top 3 donors (in 2010): European Union Institutions 5 14 10 74 8 United States 16 14 1 58 6 Ireland 4 3 9 16 4 Aid (% of GNI) 13.4 15.4 3.6 9.5 2 Aid per capita (US$) 72 87 19 118 0 Long-Term Economic Trends -2 95 05 Consumer prices (annual % change) -84.9 11.4 6.3 5.6 GDP implicit deflator (annual % change) -31.5 12.6 3.9 5.5 GD P GD P pe r ca pi ta Exchange rate (annual average, local per US$) 0.8 2.6 6.9 8.5 Terms of trade index (2000 = 100) .. 72 100 172 1980–90 1990–2000 2001–12 (average annual growth %) Population, mid-year (millions) 1.3 1.6 2.0 2.2 2.1 2.0 1.0 GDP (US$ millions) 431 545 771 2,448 4.2 3.8 3.8 (% of GDP) Agriculture 22.4 24.7 11.9 8.1 -0.2 2.1 -0.2 Industry 24.2 34.1 30.5 33.9 8.7 7.4 5.9 Manufacturing 7.7 14.5 13.5 12.0 9.7 7.0 6.7 Services 53.4 41.1 57.6 58.8 3.4 3.3 3.9 Household final consumption expenditure 142.1 123.1 120.9 90.8 7.9 -0.2 2.8 General gov't final consumption expenditure 10.0 25.6 35.4 38.1 10.0 15.0 3.6 Gross capital formation 37.0 55.7 43.5 31.8 4.0 3.4 3.8 Exports of goods and services 21.0 18.0 34.8 46.5 8.0 13.3 10.3 Imports of goods and services 110.1 122.4 134.7 108.0 11.7 1.1 4.1 Gross savings 71.8 39.3 6.7 18.9 Note: Figures in italics are for years other than those specified. 2011 data are preliminary. .. indicates data are not available. a. Aid data are for 2010. Development Economics, Development Data Group (DECDG). 56 Lesotho Balance of Payments and Trade 2000 2012 Governance indicators, 2000 and 2010 (US$ millions) Total merchandise exports (fob) 212 1,062 Voice and accountability Total merchandise imports (cif) 769 2,232 Net trade in goods and services -516 -1,170 Political stability and absence of violence Current account balance -153 -258 Regulatory quality as a % of GDP -19.9 -10.6 Rule of law Workers' remittances and compensation of employees (receipts) 478 746 Control of corruption Reserves, including gold 459 970 0 25 50 75 100 Country's percentile rank (0-100) Central Government Finance 2 01 0 2 00 0 higher values imply better ratings (% of GDP) Source: Worldwide Governance Indicators (www.govindicators.org) Current revenue (including grants) 47.6 65.5 Tax revenue 36.0 23.5 Current expenditure 44.9 39.0 Technology and Infrastructure 2000 2010 Overall surplus/deficit -8.3 4.8 Paved roads (% of total) 18.3 .. Highest marginal tax rate (%) Fixed line and mobile phone Individual .. .. subscribers (per 100 people) 2 47 Corporate .. .. High technology exports (% of manufactured exports) 0.3 0.2 External Debt and Resource Flows Environment (US$ millions) Total debt outstanding and disbursed 677 874 Agricultural land (% of land area) 77 77 Total debt service 62 55 Forest area (% of land area) 1.4 1.4 Debt relief (HIPC, MDRI) – – Terrestrial protected areas (% of land area) 0.5 0.5 Total debt (% of GDP) 87.7 35.7 Freshwater resources per capita (cu. meters) 2,602 2,433 Total debt service (% of exports) 11.3 5.1 Freshwater withdrawal (billion cubic meters) .. .. Foreign direct investment (net inflows) 118 201 CO2 emissions per capita (mt) .. .. Portfolio equity (net inflows) 0 0 GDP per unit of energy use (2005 PPP $ per kg of oil equivalent) .. 142.1 Composition of total external debt, 2011 Energy use per capita (kg of oil equivalent) .. 