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Lesotho Poverty Reduction Support Programme PRSP

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                          AFRICAN DEVELOPMENT FUND




        PROGRAMME                    :        POVERTY REDUCTION
                                              SUPPORT PROGRAMME (PRSP)

        COUNTRY                      :        LESOTHO
        ________________________________________________________________________

        APPRAISAL REPORT
        MARCH 2009
                            Team Leader:         Mothobi P. S. MATILA, Senior Economist, OSGE.2
                                                 (Task Manager)

                            Team Members:        George HONDE, Country Economist, ORSA

Appraisal Team
                             Sector Manager
                                                 Marlene KANGA, OSGE.2

                            Sector Director      Gabriel NEGATU, OSGE
                            Regional Director:
                                                 Abdirahman BEILEH, ORSA

                                1. Issa FAYE, Senior Economist, OSGE.2
                                2. Devinder GOYAL, Public Financial Expert, ORPF.2
Peer Reviewers                  3. Suwareh DARBO, Senior Country Economist, ORSA
                                4. Abdoulaye COULIBALY, Financial Governance
                                    Expert, (OSGE.1)
                                                      TABLE OF CONTENTS

      FISCAL YEAR OF BUDGET .................................................................................................................i
      CURRENCY EQUIVALENTS ...............................................................................................................i
      WEIGHTS AND MEASURES................................................................................................................i
      ACRONYMS AND ABBREVIATIONS .............................................................................................. ii
      GRANT AND LOAN INFORMATION .............................................................................................. iii
I.                THE PROPOSAL...................................................................................................................1
II.               COUNTRY AND PROGRAMME CONTEXT..................................................................1
      2.1        GOVERNMENT OVERALL DEVELOPMENT STRATEGY AND MEDIUM TERM REFORMS
                 PRIORITIES .................................................................................................................................1
      2.2        RECENT ECONOMIC AND SOCIAL DEVELOPMENT, PERSPECTIVES, CONSTRAINTS AND
                 CHALLENGES.............................................................................................................................2
      2.3        BANK GROUP PORTFOLIO STATUS ............................................................................................5
III.              RATIONALE, KEY DESIGN ELEMENTS AND SUSTAINABILITY .........................6
      3.1        LINK WITH CSP, COUNTRY READINESS ASSESSMENT AND ANALYTICAL WORK
                 UNDERPINNINGS .......................................................................................................................6
      3.2        COLLABORATION AND COORDINATION WITH OTHER DONORS.................................................9
      3.3        OUTCOMES OF THE PAST AND ONGOING SIMILAR OPERATIONS AND LESSONS .....................11
      3.4        RELATIONSHIPS TO ONGOING BANK’S OPERATIONS ..............................................................11
      3.5        BANK’S COMPARATIVE ADVANTAGES ....................................................................................12
      3.6        APPLICATIONS OF GOOD PRACTICES PRINCIPLES AND CONDITIONALITY ..............................12
      3.7        APPLICATION OF BANK GROUP NON-CONCESSIONAL BORROWING POLICY ............................13
IV.               THE PROPOSED PROGRAMME....................................................................................13
      4.1        PROGRAMME’S GOAL AND PURPOSE ........................................................................................13
      4.2        PROGRAMME PILLARS, SPECIFIC OPERATIONAL POLICY OBJECTIVES AND EXPECTED
                  RESULTS ..................................................................................................................................13
      4.3        FINANCING NEEDS AND ARRANGEMENTS ................................................................................16
      4.4        PROGRAMME’S BENEFICIARIES ................................................................................................16
      4.5        IMPACT ON GENDER.................................................................................................................17
      4.6        ENVIRONMENTAL ISSUES .........................................................................................................17
V.                IMPLEMENTATION, MONITORING AND EVALUATION .....................................17
      5.1        IMPLEMENTATION ARRANGEMENTS ........................................................................................17
      5.2        MONITORING AND EVALUATION ARRANGEMENTS .................................................................18
VI.               RISK MANAGEMENT.......................................................................................................18
VII.              LEGAL INSTRUMENTS AND AUTHORITY ...............................................................19
      7.1        LEGAL DOCUMENTATION ........................................................................................................19
      7.2        CONDITIONS ASSOCIATED WITH BANK GROUP INTERVENTIONS.............................................19
      7.3        COMPLIANCE WITH ADF POLICIES ..........................................................................................20
VIII.             RECOMMENDATIONS.....................................................................................................20

      ANNEX I             LETTER OF DEVELOPMENT POLICY .................................................................................8
      ANNEX II            PROGRAMME INDICATORS FOR 2009 AND 2010 (EXTRACTED FROM THE PAF).............2
      ANNEX III           LESOTHO: SELECTED ECONOMIC AND FINANCIAL INDICATORS, 2004–2013.................1
      ANNEX IV            PREREQUISITES CONDITIONS FOR PRSP .........................................................................1
             FISCAL YEAR OF BUDGET
                    1 April to 31 March



             CURRENCY EQUIVALENTS
                  (6 March 2009)

National Currency      =       Maloti (M)
UA 1.0                 =       US$ 1. 46736
UA 1.0                 =       M 14.75
US$ 1.0                =       M 10.05
€ 1.0                  =       M 12.70



             WEIGHTS AND MEASURES
                  Metric System

1 metric tonne         =       2204 pounds(lbs)
1 kilogramme (kg)      =       2.200 lbs
1 metre (m)            =       3.28 feet (ft)
1 millimetre (mm)      =       0.03937 inch (“)
1 kilometre (km)       =       0.62 mile
1 hectare (ha)         =       2.471 acres
                                       ii

                  ACRONYMS AND ABBREVIATIONS
ACP        : Africa, Caribbean and Pacific
ADB        : African Development Bank
AGOA       : African Growth and Opportunities Act
CBL        : Central Bank of Lesotho
CER        : Country Economic Review
CMA        : Common Monetary Area
CPAR       : Country Procurement Assessment Review
CPI        : Consumer Price Index
CSP        : Country Strategy Paper
EU         : European Union
FDI        : Foreign Direct Investment
FTA        : Free Trade Area
GBS        : General Budget Support
GDP        : Gross Domestic Product
GNI        : Gross National Income
GoL        : Government of the Kingdom of Lesotho
GOLFIS     : Government of Lesotho Financial Information System
HDI        : Human Development Index
HIV/AIDS   : Human Immuno Deficiency Virus/ Acquired Immuno Deficiency
             Syndrome
IFMIS      : Integrated Financial Management Information System
LDC        : Less Developed Country
LNDC       : Lesotho National Development Corporation
LRA        : Lesotho Revenue Authority
LHWP       : Lesotho Highlands Water Project
MCC        : Millennium Challenge Corporation
MDGs       : Millennium Development Goals
MFA        : Multi-Fibre Agreement
MFDP       : Ministry of Finance and Development Planning
MTEF       : Medium Term Expenditure Framework
NIR        : Net International Reserve
PAF        : Performance Assessment Framework
PEFA       : Public Expenditure and Financial Accountability
PEMFAR     : Public Expenditure Management and Financial Accountability Review
PFM        : Public Financial Management
PPAD       : Procurement Policy and Advisory Division
PRS        : Poverty Reduction Strategy
PRSP       : Poverty Reduction Support Programme
RSA        : Republic of South Africa
PSIRP      : Public Service Improvement and Reform Programme
SACU       : Southern Africa Customs Union
SADC       : Southern African Development Community
SMMEs      : Small, Micro and Medium Enterprises
SARB       : South African Reserve Bank
SSA        : Sub-Saharan African
T&C        : Textile and Clothing
U.S.       : United States
VAT        : Value-Added Tax
                                         iii

