Maseru: Lesotho is grappling with a challenging economic landscape marked by low growth, high unemployment, and widespread poverty. The nation's government-led growth model has long struggled to meet its growth and development goals. Now, external shocks have further complicated the economic outlook. GDP growth is projected to decline from 2.6 percent in FY24/25 to 1.4 percent in FY25/26 due to a turbulent and uncertain external environment. The peg to the Rand has helped reduce inflation from 8.2 percent in early 2024 to 4.0 percent in April 2025.
According to African Press Organization, prudent government spending during FY24/25, supported by South African Customs Union (SACU) transfers and water royalties, resulted in a significant fiscal surplus. This surplus has enhanced fiscal sustainability and strengthened foreign reserves, supporting the currency peg. Increased water royalties from South Africa are expected to further boost revenue, offsetting any reduction in SACU transfers.
The primary challenge for Lesotho's authorities is to translate fiscal surpluses into sustainable, high-quality growth, especially given recent economic shocks. Public funds need to be saved wisely and invested strategically in high-return projects. Effective use of public funds and structural reforms should support longer-term private sector-led growth.
Lesotho's fiscal balance experienced a substantial surplus in FY24/25. SACU transfers increased by almost 14 percent of GDP compared to FY23/24, while recurrent spending remained steady due to a hiring moratorium and reduced social assistance benefits. Despite increased capital spending, execution fell short of budgeted levels, resulting in a fiscal surplus of 9.0 percent of GDP in FY24/25. This surplus helped raise gross international reserves to cover six months of imports, strengthening the currency peg. With reduced domestic debt issuance, clearance of domestic arrears, and repayment of an IMF arrangement under the Rapid Financing Facility, public debt decreased to 56.6 percent of GDP in FY24/25, down from 61.5 percent in FY23/24.
However, global uncertainty has weakened Lesotho's economic outlook, with growth expected to halve to 1.4 percent in FY25/26. The U.S.'s sudden policy shifts on tariffs and official development assistance (ODA) will significantly impact the economy. As a small, vulnerable country, Lesotho is highly exposed to changing U.S. priorities. Exports to the U.S. account for 10 percent of Lesotho's GDP, and U.S. foreign assistance typically represents around 3½ percent of GDP, primarily focused on disease prevention and critical health needs.
Looking ahead, Lesotho has options. While SACU transfers are expected to decrease to their long-term average (down 6 percentage points to less than 20 percent of GDP), renegotiated water royalty rates under the Treaty with South Africa on the LHWP-II represent a significant source of revenue, rising to nearly 13 percent of GDP in FY25/26 and stabilizing at around 10 percent of GDP over the medium term. Consequently, domestic revenues are projected to increase by 8-10 percent of GDP compared to a few years ago. The peg to the Rand remains crucial for monetary policy, with policy rates closely following South African rates. The central bank should use the current easing cycle to close the gap with South Africa.
The key challenge for authorities is to convert Lesotho's fiscal surpluses into sustained, high-quality growth. Past experiences show that increased public spending does not guarantee higher living standards. Government spending in Lesotho exceeds international norms, more than doubling the SACU average. However, this spending hasn't translated into improved economic performance. Real per capita incomes declined by 12 percent between 2016 and 2023, while unemployment and inequality remain high. Authorities must ensure that this time is different, with funds saved wisely and spent strategically.
Greater savings require ongoing fiscal prudence. Authorities should continue efforts to control recurrent spending and enhance tax revenue analysis and administration. The wage bill, the highest among SACU members and triple the sub-Saharan African average, should be contained. Authorities should focus on establishing a performance-based public employment system that rewards productivity and ensures better delivery of public services.
Improvements in tax policy design and administration are also crucial. The Tax Policy Unit, supported by IMF assistance, should strengthen its capacity to forecast revenue accurately and improve tax system design. A phased reform strategy is being implemented for tax administration, addressing identified deficiencies.
Enhancing the efficiency of social spending is vital to target the most needy. Social spending, as a share of GDP, is significantly higher than in neighboring countries. Authorities should improve the targeting of social safety schemes, such as the tertiary loan bursary fund education scheme, to free resources for the most vulnerable and enhance Lesotho's resilience to new shocks. The government should take proactive measures to address potential disruptions in services due to cuts in U.S. assistance and develop a coordinated plan to ensure essential health services continue.
Authorities should establish a well-governed savings framework, such as a stabilization fund, to ensure stable government funding and uninterrupted service delivery amid shocks. This fund can finance future development spending, like infrastructure investment. The fund should be anchored by a clear fiscal rule, set within a firm legal framework, and governed independently from political influence.
A target for Lesotho's public debt should be a key anchor within the savings framework. Debt has trended upward, rising sharply during the COVID-19 pandemic. Although the recent decline is welcome, the IMF's Debt Sustainability Analysis suggests that the risk of debt distress remains moderate, with little room to absorb further shocks. Authorities should aim for a medium-term public debt goal of 50 percent of GDP to enhance resilience. This entails scaling back new borrowing and considering retiring existing high-cost debt.
Improved public investment management is needed to enhance capital spending quality. Authorities should establish controls to ensure value for money in investment projects. Historically, high public investment levels in Lesotho have not resulted in a capital stock of equal quality. Authorities should boost public investment efficiency by creating a centralized asset registry, establishing a prioritized project pipeline, and enhancing project management and monitoring capacity. The request for a Public Investment Management Assessment from the IMF is timely.
Enhancing Public Financial Management (PFM) is crucial to ensure value for money. Authorities must strengthen budget preparation and execution to enhance budget credibility, improve expenditure control, and conduct regular audits. Implementing the Medium-Term Expenditure Framework will align policy objectives with budget allocations over a multi-year timeframe.
Strengthening internal controls within the integrated financial management system is essential. Authorities should expedite digital signature deployment to strengthen payment processes and prevent arrears accumulation. Comprehensive fiscal risk analysis and management are also necessary, given recent fiscal risks, such as collapsed public-private partnerships and unquantified arrears.
Pending PFM legislation, including the Public Financial Management and Accountability Bill, Public Debt Management Bill, and secondary legislation to implement the 2023 Public Procurement Act, should be passed promptly. This legislation will improve procurement efficiency, fiscal responsibility, and budget processes, strengthening financial management and fiscal reporting.
Improved public investment must be accompanied by structural reforms to support private-sector growth. Authorities should accelerate efforts to unlock the private sector's growth potential, addressing access to finance challenges for small and informal firms. The new Financial Sector Development Strategy and National Financial Inclusion Strategy should be implemented swiftly.
Authorities should also provide a stable, predictable, and well-regulated business environment, reducing the cost of doing business and boosting private investor confidence. Efforts should focus on coordinating the Lesotho National Development Corporation and the Basotho Enterprise Development Corporation and enhancing the regulatory framework for state-owned enterprises.
Mitigating corruption and strengthening the rule of law is essential to restoring confidence, investment, and growth. Authorities should strengthen key bodies, such as the Office of the Auditor General and the Directorate on Corruption and Economic Offences, to incentivize private sector development. The increased funding and expansion of the DCEO is a positive development.