Source: APO

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• Against a backdrop of low growth, high unemployment, and widespread poverty, Lesotho’s government-led growth model has long struggled to deliver on the authorities’ growth and development goals. Now, an additional set of external shocks has further clouded the outlook. From a modest peak of 2.6 percent in FY24/25, GDP growth is expected to almost halve to 1.4 percent in FY25/26, reflecting a much more turbulent and uncertain external environment. The peg to the Rand has continued to serve Lesotho well, helping bring inflation down from a peak of 8.2 percent in early 2024 to 4.0 percent in April 2025.
• Prudent government spending during FY24/25, along with buoyant South African Customs Union (SACU) transfers and water royalties have once again resulted in a sizable fiscal surplus. This has enhanced longer-term fiscal sustainability and helped strengthen foreign reserves, which supports the peg. Looking forward, increased water royalties from South Africa will further boost revenue, and help offset easing SACU transfers.
• The main challenge for the authorities is to transform these fiscal surpluses into sustainable and high-quality growth — now even more urgent in light of recent shocks. Public funds should be saved wisely and spent strategically, with an emphasis on high-return investment projects. More effective use of public funds, alongside structural reforms, should support longer-term private sector-led growth.

An International Monetary Fund (IMF) team led by Mr. Andrew Tiffin held meetings in Maseru with the authorities of Lesotho and other counterparts from the public and private sectors and civil society from June 4 to 17, 2025, as part of the 2025 Article IV consultation. Discussions focused on the mix of fiscal and monetary policies to ensure macroeconomic stability and debt sustainability, as well as the structural reforms needed to create jobs, reduce poverty, and facilitate the transition to private-sector-led growth.

Context and Outlook

IMF staff estimates suggest that real GDP growth picked up modestly in FY24/25 to 2.6 percent, up from 2.0 percent the previous year. In large part, this reflects spillovers from the Lesotho Highlands Water Project (LHWP-II), which has helped offset declining competitiveness in the apparel sector and the impact on exports of lower diamond prices. Headline inflation was 4.0 percent in April, down from a peak of 8.2 percent in January 2024. The gap between CPI inflation in Lesotho and South Africa mainly reflects the larger share of food in Lesotho’s CPI basket.

Lesotho’s fiscal balance registered a sizable surplus in FY24/25. South African Customs Union (SACU) transfers are up by almost 14 percent of GDP compared with FY23/24, and recurrent spending has remained steady as a proportion of GDP, owing to a moratorium on public sector hiring and a reduction in the in-kind social assistance benefits. Capital spending increased but execution remained short of budgeted levels. The net impact has been a fiscal surplus of 9.0 percent of GDP in FY24/25, which helped lift gross international reserves to 6 months of imports; strengthening the peg. With less issuance of domestic debt, clearance of domestic arrears, and repayment of an IMF arrangement under the Rapid Financing Facility, public debt fell to 56.6 percent of GDP in FY24/25, down from 61.5 percent in FY23/24.

However, a more uncertain global environment has undermined Lesotho’s economic outlook, with growth expected to almost halve to 1.4 percent in FY25/26. In particular, the sudden shift in policies by the United States on tariffs and official development assistance (ODA) will hit the economy hard. Details of US intentions are still unclear, but as a small and vulnerable country, Lesotho is one of the most exposed countries in Africa to changing US priorities. Exports to the United States represent 10 percent of Lesotho’s GDP, and foreign assistance from the United States has typically amounted to around 3½ percent of GDP, mostly concentrated on disease prevention and other critical health needs.

Looking ahead, Lesotho has options. SACU transfers are expected to drop to their long-term average this year (down 6 percentage points to less than 20 percent of GDP). Filling the gap, however, renegotiated water royalty rates under the Treaty with South Africa on the LHWP-II represent a significant source of revenue—rising to almost 13 percent of GDP in FY25/26 and then settling at around 10 percent of GDP every year over the medium term. In sum, domestic revenues are expected to be around 8-10 percent of GDP higher than just a few years ago. On the monetary side, the peg to the Rand continues to serve the economy well and should remain the main focus of monetary policy. Policy rates should continue to follow South African rates closely. The central bank should take advantage of the current easing cycle to close the remaining gap with South Africa.