                     GRANT AND LOAN INFORMATION

Borrower             :        Government of the Kingdom of Lesotho
Executing Agency     :        Ministry of Finance and Development Planning

Financing Plan       :

Source :                             Amount:                      Instrument:

ADF                                  UA 5.64 million                     Grant
ADF                                  UA 0.74 million                     Loan

Programme Timeframe-Main stepping stones (expected)

Concept Note approval                             December 2008
Appraisal mission                                 February/March 2009
Board Presentation/Approval                       June 2009
Effectiveness                                     August 2009
Completion                                        March 2011
                                                                                              iv



       Results Based Logical Framework (based on the Performance Assessment Framework)

HIERARCHY OF             EXPECTED                               OUTCOME INDICATORS                                               INDICATIVE TARGETS
                                                 REACH                                                    BASELINE                                                ASSUMPTIONS / RISKS
 OBJECTIVES               RESULTS                                                                                                    TIMEFRAME

Goal:                 Impact:                 Beneficiaries:    Outcome Indicators:                Baseline                     Progress anticipated in the       Risks:
1.0 To improve the    1.0 Reduced poverty     1.0 The           1.0 GNI per capita.                1.0 GNI per capita in        long term :
living standard of    and improved living     citizens of the                                      2007 was 1000 USD            1.0 GNI per capita increases      1: Deterioration of
the people in         standards.              Kingdom of                                                                        over USD 3.595 by 2030 (i.e.      economic situation in
Lesotho through                               Lesotho                                                                           Lesotho is an upper middle        Southern Africa due to
enhanced delivery                                               2.0 Poverty reduction as           2.0 People living below      income country)                   global financial crises.
of public services                                              measured by goal one of the        poverty line were 50.2%      2.0 Reduce the percentage of
                                                                MDGs.                              according to the 2002/03     people living below poverty       2: Political instability in
                                                                                                   Household Budget Survey      line by 2015 (i.e. MDG target).   Lesotho
                                                                                                   concluded in 2007.
Programme             Outcomes:               Beneficiaries:    Outcome Indicators:                Baseline (Based on the       Progress anticipated in the       Risks:
purposes:                                                                                          2007 PEFA)1                  medium term
To improve            1.0 Comprehensive,      1.0 The           1.0 PI-6= Comprehensiveness        1.0 PI-6 was assessed as B   Timeframe:
governance in         credible, transparent   citizens of the   of information included in the     in 2007                      1.0 PI-6 expected to improve      1: Insufficient Institutional
public financial      and poverty             Kingdom of        budget.                                                         to B+ in 2009                     capacity.
management and        responsive budget       Lesotho           1.1 PI-10= Public access to        1.1 PI-10 was assessed C     1.1 PI-6 to improve to C+ in
procurement                                                     key fiscal information             in 2007                      2009

                                                                1.2 PI-1= Aggregate                1.2 PI-1 was assessed as     1.2 PI-1 to improve to B+ in
                                                                expenditure outturn compared       at B in 2007                 2009
                                                                to original approved budget

                                                                1.3 PI-16= Multi-year              1.3 PI-16 was at B in 2007   1.3 PI-16 expected to improve
                                                                perspective in fiscal planning,                                 to B+ in 2009
                                                                expenditure policy and
                                                                budgeting


       1
         PEFA assessment was undertaken in 2007 and is expected to be undertaken again in 2009. PEFA rates performance on PFM indicators and uses alphabets. The Bank will
       participate in the 2009 PEFA.
                                                                          v


    2. Improved             2.0 Ministry   2.0 PI-25= Quality and             2.0 PI-25 assessed at D in   2.0 PI-25 to improve to C in        2. Reduced SACU
    financial               of Finance     timeliness of annual financial     2007                         2009                                revenues and remittances
    management in line      and            statements
    with the PEFA           Development
    recommendations         Planning
    and better internal                    2.1 PI-21= Effectiveness of        2.1 PI-21 was D+ in 2007     2.1 PI-21 to improve to C by
.   control, cash                          internal audit                                                  2009/10
    management and
    accounting leading
    to transparent
    analysis of the
    financial
    performance

    3. A more efficient     3. All         3.0 PI-19=Competition, value       3.0 PI-19 assessed at C in   3.0 PI-19 to improve to C+ in
    and professional        ministries     for money and controls in          2007                         2009/10
    procurement systems                    procurement.
    that ensures
    transparency, equity
    and economy in
    Government
    procurement.

    4. Effective external   4. Auditor     4.1 PI-26= Scope, nature and       4.0 PI-26 was D+ in 2007.    4.0 PI-26 expected to attain C in
    auditing and scrutiny   General,       follow-up of external audit                                     2009
    with enhanced           Ministry of
    transparency and        Finance and    4.2 PI-28= Legislative             4.1 PI-28 was assessed to    4.1 PI-28 to be assessed at C in
    accountability.         Development    scrutiny of external audit         be D+.                       2009
                            Planning and   reports.
                            Parliament.
                                                                                              vi


Inputs: (2009-        Outputs:                 Beneficiaries:   Output Indicators:                 Baseline                      Progress anticipated in the         Assumptions/Risks:
2010)                                                                                                                            short term:
1.0 USD9.36           1.Use of MTEF in         1. MFDP and      1. Budget book                     1. Budget framework           1. MTEF documentation for           1. Failure of GoL and
million of ADF-XI     budget preparation       DPs                                                 papers prepared for           2009/10 to 2011/12 published as     Development Partners to
resources                                                                                          2009/2010 budget by all       part of the Budget.                 agree on the PAF.
(Grant/loan)                                                                                       ministries and MTEF to                                            Mitigations is GoL to take
2. USD 20.0 million                                                                                be rolled out.                                                    lead in aid coordination.
IDA resources                                                                                                                                                        2. Low implementation
                                                                                                                                 2. New regulations based on
(credit +loan)        2. Revised               2. All           2. Procurement units adhere        2. Weak procurement                                               capacity could lead to
                                                                                                                                 the action plan and the new
3. USD20.63           procurement              ministries and   to new regulations.                units and no independent                                          failure to sustain IFMIS
                                                                                                                                 PFMA established in 2009.
million EU            regulations and          procurement                                         appeal mechanism, action                                          and MTEF. Training of end
resources             procurement plans        units                                               plans on CPAR                                                     users will mitigate it.
2.0 Staff time                                                                                     recommendations
(country and                                                                                       prepared.
sectoral                                                                                                                                                             3. Lack of transparent
                                                                                                                                 3. IFMIS to be rolled out to        systems and weak external
departments).         3. Improved              3. Accountant    3. Implementation of IFMIS
                                                                                                                                 ministries in April 2009, bank      audit system may
                      financial                General’s        by April 2009.                     3. IFMIS to replace
                                                                                                                                 accounts rationalized and           compromise the roles of
3.0 Mission costs     management and           Department                                          GOLFIS, soft and
                                                                                                                                 training of core team               the oversight institutions
for donor             legal system                                                                 hardware connections
                                                                                                                                 undertaken in 2009. An              and render GoL PFM
coordination and                                                                                   being installed.
                                                                                                                                 independent quality assurance       inefficient.
supervision.
                                                                                                                                 to be done in 2010.
                                                                                                                                 4. GoL to review the Audit Act in   The ongoing public sector
Activities                                                                                                                       2009. 2007/08 accounts to be        reforms will mitigate
Refer to Annex II     4. Timeliness of         4. Population    4.0 Improved public audit          4. The independence of        submitted to Parliament in 2010.    against the weaknesses.
                      submission of audit      and MFDP         system with enhanced               the Auditor General is
                      reports to legislature                    transparency                       compromised because the
                                                                                                   Minister of MFDP
                                                                                                   submits the audit report to
                                                                                                   parliament. There is a
                                                                                                   backlog of audited
                                                                                                   accounts including those
                                                                                                   audited but not presented
                                                                                                   to Parliament.
                                                vii