9 Private, 12 IBRD, Short-term, 0 1 Bilateral, 62 World Bank Group portfolio 2000 2012 IDA, 322 (US$ millions) Other multi- lateral, 315 IBRD Total debt outstanding and disbursed 59 0 Disbursements 10 0 IMF, 80 Principal repayments 4 1 Interest payments 3 1 US$ millions IDA Total debt outstanding and disbursed 183 316 Disbursements 8 3 Private Sector Development 2000 2012 Total debt service 4 11 Time required to start a business (days) – 24 IFC (fiscal year) Cost to start a business (% of GNI per capita) – 13.0 Total disbursed and outstanding portfolio 0 0 Time required to register property (days) – 101 of which IFC own account 0 0 Disbursements for IFC own account 0 0 Ranked as a major constraint to business 2000 2012 Portfolio sales, prepayments and (% of managers surveyed who agreed) repayments for IFC own account 0 0 Access to/cost of financing 54.1 .. Crime 45.9 .. MIGA Gross exposure 24 – Stock market capitalization (% of GDP) .. .. New guarantees 0 0 Bank capital to asset ratio (%) 17.0 8.4 Note: Figures in italics are for years other than those specified. 2011 data are preliminary. 4/24/13 .. indicates data are not available. – indicates observation is not applicable. Development Economics, Development Data Group (DECDG). 57 Millennium Development Goals Lesotho With selected targets to achieve between 1990 and 2015 (estimate closest to date shown, +/- 2 years) Lesotho Goal 1: halve the rates for extreme poverty and malnutrition 1990 1995 2000 2012 Poverty headcount ratio at $1.25 a day (PPP, % of population) .. 46.2 .. .. Poverty headcount ratio at national poverty line (% of population) .. 66.6 .. 57.1 Share of income or consumption to the poorest qunitile (%) .. 1.5 .. .. Prevalence of malnutrition (% of children under 5) 13.8 .. 15.0 16.6 Goal 2: ensure that children are able to complete primary schooling Primary school enrollment (net, %) 71 68 76 73 Primary completion rate (% of relevant age group) 58 64 60 70 Secondary school enrollment (gross, %) 25 30 30 46 Youth literacy rate (% of people ages 15-24) .. .. 91 92 Goal 3: eliminate gender disparity in education and empower women Ratio of girls to boys in primary and secondary education (%) 124 115 107 106 Women employed in the nonagricultural sector (% of nonagricultural employment) .. 52 51 .. Proportion of seats held by women in national parliament (%) .. 5 4 24 Goal 4: reduce under-5 mortality by two-thirds Under-5 mortality rate (per 1,000) 89 99 127 85 Infant mortality rate (per 1,000 live births) 72 77 88 65 Measles immunization (proportion of one-year olds immunized, %) 80 83 74 85 Goal 5: reduce maternal mortality by three-fourths Maternal mortality ratio (modeled estimate, per 100,000 live births) 370 340 470 530 Births attended by skilled health staff (% of total) .. 50 60 62 Contraceptive prevalence (% of women ages 15-49) 23 29 30 47 Goal 6: halt and begin to reverse the spread of HIV/AIDS and other major diseases Prevalence of HIV (% of population ages 15-49) 0.8 14.3 24.5 23.6 Incidence of tuberculosis (per 100,000 people) 184 323 553 633 Tuberculosis case detection rate (%, all forms) 84 89 90 85 Goal 7: halve the proportion of people without sustainable access to basic needs Access to an improved water source (% of population) 61 64 74 85 Access to improved sanitation facilities (% of population) 32 31 29 29 Forest area (% of land area) 1.3 .. 1.4 1.4 Terrestrial protected areas (% of land area) 0.5 0.5 0.5 0.5 CO2 emissions (metric tons per capita) .. .. .. .. GDP per unit of energy use (constant 2005 PPP $ per kg of oil equivalent) .. .. .. 142.1 Goal 8: develop a global partnership for development Telephone mainlines (per 100 people) 0.8 1.0 1.1 1.8 Mobile phone subscribers (per 100 people) 0.0 0.0 1.1 45.5 Internet users (per 100 people) 0.0 0.0 0.2 3.9 Computer users (per 100 people) .. .. .. .. Education indicators (%) Measles immunization (% of 1-year olds) ICT indicators (per 100 people) 125 100 50 100 40 75 75 30 50 50 20 25 25 0 10 2000 2005 2010 0 0 1990 1995 2000 2010 2000 2005 2010 Pri ma ry ne t en rol lm en t ra tio L eso tho Su b- Sah a ran Africa Fix ed + mo bi le sub scr ib ers Inte rne t use rs R atio of gi rls to bo ys in pri ma ry & se con d ary e du ca tio n Note: Figures in italics are for years other than those specified. .. indicates data are not available. 