The key challenge for the authorities is to transform Lesotho’s fiscal surpluses into sustained, high-quality growth. A striking lesson from the country’s recent history, however, is that greater public spending is no guarantee of higher living standards. As a proportion of GDP, for example, government spending in Lesotho is well above international norms—more than double the SACU average. But this has not been matched by improved economic performance. Indeed, real per capita incomes shrunk by 12 percent between 2016 and 2023, and unemployment and inequality remain high. Considering the possible uses of Lesotho’s surpluses, therefore, the main goal of the authorities should be to ensure that this time is different, and that these funds are saved wisely and spent strategically.

Saving Wisely

Greater savings will require continued fiscal prudence. To this end, the authorities should maintain their efforts to control recurrent spending and enhance capacity in tax revenue analysis and administration.

• Contain the wage bill. Lesotho’s wage bill (as a share of GDP) is the highest among SACU members and triple the sub-Saharan African average. Reducing the amount spent on wages has long been a key recommendation of past Article IV consultations. And the government’s continued restraint over the past year has been a critical step in the right direction—this effort should continue, with a continued moratorium on hiring, streamlining of the establishment list, and regular reviews of the compensation system. It should be noted, however, that reducing the wage bill is not an end in itself. Ultimately the objective is a fair and performance-based public employment system that rewards productivity and ensures better delivery of public services.
• Improve tax policy design and strengthen tax administration. The Tax Policy Unit has been established and key staff are being hired. With help from the IMF, the unit’s capacity to accurately forecast revenue and improve tax-system design should be strengthened quickly. On tax administration, a phased reform strategy is being implemented in line with the IMF’s 2023 TADAT assessment. Prompt approval of the two tax policy bills and tax administration bill could help address identified deficiencies in many areas.
• Improve the efficiency of social spending to target the most needy. Social spending is several times that of neighboring countries as a share of GDP but the targeting of social safety schemes should be improved. For example, the tertiary loan bursary fund education scheme (2.7 percent of GDP) provides loans to many who typically do not need support and fail to repay (loan recovery is only 2 percent). A better targeted safety net would not only free resources for the most vulnerable but would also help enhance Lesotho’s resilience to new shocks. In this regard, the authorities should move proactively to take stock of services likely to be disrupted by cuts in U.S. assistance and swiftly develop a coordinated plan to ensure continued delivery of essential health services. More broadly, the authorities should enhance the operation of existing cash transfer programs, reinstate the national digital system for social registry to better streamline the identification and registration of beneficiaries, and accelerate the deployment of new benefit delivery tools.

The authorities should quickly establish a well-governed savings framework (stabilization fund). The details of a framework have been developed in close cooperation with Lesotho’s development partners and aim to ensure a stable source of government funding going forward, which in turn would allow for uninterrupted service delivery even in the face of shocks. With sufficient savings, the fund might also help finance future development spending, such as infrastructure investment. To be effective, the fund needs to be anchored by a clear and credible fiscal rule, which would guide the conditions under which funds are deposited and withdrawn. The fund should also be set within a firm legal framework, with a clear governance structure that is independent from political influence, safeguarding Lesotho’s savings until they can be used wisely. In this regard, the authorities are currently developing the policy, expected by July 2025, that will guide the stipulated legal framework for the stabilization fund.

• Within the framework, a key anchor would be a target for Lesotho’s public debt. Until very recently, debt has trended steadily upward, rising sharply during the COVID-19 pandemic. The decline over the past year has been welcome, but the IMF’s Debt Sustainability Analysis still suggests that, although the risk of debt distress is “moderate,” there is little scope to absorb any further shocks. These might easily push debt to a level where the risk of debt distress is high. A medium-term goal of 50 percent of GDP would be appropriate, as it would allow for greater resilience and is consistent with the debt anchor proposed in the fiscal rules. The authorities should therefore scale back new borrowing but might also consider first retiring existing (high cost) debt. In addition, the authorities should clear any remaining or new domestic arrears as soon as possible.

Spending Strategically

Improved public investment management is needed to increase the quality of capital spending. Before Lesotho’s savings are allocated for investment or infrastructure projects, sufficient controls should be in place to ensure that this investment represents value for money. Historically, high levels of public investment in Lesotho have not resulted in a capital stock of equal quality. And owing to longstanding capacity constraints, the capital budget continues to be significantly under executed. Authorities should take steps to boost the efficiency of public investment, including by creating a centralized asset registry, establishing a prioritized project pipeline and enhancing capacity for project management and monitoring. In this regard, the request for a Public Investment Management Assessment from the IMF is timely and welcome.