                     PROGRAMME EXECUTIVE SUMMARY

1.      The Poverty Reduction Support Programme (PRSP I) for Lesotho is a two year
programme aimed at assisting the country to implement the Poverty Reduction Strategy (PRS).
The programme will be supported by a budget support loan amounting to UA 740 000 and a grant
of UA5.64 million to be disbursed in one tranche. The expected outputs are: (i) a Performance
Assessment Framework (PAF) agreed and used for managing and monitoring budget support; (ii)
Revised procurement regulations and establishment of procurement units in line ministries; (iii)
Introduction of Integrated Financial Management Information System (IFMIS) to enhance
management of financial accounts: (iv) Medium Term Expenditure Framework (MTEF) aligned
to poverty reduction expenditure priorities; (v) Transparent budget formulation and dissemination
among stakeholders; (vi) adoption of the Public Financial Management and Accountability Act;
and (vii) improved external audit system to enhance fiscal transparency and accountability.

2.      The expected outcomes of the programme are: (i) Comprehensive, credible, transparent
and poverty responsive budget; (ii) Improved financial management in line with the Public
Expenditure Management and Financial Accountability Review (PEMFAR) recommendations
and better internal control, cash management and accounting leading to transparent analysis of
the financial performance; (iii) A more efficient and professional procurement systems that
ensures transparency, equity and economy in government procurement; and (iv) Effective
external auditing and scrutiny with enhanced transparency and accountability. This operation will
benefit the citizens of Lesotho through improved service delivery, transparency and
accountability and management of public resources. The Auditor General, Ministry of Finance
and Development Planning and all ministries will benefit from improved financial management
and accounting system as a result of introduction of IFMIS.

3.      GoL has undertaken reforms in the past which are predicated upon several studies done
by different donors. The findings and recommendations of these reports led to the elaboration of
the Public Service Improvement and Reform Programme (PSIRP) supported by development
partners which aimed at resolving the identified weaknesses. The PFM reform component of the
PSIRP focuses on improving the link between the country’s poverty reduction strategy and the
annual planning and budgeting processes through introduction of a three year MTEF in six pilot
ministries in 2005/06. While the roll out of MTEF to other ministries including training of staff is
ongoing, all ministries prepared budget framework papers for 2009/2010-2011/2012 period.
Weaknesses have been identified in the legislative, regulatory and institutional framework, as
well as in market practices, transparency and integrity of the procurement system. An action plan
has been prepared to address these weaknesses.

4.       Budget support is suitable for reforms undertaken by a country which has set up a donor
coordination mechanism. Lesotho has a framework for budget support management with
development partners and a framework for monitoring progress. The Bank will collaborate with
other development partners like the World Bank which has already provided budget support last
year and is working on its second operation for 2009 and the European Union which is working
on its support. The Bank’s allocation to Lesotho is small and could not be split into many sectors
and is best used through budget support to augment national resources. The Bank will use its
experience of budget support and managing projects in Lesotho as well as in other countries
including fragile states to manage this operation.

5.      The operation will in particular contribute to institutional development and knowledge
building through knowledge sharing during formulation and management of the performance
assessment framework.
I.      THE PROPOSAL

1.1      We submit the following Report and Recommendation on a proposed loan and grant to
Lesotho for UA 6.38 million (Six Million Three Hundred Eighty Thousand Units of Account) to
finance the first Poverty Reduction Support Programme (PRSP I) in Lesotho. It is a general
budget support programme and will cover twenty two months from June 2009 to March 2011.
The programme has been appraised by a Bank mission from 23 February to 6 March, 2009. It
results from a request of the Government of the Kingdom of Lesotho (GoL) dated 5 March 2009
and discussions held with previous Bank missions and is in line with the Lesotho PRS and the
Bank’s Country Strategy Paper for Lesotho (2008-2012) adopted in December 2008. The PRS
has been endorsed by the donors in 2006 when they began discussion for budget support. The
design of the programme took into account good practices on conditionality and Bank Group
provisions on non-concessional debt accumulation policy for ADF grant and loan, HIPC and
MDRI beneficiaries. Lesotho is not a HIPC or MDRI beneficiary.

1.2     The programme goal is to improve the living standard of the people in Lesotho through
enhanced delivery of public services. Its policy objective is to reduce poverty and increase
economic growth, through improvement in governance and public financial management (PFM).
The expected outcomes of the programme are: (i) Comprehensive, credible, transparent and
poverty responsive budget; (ii) Improved financial management in line with the PEMFAR
recommendations and better internal control, cash management and accounting leading to
transparent analysis of financial performance; (iii) A more efficient and professional procurement
system that ensures transparency, equity and economy in government procurement; and (iv)
Effective external auditing and scrutiny with enhanced transparency and accountability. These
outcomes will lead to improved service delivery and, hence, improved living standards of the
people.