4/24/13 Development Economics, Development Data Group (DECDG). 58 Annex 6: Fiscal Sustainability Analysis The fiscal sustainability analysis presented in this annex is based on the macroeconomic framework summarized in Table 2 of this program document. The projected figures differ slightly from those presented in Table 2 because of the following reasons: (i) real exchange rate is assumed to stay unchanged; and (ii) seigniorage revenues are assumed to be zero over the projection period. This analysis has been carried out on Lesotho’s fiscal rather than a calendar year which began on April1st. Lesotho’s debt ratios are projected to change slightly from the levels ascertained in the joint Bank-IMF DSA carried out last year, reflecting the fact that Southern African Customs Union (SACU) revenues are projected to recover and the country’s fiscal position will improve. Lesotho’s public debt is particularly vulnerable to adverse global or regional shocks affecting the exchange rate. 1. Lesotho’s public debt is mainly external (83 percent of total debt). Domestic debt corresponds to about 17 percent of total debt. As of June 2012, US$780 million of the total public sector debt was owed to external creditors, primarily multilaterals (US$745.3 million), and mainly IDA and the African Development Fund. Public domestic debt held by residents amounted to US$166.1 million at the end of March 2012, and was composed of Treasury bills and Treasury bonds. Table A1. Lesotho: Public debt outstanding at the end of June 2012 In millions of Maloti In millions of USD Total public debt 7,677 997 Domestic debt 1,279 166.1 Banks 1,158 150.4 Non-banks 120 15.6 External 6,398 831 Of which Multilateral 5,739 745.3 Concessional 5,443 706.9 Non-concessional 297 38.6 Bilateral 261 33.9 Concessional 261 33.9 Non-concessional 0 Note: Domestic debt stock is as of March 2012. Source: Ministry of Finance 2. The baseline scenario below is based on the following macroeconomic projections and assumptions. Output growth reached 6.8 percent in FY2010/11, 5.4 percent in FY2011/12, and is estimated to reach 3.6 percent in FY2012/13. Inflation (as measured by the implicit GDP deflator) is assumed to move from an average of 6.8 percent over the past 10years (elevated in part by the food and energy price shocks in 2007–08) to 7.9 percent between FY2012/13 and FY2017/18—in line with projected consumer price inflation in South Africa. Fiscal performance in FY2010/11 was stronger than envisaged under the IMF’s ECF program, reflecting strong revenue performance, boosted by windfall revenues and a large dividend payment by the central bank, and expenditure containment. 59 SACU payments are estimated to recover to 28.9 percent of GDP in FY2012/13, and are projected to stabilize around 21 percent of GDP in the medium term. The fiscal deficit reached 10.2percent of GDP in FY2011/12 and is estimated at 4.9 percent of GDP for FY2012/13. The fiscal balance is estimated to have turned into a surplus of 5.6 percentage points of GDP inFY2012/13. This balance is expected to stabilize at around 3 percentage points of GDP in the medium-run. The external current account position deteriorated to an estimated deficit of 10.6 percent of GDP in FY2012/13 due to a widening of the trade deficit. The current account deficit is expected to increase to 14.1 percent in FY2013/14 and then narrow over the medium term, supported by strong export performance in the mining sector and slow import growth as a result of the fiscal adjustment. The current account is projected to fall to 4.3 percent of GDP in FY2017/18. Reserve coverage