In support of efforts to ensure value for money, the authorities should redouble their efforts to enhance Public Financial Management (PFM). Without these measures in place, there is a danger that new revenues will simply be wasted.

• Budget preparation and execution must be strengthened to enhance budget credibility. This requires improved expenditure control through better collaboration between departments, monitoring and identification of mis-appropriated funds, and regular and timely audits. More broadly, the authorities should implement the Medium-Term Expenditure Framework to better align policy objectives with budget allocations over a multi-year timeframe and enhance long-term planning.
• To build further trust in PFM, the authorities should strengthen internal controls within the integrated financial management system. The authorities should accelerate the deployment of digital signatures to strengthen payment processes and prevent the accumulation of arrears.
• The authorities should also continue their efforts to ensure a comprehensive analysis and management of fiscal risks. Several fiscal risks have materialized in recent years, including from collapsed public private partnerships; unquantified arrears; and transfers and contingent liabilities from state-owned enterprises (SOEs). The authorities should further strengthen the effectiveness of SOE management and reporting and continue the release of a fiscal risk statement as part of the annual budget process.

As a matter of priority, therefore, pending PFM legislation should be passed as soon as possible. Currently, the most pressing items include i) the Public Financial Management and Accountability Bill; ii) the Public Debt Management Bill; and iii) secondary legislation to implement the 2023 Public Procurement Act. Together, this legislation will improve the efficiency and transparency of procurement, enhance fiscal responsibility and budget processes, strengthen financial management and fiscal reporting. The legislation will also help ensure that the government’s public borrowing plan is well integrated with the budget process.

With these measures and controls in place, Lesotho would be in a much better position to transform its accumulated surpluses into high-quality growth. In line with the authorities’ announced shift in emphasis from recurrent spending to capital spending, a focus on the cost effectiveness of public investment would allow for increased levels of better-quality investment, and ultimately higher growth. This would naturally entail lower fiscal surpluses going forward. However, in this context, a more relaxed fiscal stance would not necessarily entail a higher debt path, but would instead result in a slower, but acceptable, pace of reserve accumulation.

Supporting Private-Sector Growth

Improved public investment will need to be accompanied by broad structural reforms. Better service delivery and higher-quality investment will be helpful. But the current government-led growth model has resulted in an economy with a small and undiversified private sector—contributing to low productivity, anemic private investment, declining competitiveness, and high informality. In parallel, therefore, the authorities should accelerate efforts to unlock the growth potential of the private sector.

• Supporting financial inclusion and literacy is imperative. Evidence suggests that access to finance remains a key challenge, particularly for small and informal firms. This in turn undermines private-sector job creation. The authorities have addressed this through various interventions, including partial credit guarantees, establishment of a moveable asset registry, and support of a credit bureau. And signs of a positive impact are emerging, particularly in financial access for small enterprises. Building on this success, the new Financial Sector Development Strategy and National Financial Inclusion Strategy are welcome and should be implemented swiftly as a matter of priority.
• Providing a stable, predictable, and well-regulated business environment is also essential. For larger firms, needed reforms include measures to reduce the cost of doing business, and efforts to boost private investor confidence—including through transparent and consistent regulatory frameworks, greater policy consistency, and a clear long-term strategy for infrastructure development. To reverse the long-term decline of some industries (e.g., textiles) and take full advantage of new opportunities, the authorities should focus on coordinating and streamlining the efforts of the Lesotho National Development Corporation and the Basotho Enterprise Development Corporation. The authorities should also enhance the regulatory framework for the establishment, operation, and oversight of SOEs, while developing a strategy for the gradual privatization of non-performing SOEs to enhance efficiency and attract investment.
• Mitigating corruption and strengthening the rule of law is essential to restoring confidence, investment, and growth. Legacy fraud cases point to underlying vulnerabilities in payment and procurement, underscoring the need for the transparency and accountability that would result from successful PFM reform. More broadly, strengthening key bodies such as the Office of the Auditor General and the Directorate on Corruption and Economic Offences (DCEO) would also send a strong signal of the government’s resolve, and help incentivize private sector development. In this regard, the increased funding and expansion of the DCEO has been most welcome.

The IMF team thanks the Lesotho authorities and other counterparts for their hospitality and for a candid and productive set of discussions.

Distributed by APO Group on behalf of International Monetary Fund (IMF).

MIL OSI Africa –