II      COUNTRY AND PROGRAMME CONTEXT


2.1     Government Overall Development Strategy and Medium term Reforms priorities

2.1.1 Lesotho’s Poverty Reduction Strategy (PRS), which originally covered the period
2004/05-2006/07, and has been extended up to April 2011, was prepared through an extensive
and elaborate national consultative process. The                   Table 1: PRS in Short
PRS articulates priorities and strategies for PRS Pillars            PRS Priority Areas of Action
poverty reduction in Lesotho through economic      I: Accelerating   o   Private sector development
                                                   shared &          o   Tourism
growth and empowerment of the poor. The PRS sustainable              o   Mining & quarrying
continues to reflect Lesotho’s priorities and economic               o   Agriculture
                                                   growth            o   Economic infrastructure
strategies for poverty reduction, within the four                    o   Protecting & conserving environment
key pillars of policy objectives, namely: (i) II. Human              o   Education & training
accelerating shared and sustainable economic development             o   Healthcare
                                                                     o   HIV & AIDS epidemic
growth; (ii) human development; (iii) protecting                     o   Social infrastructure
and enabling disadvantaged groups; and (iv) III. Protecting          o   Women’s empowerment
                                                                         Youth & children’s issues
good governance. The PRS’ priority areas of and enabling
                                                   disadvantaged
                                                                     o
                                                                     o   Other disadvantaged groups
actions have been identified for each pillar as groups               o   Food insecurity
indicated in Table 1. The PRS links policy, IV. Good                 o   Improving public service delivery
                                                   governance        o   Deepening democratic institutions
planning and budgeting processes and ensures                         o   Justice, safety & security
that there is synergy between key initiatives such
                                                2

as the National Vision 2020 published in 2004 which articulates the level of development that
Basotho2 aspire to attain by 2020, the Millennium Development Goals (MDGs) to be achieved by
2015 and national goals and PRS priorities.

2.1.2 The PRS will be replaced by a National Development Plan (NDP) because GoL has now
decided to move away from a PRS process to a comprehensive planning framework that would
not only reflect financial and human capacity issues, but also place emphasis on growth priorities.
To complement the PRS during the interim period leading to the development of a National
Development Plan, the Government has: (i) introduced budget framework papers in all line
ministries for 2009/10-2011/12 period; (ii) finalised a Growth Strategy Paper (GSP) to identify
potential drivers of growth; and (iii) completed an Issues Paper for the NDP (2008/09-2009/10) in
order to ensure that a strategic document exists to guide the budgeting process during the
intervening fiscal years.

2.2        Recent Economic and Social Development, Perspectives, Constraints and
           Challenges

           Recent Macroeconomic Performance

2.2.1 Lesotho has ensured prudent macroeconomic management and economic stability since
2000. Gross Domestic Product real growth was 8.1% in 2006 and declined to 5.1% in 2007 due to
drought and agriculture’s negative contribution to GDP growth. However, the economic growth
weakened to 3.9% in 2008 in the wake of the global financial crisis and economic downturn.
Specifically, manufacturing activity slowed down reflecting a reduction in textile exports to the
U.S. by about 11% year-on-year in December 2008, which experienced recession in the latter part
of 2008, while mining production and exports also fell due to weak prices for diamonds. By the
end of 2008, one mining company had suspended production in response to rapid fall in prices. It
is estimated that the economic growth momentum will further slow down to 2.1% in 2009 due to
the global financial crisis. Growth will be vulnerable to external shocks, the weak global
economy and recession. The reduced diamond mining activities, declining export of the textile
sector and the resultant job losses will further weaken economic activities and slow down growth.
The current account balance is projected to register deficit from 2008 to 2011 due to declining
transfers from the Southern African Customs Union (SACU) resulting from reduced economic
activity in South Africa and the SACU region. Implementation of the SADC Trade Protocol will
have the potential to reduce the SACU revenue due to the 85% tariff reduction of some traded
goods and services to zero tariffs in the region. SACU will be subsumed under the SADC trade
protocol and reduce further the revenue pool. (Paragraph 2.2.12)

2.2.2 The fiscal balance (including grants) in 2006/07 was 12.7% and was estimated to be
16.7% of GDP in 2007 due to favourable SACU revenues and under spending of the budget,
improved domestic revenue collection, largely reflecting improved tax administration since the
establishment of the Lesotho Revenue Authority in 2003, and rapid growth in South African
imports leading to increased import and excise duty. Overall fiscal (including grants) balance
registered a surplus of about 8.9% of GDP in 2008. The sharp increase in SACU receipts in
recent years was due to both high economic activity in South Africa and the impact of a new
sharing formula that became effective in 2005. In addition to that, Lesotho received adjustment
payments due under the previous sharing arrangements. This was transitory as overall fiscal
balance excluding grants is projected to be in deficit from 2009 to 2011 according to the IMF and
GoL projections. The 2009/10 GoL budget estimates put the budget deficit at 10.6% partly due to
the global downturn and stimulus programmes aimed at retaining employment and is significantly

2
    People of Lesotho.
                                                         3

different from the IMF Article IV Consultations estimates. The discussion between the IMF and
GoL to agree on realistic budget figures are ongoing. Some of the economic indicators are shown
in table 2.

                   Table 2: Macroeconomic and Financial Indicators (calendar year)
                                                    2005     2006 2007        2008            2009     2010
                                                                                              Proj.    Proj.
 Real GDP growth (%)                                          0.7     8.1     5.1      3.9      2.1      5.5
 Fiscal balance (incl. grants) (% of GDP)                     5.0    12.7    16.7      8.9      3.4      3.9
 Fiscal balance (excl. grants) (% of GDP)                     2.8    11.7    15.2      6.8     -0.3     -1.0
 Non SACU fiscal balance                                            -21.0   -23.9    -28.3    -27.1    -25.5
 Consumer price index (% change; period average)              3.4     6.1     8.0     12.0      8.5      6.6
 Current account balance (incl. off. trans) (% of GDP)       -7.5     4.3    12.7     -3.7     -8.5     -6.5
 External debt (% of GDP)                                    54.5    50.3    42.9     52.4     43.1     39.6
 Exchange rate (maloti per US$, end of period)                6.4     6.8
 Gross official reserves (months of imports)                  4.3     5.7     6.7      6.6      6.3      5.9
  Source: IMF, ESTA and GoL


2.2.3 Fiscal management is likely to become more challenging in the near future and GoL
needs to strengthen non-SACU revenue while containing overall expenditures and shifting the
allocation of resources towards development oriented activities that support growth.

2.2.4 GoL accumulated gross international reserves reached 6.7 months of import cover in
2007 and 6.6 months of import cover in 2008 and are expected to slightly decline to 6.3 months
in 2009. The foreign reserves are likely to decline further if GoL draws them down to finance the
budget deficit. The maintenance of high international reserves depends highly on the continued
pursuit by Government of a prudent fiscal stance in the face of falling levels of exports and
remittances. Lesotho’s external debt has been brought down to sustainable levels from 54.5% of
GDP in 2005 to 42.9% in 2007 and surged Box 1: Impact of the Global Financial Crisis and
up lightly to 52.4% of GDP in 2008. It will Economic Downturn
increase due to the need to finance the Lesotho is facing significant downside risks arising from the
budget deficit resulting from reduced global financial crisis and economic downturn mainly because
                                                  of the country’s high dependency on: insufficiently diversified
revenues. The reduction of debt was due to textile-based exports to the U.S.; fast expanding diamond
GoL’s policy to use part of the SACU mining; SACU revenues; and remittances from migrants
revenue windfalls to retire its non- workers employed in South African mines. Consequently, the
                                                            knock-on effects of the crisis are
concessional debt as well as its policy to followingGDP growth is expected to havebeing felt: by only
                                                  •    real                                     increased
contract concessional loans with a grant               3.9% in 2008 from 5.1% in 2007 essentially due to falling
element of 35% and above. Annual average               demand for its textile exports to the U.S. and a reduction
inflation rose from 8.0% in 2007 to 10.7% in           in mining production and exports;
                                                  •    some of the Asian owned garment factories are finding it
2008 mainly due to the surge in food and oil           hard to obtain credit for input financing from their
prices. Inflation is expected to fall under            countries’ banks due to the global credit crunch;
double digits in 2009, reflecting favourable • SACU receipts, which account for over 50% of public
developments in food and international oil             revenue, are projected to fall significantly following a
                                                       recession in South Africa’s growth prospects; and the
prices. Some of the impacts of the global              global financial crisis
financial crisis that are affecting Lesotho are • remittances from migrant mineworkers in South Africa,
shown in Box 1.                                        which account for about 20% of GDP, are expected to
                                                              decline due to the fall in the number of migrant
                                                              mineworkers, which is likely to exacerbate Lesotho’s
                                                              unemployment rates.
                                                 4