is projected to stabilize at about five months of imports of goods and services in the medium term. 3. The public external debt-to-GDP ratio is projected to remain on a downward path in the medium term. This ratio is estimated to have reached 37.7 percent in FY2012/13, and it is projected to fall gradually over the medium term to reach 32.5 percent at the end of FY2017/18. The ratio of debt service to exports is expected to remain stable at around 2.5 percent of GDP between FY2013/14 and FY2017/18; this ratio would remain well below the indicative thresholds due to the highly concessional nature of existing debt. 4. Lesotho’s total public debt is also projected to stay on a sustainable path from FY2012/13 to FY2017/18. Under the baseline scenario, the public debt-to-GDP ratio will gradually decline from an estimated 43.1 percent in FY2012/13 to about 32.5 percent at the end of FY2017/18. A stronger fiscal adjustment would lead to a sharper reduction in the public debt ratio. Under a scenario where the primary surplus stays at its estimated FY2012/13 level of 5.6 percent of GDP, the public debt-to-GDP ratio would fall to almost 29.1 percent. 5. Although the public debt outlook under the baseline scenario looks fairly stable, there are still potential risks that could arise in the medium term. To examine the potential implication of these risks, Table A2 presents the projected debt dynamics under a number of pessimistic alternative scenarios: • Under higher average real interest rates for public debt over FY2013/14-FY2014/15 (Scenario B1), the projected debt ratio for FY2014/15 would be 2.9 percentage points higher than under the baseline scenario. • Under a less optimistic scenario for growth at the baseline minus two standard deviations (Scenario B2), the projected debt ratio would be 2.3 percentage points higher than under the baseline scenario in FY2017/18. • Assuming a looser fiscal policy (Scenario B3) with a primary deficit of 12.3 percent of GDP over FY2013/14-FY2014/15 instead of an average primary surplus of 2.7 percent of GDP under the baseline scenario, the projected debt ratio would be 14.5 percentage points higher than under the baseline scenario in FY2017/18. • Under a scenario of simultaneous shocks in which GDP growth, the primary balance, and real interest rates are affected (Scenario B4), the projected debt ratio would reach 60 46.3 percent in FY2017/18 or 13.8 percentage points higher than in the baseline scenario. Such a shock is projected to place the public debt ratio on an upward trend until FY2015/16, slowly stabilizing thereafter. Table A2: Lesotho Public Debt to GDP Simulations 2012 2013 2014 2015 2016 2017 Baseline 43.1 41.2 39.9 37.4 35.2 32.5 Key variables are at their historical averages in 2013/14-14/15 43.1 41.4 40.0 37.5 35.0 31.8 B1. Real interest rate is at historical average plus two standard deviations in 2013/14-14/15 43.1 42.8 42.8 40.3 37.9 34.9 B2. Real GDP growth is at historical average minus two standard deviations 2013/14-14/15 43.1 42.7 42.7 40.2 37.8 34.8 B3. Primary balance is at historical average minus two standard deviations in 2013/14-14/15 43.1 56.3 55.0 52.2 49.9 47.1 B4. Combination of 1-3 using one standard deviation shocks 43.1 51.6 54.3 51.5 49.2 46.3 B5. One time 30 percent real depreciation in 2013/14 43.1 55.8 53.8 50.6 47.5 43.9 B6. 10 percent of GDP increase in other debt-creating flows in 2013/14 43.1 41.2 39.9 37.3 34.9 31.9 6. Lesotho’s public debt is considerably vulnerable to exchange-rate changes. That’s not surprising because Lesotho’s public debt is largely denominated in foreign currency. A one-time 30 percent real maloti depreciation in FY2013/14 would result in a public debt-to-GDP ratio as high as 56 percent. Although it is projected to move downward after FY2013/14, the debt ratio would stay around 44 percent at the end of FY2017/18—a level almost 11.5 percentage points above the baseline level. 