        Recent Developments in Poverty and Social Indicators

2.2.5 The incidence of poverty in Lesotho remains a concern in spite of the strong economic
growth in recent years. The 2002/03 Household Budget Survey finalised in 2007, indicated that
slightly over half of the population, at 50.2%, still lived below the poverty line in 2002/03, an
improvement from 62.1% registered in 1994/95. The leading cause of poverty is rising
unemployment, estimated at 23.2% of the total labour force in 2002/03, and underemployment
resulting from a series of structural changes which began in early 1990s with the decline of
mining employment in RSA that has been worsened by the recent retrenchments in both mining
and textiles industries due to the global financial crisis. Income inequality, though still high, has
also been showing declining trends, with the Gini coefficient decreasing from 0.57 in 1994/95 to
0.52 in 2002/03. In 2008, Lesotho’s overall human development index (HDI) was 0.496, ranked
155th out of 179 countries, compared to 0.549 and 1138, respectively, in 2007.

2.2.6 On progress in achieving the MDGs, while Lesotho will almost meet the targets for
attaining universal primary education and eliminating gender disparity in primary and secondary
education, it is unlikely to achieve targets on halving poverty, eradicating hunger, as well as
reducing under-five and maternal mortality rates. The slow progress in improving social
indicators and attaining MDGs can be attributed to the high HIV/AIDS prevalence rate, chronic
drought, reduction in remittances from migrant mineworkers and poor coverage of basic health
services. In 2008, about one in four Basotho (15-49 years) were HIV positive, ranking Lesotho
the third highest HIV prevalence country in the world. As a result of the impact of AIDS, average
life expectancy is estimated to have fallen from 60 years in 1996 to about 43 years by 2008.

        Business Environment

2.2.7 Although the private sector business climate in Lesotho is complemented by the country’s
access to the range of South Africa’s developed infrastructures and wider capital and financial
markets, the country has not made any significant strides in improving the investment climate in
recent years. Obstacles to private sector development that still exists relate to outdated laws and
regulations, which impose unnecessarily long and complex procedures for the registration and
licensing of firms, as well as administrative requirements that make it unnecessarily long and
cumbersome to obtain work and resident permits. According to the 2009 Ease of Doing Business
(EDB) published by the World Bank, it takes 40 days to start a business in Lesotho. Overall, it
ranked Lesotho 123 out of 181 countries. Lesotho is ranked below other SACU countries.
Recognising these weaknesses, with the support of the World Bank and Millennium Challenge
Corporation (MCC), GoL is currently undertaking major policy reforms, including measures to
improve the business environment and reduce the costs of doing business by reviewing several
obsolete laws and business procedures, increase economic diversification through skills
development, improve access to credit and increase the participation of women in the formal
sector. A Trade Facilitation and Investment Centre, a one-stop-shop, has also been established to
assist investors to rapidly obtain company registration, tax compliance, import and export permits
as well as work and residence permits.

        Perspective, Constraints and Challenges

2.2.8 Lesotho faces a number of challenges, which emanate partly from its geographical
location and landlocked position. It is completely surrounded by South Africa and has no access
to the sea and any other country without passing through South Africa. Its small population of
about 2.0 million makes it unattractive to large investors. Hence, it largely depends on South
Africa on trade, business, infrastructure, etc. Unemployment remains high, which is exacerbated
by the retrenchment of migrant mineworkers from South Africa due to reduced mining activities
                                                5

resulting from the global economic downturn, as well as lack of education, skills and
opportunities.

2.2.9 Lesotho’s growth prospects remain extremely vulnerable to external risks, including
slowdowns in its markets and exchange rate fluctuations. This is aggravated by the country’s high
dependency on an insufficiently diversified textile-based industry. In spite of the expansion in
diamond mining, the country needs to further diversify its export base in order to ensure
sustainable economic growth. The weak competitiveness of the Lesotho economy, low levels of
infrastructural facilities, including inadequate road transport network and lack of reasonably
priced and efficient utilities (electricity, water and telecommunication services), continue to
constrain private sector development and economic growth in Lesotho. Institutional capacity is
also a constraint to service delivery. GoL through its growth strategy intends to address these
constraints.

2.2.10 Regional Integration: Lesotho’s challenges and opportunities are greatly influenced by
its inherent geographic integration in the economy of South Africa. Lesotho is a member of the
Southern African Customs Union (SACU) which governs trade between member countries
namely; Botswana, Lesotho, Namibia, South Africa and Swaziland. Lesotho’s revenue from the
SACU Revenue Pool represented 35% of GDP in 2006/07 and its high dependence on the foreign
taxes for fiscal revenue and its geographical location means that it cannot implement a trade
policy and undertake trade liberalization without consultation with members of SACU as per the
2002 Agreement. Lesotho is also a member of the Common Monetary Area (CMA) comprising
South Africa and smaller countries, namely Lesotho, Namibia and Swaziland (LNS states) which
integrates them into the South African money and capital markets. The LNS states membership of
CMA limits their discretion in monetary and exchange rate policies due to the free circulation of
the South African rand in their territories. The pegging of their currencies at par to the rand
makes it difficult for them to adjust quickly to external shocks other than through coordinated
decisions with RSA. However, on the positive side, LNS states benefit from the policy
creditability of the South African Reserve Bank and the CMA allows an unrestricted transfer of
funds without any transaction costs and foreign exchange risks, whether for current or capital
transactions, between CMA member states, which has facilitated cross-border trade among them.

2.2.11 Lesotho is also a member of the Southern African Development Community (SADC) and
has joined the SADC Free Trade Area (FTA), which was launched in August 2008. Although this
will open up markets for Lesotho’s products, the FTA will reduce the SACU revenue as other
SADC members become eligible for free trade and not pay the SACU external tariff. The FTA
precedes a customs union planned for 2010, a common market by 2015, monetary union by 2016
and a single currency by 2018. Lesotho has already met all the macroeconomic convergence
criteria under SADC. In addition to the FTA, together with Botswana, Namibia, Mozambique and
Swaziland, Lesotho also signed an interim (goods only) Economic Partnership Agreement with
the EU in November 2007. This allows for duty-free and quota-free access to the EU market as of
1 January 2008.

2.3    Bank Group Portfolio Status

2.3.1 Since 1974, the Bank Group has funded 52 operations in Lesotho with a total net
commitment amounting to UA 253.53 million. In terms of sectoral distribution, transport (36%),
social sectors (27.2%) and public utilities (18%) are the largest recipients of Bank financing. As
at 31 March 2009, six operations were at varying stages of implementation consisting of one
project in transport (34.5%), two in social sector (31.71%), one in power (21.8%), one in
agriculture and rural development (10.4%) and one in multi-sector (1.6%). The financial
commitment relating to ongoing operations amounted to UA 50.36 million, of which UA 21.79
million was disbursed.
                                                6


2.3.2 The 2007 Country Portfolio Performance Review Report (CPPR) rated the quality of the
Bank Group portfolio in Lesotho as satisfactory. The common problems that were highlighted by
the CPPR as contributing to project implementation delays included: start-up delays essentially
relating to the fulfillment of conditions; communication difficulties between the Bank and
Government; capacity constraints and weak project management; frequent changes to project
management teams; and difficulties in adhering to Bank Group’s rules of procedures for
procurement and disbursement. GoL has been making progress to address these generic problems
by, among other things: putting in place mechanisms that would ensure that procurement and
disbursement documents sent to the Bank Group are in conformity with Bank procedures; and
encouraging regular meetings involving the Ministry of Finance and Development Planning
(MFDP), line ministries and executing agencies to appraise each other on portfolio
implementation issues and iron out any problems, as well as share experiences. The transition of
the Bank’s Regional Office from Mozambique to South Africa will benefit Lesotho given its
close links with that country.

III    RATIONALE, KEY DESIGN ELEMENTS AND SUSTAINABILITY

3.1    Link with CSP, Country Readiness Assessment and Analytical Work Underpinnings

       Links with CSP

3.1.1 The 2008-2012 Country Strategy Paper (CSP) for Lesotho focuses on two Pillars,
namely: (i) improving transparency and accountability in management and use of public
resources; and, (ii) promoting economic growth and diversification. The proposed operation
(PRSP I) is linked to the first pillar of the CSP whose objective is to support the implementation
of the PRS by establishing a sound fiscal policy management that includes transparency and
accountability in the management of public resources. It also supports one of the PRS’ priorities,
namely Improving Public Service Delivery.

3.1.2 The expected outcomes identified in the CSP are: improved monitoring and evaluation of
GoL service delivery; improved budget preparation and execution; improved financial
management and reporting; and strengthened external audit and public oversight. The CSP
indicated that the Bank operation under the pillar of “Improving transparency and accountability
in management and use of public resources” will be in the form of general budget support, which
this operation is addressing.

       Analytical Works Underpinnings

3.1.3 GoL has undertaken reforms in the past which were based on several analytical studies.
The PFM reforms, which are anchored on the PSIRP supported by development partners, focus
on improving the link between the country’s poverty reduction strategy and the annual planning
and budgeting processes through introduction of the three year Medium Term Expenditure
Framework (MTEF) in six pilot ministries in 2005/06. While work is currently underway,
including training of staff, to roll out the MTEF to other ministries for the 2010/11-2011/12
period, all ministries have already prepared budget framework papers for 2009/2010-2011/2012
period.

3.1.4 The effectiveness of the public expenditure and financial management has been assessed
by many donors. The fiduciary assessments led to the adoption of the Public Sector Improvement
and Reform Programme which includes integration of planning and budgeting, accounting and
reporting as well as oversight bodies like the Auditor General and the Public Accounts
Committee of Parliament, procurement reforms and internal audit. In 2005, Irish Aid provided
                                                 7

support for reforms of the PFM including procurement. The European Commission in 2007
provided support for PFM reforms especially on the introduction and implementation of the
Integrated Financial Management Information System (IFMIS) which is to replace the outdated
Government of Lesotho Financial Information System (GOLFIS) in April 2009. The World Bank
undertook studies on Managing Public Finances for Growth and Poverty Reduction, Public
Expenditure Management and Financial Accountability Review (PEMFAR 2007); and Country
Procurement Assessment Review (CPAR) 2007/08, with the involvement of the African
Development Bank (ADB), the United Kingdom’s Department for International Development
(DFID) and Irish Aid. The Government, with support from DFID, in 2005/06 prepared the Public
Financial Management (PFM) Inception Report and subsequent period reviews of the PFM
implementation programme. These reports identified strengths and weaknesses of Lesotho’s
fiduciary system and have guided the development of Government’s PFM reform programme
over the past two years.

3.1.5 Some of the shortcomings/weaknesses identified included: existence of incremental
budgeting based on inputs rather than outcomes; weak alignment of the budget and the PRS
priorities and activities. The PEMFAR proposed introduction of the MTEF to improve linkages
between budget and expenditure. The CPAR findings noted some improvements in regulatory
and institutional frameworks following the adoption of the Public Procurement Regulations in
2007 and establishment of the Procurement Policy and Advisory Division (PPAD). Further
weaknesses were identified in legislative and regulatory framework, institutional framework and
management as well as in market practices, transparency and integrity of the procurement system.
An action plan has been drawn based on the recommendations of the CPAR, including the review
of the legislation which will set the basis for a new procurement law and the establishment of a
more autonomous procurement structure.

3.1.6 In addition to the aforementioned reforms, in the context of the PSIRP, Lesotho is also
gradually implementing a decentralised system of devolving functions, resources and authority
from the central government to local authorities. The decentralisation and community
empowerment reform is a result of the Local Governance, Decentralisation and Demand Driven
Service Delivery Report of 2007. Following the first elections of local government structures in
April 2005, progress has been made, particularly on the establishment of the Local Government
Service Commission and capacity building activities for District and Community Councils. The
major challenges GoL continue to face include delays in the development of the fiscal
decentralization strategy. However, the ongoing public sector reforms are expected to improve
capacity and service delivery.

       Country Readiness Assessment

3.1.7 The prerequisites for budget support including political stability, economic stability and
government commitment, and existence of a PRSP have been analysed and found adequate for
budget support. (Annex IV).

3.1.8 The fiduciary system of Lesotho has been found adequate overall to receive Policy Based
Lending in the form of budget support. Lesotho has adopted a comprehensive PFM reform
programme whose implementation is supported by DfID, EU, Ireland and World Bank. The
reform covers budget execution, financial accounting and recording, accountability and
transparency, auditing and procurement. The PEFA Framework Assessment was concluded in
2007 and scored Lesotho well in seven (7) areas (above C) which included creditability and
comprehensiveness of the budget, orderliness and participation in the budget process,
introduction of the MTEF and predictability of the flow of funds. The main areas of weakness
were in management of expenditure arrears, oversight of fiscal risk, effectiveness of internal
control and internal audit, accounting, recording and reporting, external audit and donor practices.
                                                8

Several steps to improve PFM management have already been taken including deepening of
MTEF, drafting of the Public Financial Management and Accountability Bill, launching of a
project for the design and implementation of IFMIS, preparation of outstanding accounts up to
2006/07, auditing of public accounts (2004/05) and adoption of the procurement regulations.
Introduction of IFMIS will replace the inadequate and weak GOLFIS in April 2009. The 2009/10
budget has been presented in the IFMIS system and the roll out scheme to ministries is planned
for April 2009. All logistics, both hardware and software are in place. IFMIS is expected to
improve management and record keeping as well as speed up preparation of financial accounts.
The draft Financial Management and Accountability Act has been finalised and is expected to be
presented to Parliament this year to legalise the operation and utilization of IFMIS. The Bank and
other development partners namely, DFID, European Commission and Irish Aid are preparing to
undertake a PEFA assessment during the second and third quarter of 2009 to inform the
September 2009 annual assessment review.