7. Additional external borrowing or a fall in SACU revenues could reverse the projected downward trend of the public debt ratio. The team has constructed an alternative scenario characterized by an additional external borrowing amounting to a total of 20 percentage points of GDP in 2013/14 and 2014/15. Under such scenario the debt ratio reaches 48.5 percent, close to its 2008 level. In another scenario the team considered a decline in SACU revenues. The scenario takes into account the volatility of SACU revenues in the past. In particular the volatile component of SACU revenues is assumed to be zero over the projection period. Under this scenario the budget may run a deficit, amounting to 7.6 percentage points of GDP, and the public debt ratio moves on an upward trend, reaching 59 percent in 2017/18. 8. Stochastic simulations assign a low probability to a sharp increase in the debt ratio. Stochastic simulations produce confidence intervals for public debt ratios that correspond to varying degrees of uncertainty for four key macroeconomic variables: (i) domestic interest rates, (ii) the growth rate, (iii) the exchange rate, and (iv) the foreign interest rate. Keeping the fiscal assumptions under the baseline scenario, there is a 97.5 percent probability that the public debt-to-GDP ratio will remain between 32 and 52 percent during the projection period (Figure A1). In addition, there is a 95 percent probability that the ratio will stay below 50 percent over the projection period. 61 Figure A1: Public Debt-to-GDP Ratio (Stochastic simulations) 60 50 40 30 20 10 0 2012 2013 2014 2015 2016 2017 2018 Source: Staff projections Table A3. Public Sector Debt Sustainability Framework, FY2009/10-FY2017/18 (In percent of GDP, unless otherwise indicated) 2009 2010 2011 2012 2013 2014 2015 2016 2017 Baseline Projections Public sector debt 36.9 34.4 37.8 43.1 41.2 39.9 37.4 35.2 32.5 o/w foreign-currency denominated (gross) 33.5 29.7 32.2 37.7 36.5 35.8 33.9 31.9 29.9 Change in public sector debt -13.7 -2.6 3.5 5.2 -1.9 -1.2 -2.5 -2.2 -2.7 Identified debt-creating flows -6.9 -0.7 7.1 -3.8 -1.9 -1.2 -2.5 -2.2 -2.7 Primary deficit 3.9 5.0 9.4 -5.6 -2.8 -2.6 -3.8 -3.8 -4.5 +Automatic debt dynamics: -10.8 -5.7 -2.3 1.8 -2.1 -1.6 -1.7 -1.4 -1.2 Residual, including asset changes -6.8 -1.8 -3.6 9.0 0.0 0.0 0.0 0.0 0.0 Key Macroeconomic and Fiscal Assumptions Real GDP growth (in percent) 4.7 6.8 5.4 3.6 4.4 4.2 4.0 4.0 4.0 Average nominal interest rate on public debt (in percent) 1.6 1.8 2.6 2.3 2.1 2.5 2.3 2.7 2.7 Inflation rate (GDP deflator) 3.9 4.6 7.5 5.5 10.7 7.5 8.7 7.4 7.8 Primary deficit 3.9 5.0 9.4 -5.6 -2.8 -2.6 -3.8 -3.8 -4.5 Source: Staff projections 62 FISCAL SUSTAINABILITY FRAMEWORK 9. The level of public debt is said to be sustainable whenever it does not exceed the present value of future primary surpluses. In simple terms, an upward trend in public debt-to-GNP ratio is regarded as a signal of unsustainability. The deterministic models of fiscal sustainability are based on some accounting identities. The first step of the analysis is to produce a baseline scenario projection for the public debt-to-GNP ratio based on some specific macroeconomic and fiscal policy forecasts. The next step is to conduct stress tests to determine the debt ratio’s bounds under less favorable assumptions. A declining trend in the debt ratio is deemed favorable for sustainability, but judgment critically depends on the soundness of the underlying forecasts of the key macroeconomic variables. Although the analysis is practical and the interpretation of its results is quite straightforward, the framework has many shortcomings. The main drawback is the failure to account for interaction among the variables; a shock to a specific variable is assumed to have no repercussions on other key variables. This implies that the final impact could underestimate a shock on the debt ratio. 