3.1.9 In 2007 Lesotho adopted a new procurement system and prepared the Public Procurement
Regulations of 2007. The regulations provided for a Procurement Policy and Advice Division
(PPAD) in the Ministry of Finance and Development Planning whose objectives were to provide
policy guidance and information, training and professional development and performance
measurement. All line Ministries were required to have Tender Panels, Procurement Units and
Evaluation Teams. The CPAR identified weaknesses in the system, notably lack of an
independent authority and no oversight and appeal mechanisms because the Advisory Division
was under the MFDP. An Action Plan has been drawn based on the recommendations of the
CPAR. GoL has accepted the recommendations and wants to professionalise the procurement
system. A proposal to transform the PPAD into an autonomous entity has been submitted to
Cabinet, while the provisions and coverage of the 2007 Public Procurement Regulations are being
reviewed.

3.1.10 The Bank participated in the Joint Budget Support (JBS) group meetings held between
the Government and Development Partners interested in providing budget support. The Bank was
part of the process that established the Performance Assessment Framework in 2008 including
targets that Government was to meet in 2008, 2009 and 2010. The 2008 targets were meant partly
to be used as pre-requisites for GoL’s willingness and capability to implement the PAF policies
and targets. A joint assessment of these targets took place in November 2008 and a report was
prepared in December 2008 providing progress as indicated in Table 4 below. The Bank did not
participate in the assessment but found progress to be satisfactory, although requiring
improvements. The 2008 targets indicated in Table 4 below reflects areas of focus and have been
used as baseline data for this operation.
                                                                 9

        Table 3: 2008 Targets (extracted from PAF)

Target (to 08 2008)     Required Action                          Criticality of Indicator        Progress up to December 2008
                                          Budget Execution and Management (PFM)
Budget framework        Implementation of MTEF to It is necessary to align the                   All ministries had prepared
papers prepared for     improve budget process and budget to the national                        budget framework papers for
all ministries for      creating links between the budget priorities. This will ensure           2009/10-2011/12.
2009/10-2011/12         and national growth and poverty cash flow management and
                        reduction objectives (national predictability of resources.              National budget     Framework
                        priorities)                                                              completed
National     budget     The budget framework will assist
framework drafted.      in preparing budget execution
                        reports.
                                                       Financial Management
Consultants (Turnkey    Introduction of IFMIS to improve IFMIS will enhance record               The budget module for 2009/10
Supplier) configure     internal control, cash management keeping and public accounts            has been prepared and recorded
IFMIS                   and accounting                           statements. This will lead to   in IFMIS.
Core         training   The end users of the IFMIS need timely audits and financial
commenced               training to be able to use it.           statements
                                                                 IFMIS
Drafting of public      Improvements of the legal and There is need to improve the               Draft     legal     framework
Financial               institutional    framework         that legal framework to include       completed and the draft is with
Management       and    promotes financial accountability items that were not originally         the Legal Department of
Accountability Act      and transparency                         covered.                        Lesotho.
ongoing
Audit     of  public    Improvement of the auditing of     Auditing of public accounts           The 2004/05, 2005/06 and
accounts for years      public accounts to enhance fiscal  should be done annually and           2006/07 public accounts have
2004/5 and 2005/6       transparency and accountability    they should be independent            been audited and presented to
                                                           and credible.                         Parliament
                                               Public Procurement Reform
CPAR submitted.         Improvement of regulations and the The CPAR identified some              The CPAR was submitted in
                        procurement process based on weaknesses of the current                   June 2008. MFDP prepared
                        agreed reforms from Country procurement system and                       Action Plan in response to the
                        Procurement Assessment Review.     some compliance deficiencies          recommendations of the CPAR.
                                                           that need to be improved. It          Preparations    are    underway
                                                           also identified lack of               towards      establishing    an
                                                           independence of the PPAD              autonomous institution with
                                                           which was under MFDP.                 appeal mechanisms

        Source: Appraisal Report (extracted from the PAF matrix)

        3.2       Collaboration and Coordination with Other Donors

        3.2.1 The PRS provided GoL and its development partners (DPs) with the framework to engage
        in efforts to harmonise aid procedures, align them to country systems and prepare the ground for
        increased SWAPs and programme lending. GoL has made efforts to address weaknesses in donor
        coordination by strengthening its aid coordination capacity and sought technical assistance from
        the United Nations Development Programme (UNDP) to assist it in establishing a clear
        Government focal point for coordination of development assistance. Donor coordination is now
        managed by GoL and the Principal Secretary of MFDP chairs the GoL/DPs meetings and seldom
        the Minister chairs depending on the issues on the table. The Department of Development
        Planning coordinates the day to day communications. Lesotho’s net total official development
        assistance was estimated at 5% of GDP in 2006 and net total ODA per capita at about US$ 36,
        compared with averages for ADF-only eligible countries of 10% and US$ 44, respectively.
        Lesotho signed the Paris Declaration in 2008.
                                                       10

3.2.2 The Bank collaborated closely with other DPs in the formulation of this proposed
programme, through joint meetings of DPs and with GoL. The Government first requested for
general budget support (GBS) during the Ninth Donor Roundtable Conference held in November
2006 in order to ensure that the implementation of its poverty reduction strategy is underpinned
by predictable flow of resources. In recognition of recent reform efforts by the GoL to improve
fiduciary systems and in support of the implementation of Lesotho’s poverty reduction strategy,
three DPs have confirmed their participation in budget support, namely the ADB, EU and World
Bank. On the other hand, DFID and Irish Aid are not at the moment providing budget support
partly due to lack of resources but may join at a later stage and will remain members of the group.
DP’s intending to provide budget support have been meeting since 2006 to discuss issues related
to budget support and have jointly developed a Performance Assessment Framework (PAF) with
GoL. The four policy areas of the PAF are as indicated in the Table 4 below and indicators are in
Annex V. While all other donors support the whole PAF, the Bank has selected a subset of PAF
policies and indicators.