10. An alternative approach to fiscal sustainability is utilizing a stochastic simulation tool. 26 This framework takes the interactions among key variables into account, contrary to the deterministic approach. The common practice is to estimate a VAR model to obtain the correlation matrix of the key macroeconomic variables assumed to have an impact on the debt ratio. The next step is to use these correlations to carry out Monte Carlo simulations with an aim of generating a large sample of bound tests. As a result, frequency distributions of the debt ratio can be derived for each projection year, which provides a probabilistic assessment of debt sustainability. The goal of the analysis is not to determine the path of the public debt ratio but to produce “fan charts� that display confidence bands for varying degrees of uncertainty around a median projection. More simply, the analysis produces the probability that the simulated debt ratio exceeds a certain level. 11. This methodology developed by Bandiera et al (2006) aims at determining how the interaction amongst the key variables in the fiscal sustainability analysis takes place. 27 The key variables that are assumed to have significant impacts on the public debt ratio are : (i) the real interest rate on foreign and domestic debt, (ii) real GDP growth rate, and (iii) the change in the real exchange rate. The analysis then carries out Monte Carlo simulations to generate random numbers for these four key variables, each of which has a standard normal distribution. Finally, shocks are created for these variables, with a joint distribution given by the estimated covariance matrix. The results of the simulations are summarized in the fan charts, which represent the frequency distribution of the public debt paths generated by the simulations. 26 See for example, Celasun et al. (2007) IMF Staff Papers, Vol. 53, No.3 27 See Bandiera, Budina, Klijn, and Wijnbergen (2006) for details. 63 IBRD 33434 L E S O TH O SELECTED CITIES AND TOWNS MAIN ROADS LESOTHO DISTRICT CAPITALS RAILROADS NATIONAL CAPITAL DISTRICT BOUNDARIES RIVERS INTERNATIONAL BOUNDARIES 27°E 28°E 29°E S OU TH AF R I C A on To Caled Fouriesburg Libono Mont-aux- Sources (3,282 m) Butha-Buthe To Senekal BUTHA- Leribe BUTHE Maputsoe To Clocolan Peka LERIBE 29°S 29°S Pitseng Mapoteng Njesuthi MOKHOTLONG (3,446 m) Teyateyaneng . tns To Makheka Ladybrand (3,461 m) BEREA M Mokoeng ti a lu Mokhotlong Thaba- MASERU Machache M Phafane Thabana ge Mazenwood (2,885 m) (3,250m) Ntlenyana s . O ra n 3,482 m) tn e ar Roma M ok oh M Seqoqo g Thaba-Tseka (3,394 m) b er MASERU ns Mantsonyane Ranko THABA-TSEKA e Matsieng ak To Mashai Dr Himeville To Thaba Dewetsdorp Putsoa MAFETENG (3,095 m) Semonkong Mafeteng Sehlabathebe Tsoloane Sekake Q A C H A’ S N E K 30°S To ng e 30°S Zastron MOHALE’S Ora Qacha’s HOEK Nek To Matatiele Mohale’s Hoek To To Matatiele Zastron Mekaling Mount Moorosi QUTHING Quthing To Sterkspruit SO UT H A FRICA Sinxondo This map was produced by the Map Design Unit of The World Bank. The boundaries, 0 10 20 30 40 50 Kilometers colors, denominations and any other information shown on this map do not imply, on the part of The World Bank 0 10 20 30 Miles Group, any judgment on the legal status of any territory, or any endorsement or acceptance of such 27°E 28°E 29°E boundaries. SEPTEMBER 2004