Table 4: PAF Policy objectives and Action
 Policy                                   Action
 Growth and Macroeconomic Performance       Enhancement of the investment climate; improved road maintenance; and
                                            enhanced industrial infrastructure
 Governance    and      Public    Finance   Improved        poverty      reduction        responsiveness,     creditability,
 Management                                 comprehensiveness and transparency of the budget; more efficient and
                                            professional procurement systems; and improved financial management;
                                            improvements in the legal and institutional framework that promotes
                                            financial accountability and transparency; improvement in preparation and
                                            processing of the annual financial statements; improved effectiveness of
                                            internal audit; improving the auditing of public accounts; reduction of
                                            corruption in the public sector; civil service reform and decentralization.
 Human Development and HIV and AIDS         Improved primary education; improved coverage of secondary education;
                                            improvements in child nutrition; sustained disease prevention;
                                            improvements in disease treatments; improved coverage and reliability of
                                            rural water supply; improved support to orphaned and vulnerable children;
                                            and extension of ARV treatment.
 Capacity Development                       strengthening monitoring and evaluation; and development of national
                                            statistical capacity.
Source: PRSP I Appraisal Report

3.2.3 The World Bank has approved a budget support operation for an amount of US$ 8.7
million credit and US$ 7.2 million grant totaling US$15.9 million in May 2008 and is preparing
the second operation for an amount of USD10.0 million for 2009. The EU is also preparing its
support for an amount of Euro 15.5 million for 2009 and 2010. The annual review of the PAF
will be done in September and donors will be expected to indicate their commitments for the
following year which will be included in the budget. Examples of good practices in Lesotho are
indicated in Box 2.

Box 2: Lesotho’s Good practices of Aid Coordination
     In 2006, Government of Lesotho started meeting with donors to established a mechanism to
     coordinate donors activities and harmonise their programmes.
     GoL and donors prepared a Memorandum of understanding which is yet to be finalized.
     A Performance Assessment Framework was completed in November 2008 which sets out the areas of
     focus for the budget support programme and agreed targets for the three years (2008, 2009, 2010.)
      Five donors have indicated willingness to support budget support with World Bank already
     providing budget support based on the agreed areas and others yet to provide support namely African
     Development Bank and European Union.
     In education and health DPs have pooled funds to support the Ministries of Health and
     Education through sector budget support
     The DPs and GoL agreed to support the public sector reforms through the budget support which is
     based on the PRS.
Source: PRSP I Appraisal Report
                                                11

3.3    Outcomes of the Past and Ongoing Similar Operations and Lessons

3.3.1 The Agricultural Sector Adjustment Programme (ASAP), which was approved in March
1999 for a total amount of UA 4.83 million, is the only Policy Based Lending operation that the
Bank Group has ever provided to Lesotho. The operation was closed in July 2003 after achieving
a disbursement rate of 49 percent. The lessons that were learnt from the implementation of the
ASAP include: (i) Government ownership of development interventions and aligning them to the
socio-economic environment in the country; (ii) participation of relevant stakeholders in project
identification and other phases of project implementation; (iii) setting of attainable realistic
targets and quantifiable indicators for future assessment of project progress and impact; (iv)
provision of timely and appropriate support to the project implementation team; (v) complicated
conditions imposed on Government prior to disbursement of loans and grants can have a negative
implication on the timeliness of project start-up; and (vii) effective donor coordination

3.3.2 The proposed programme is based on the fiduciary assessment made by the team during
appraisal and other development partners interested or already providing budget support. It takes
into account the lessons derived from ASAP and the following issues:
    • It should be selective and have limited conditionalities/milestones and indicators that are
        to be monitored during the life of the programme.
    • The program should focus on reform areas that will have a significant impact when
        completed.
    • The program should be realistic as to what can be achieved, mindful of capacity
        constraints.
    • It should be aligned with the Government’s budget timetable.
    • It should be monitorable.

3.3.3 The proposed Bank operation also draws from the lessons of the past projects, some of
which are contained in the 2005-2007 CSP Completion Report. During the previous CSP period
two projects were approved by the Bank on infrastructure development (road project) and
enhancing human capital (education) and are ongoing. Three projects approved during the
previous CSP on health reforms, capacity building and natural resources income enhancement are
also ongoing. All the three operations experienced start-up delays which will be avoided in this
programme. Lesotho has institutional capacity weaknesses and it is expected that the reforms
under implementation will improve service delivery. Lessons learnt on budget support from other
countries that have been considered point to the need for few and explicit conditions as well as to
make budget support a fast disbursing operation.

3.4    Relationships to Ongoing Bank’s Operations

        Out of the 52 projects supported since 1974 only six projects are currently ongoing: one
in agriculture and rural development on Highlands Natural Resources & Rural Income
Enhancement aimed at reducing poverty; one multi-sector, Institutional Support to the Ministries
of Finance and Development Planning and Works and Transport on capacity building; two in the
social sector, Support to Health Reforms Programme and the Education Quality Enhancement
(Education III); and two in infrastructure, Likalaneng-Thaba Tseka Road Project and Lesotho
Electricity Supply Project. The projects are at different stages of implementation. The target for
budget execution and financial management will improve overall project management. The
proposed operation will also complement the ongoing projects in achieving the country’s PRS
and MDGs objectives and service delivery through the ongoing public finance management and
governance reforms including the recently approved electricity supply project. GOL has also
increased use of the Bank’s Regional Office in Mozambique, which facilitates implementation of
Bank projects in Lesotho.
                                                       12

3.5      Bank’s Comparative Advantages

         The Bank has been operating in Lesotho since 1974 and has a good understanding of the
country systems. The Bank also participated in the CPAR for Lesotho done by the World Bank as
well as in the formulation of an MOU and PAF by donors interested in providing budget support
assistance to Lesotho. This made the Bank aware of constraints as well as ongoing reforms in
financial management. The Bank will use experience on designing and managing poverty
reduction support programmes gained elsewhere to design and manage this programme. The
transition of regional office functions from the Mozambique office to the new office in Pretoria,
South Africa, will have positive spillovers on Lesotho in terms of the quality of its Bank Group
portfolio given the country’s closer proximity and strong links to South Africa.

3.6      Applications of Good Practices Principles and Conditionality

         The Bank is a member of the budget support donors group in Lesotho and will use the
areas defined by the group, as well as select targets/conditions from the PAF. The group use good
practices of conditionality, which have been agreed in the PAF in advance. The Bank will also
participate in the annual review of the PAF scheduled for September of each year. The operation
is fully aligned to these principles of good practice of conditionality as indicated in Box 3.

Box 3: Applications of Good Practices Principles and Conditionality
Principle 1: Reinforce Ownership
The proposed operation supports implementation o f Lesotho’s PRS adopted by the government in 2004 after
extensive consultations with broad spectrum of stakeholders. Government is preparing the NDP to replace the
PRS based on the lessons learnt from its implementation experience and the development of a home grown
growth strategy. It requested joint donor budget support for implementation of its PRS, using the PAF which
provides a basis for monitoring the program of overall budget support. The PAF has four broad areas consisting
of a number of relevant, monitorable, time-bound, and realistic targets related to priority policy objectives.
Principle 2: Agree up front with the Government and other financial partners on a coordinated
accountability framework
An MOU between the Government and the Joint Budget Support Donor Group has been drafted. All missions
have been held jointly and joint aide memoires have been prepared and agreed with the Government. The broad
principles o f budget support were agreed in November 2008 and are contained in the December 2008 PAF
progress report by GoL. Reviews will be carried out jointly in September each year, to fit in with the
Government’s budget preparation timeline. Disbursements of budgetary support will be based on the outcome of
the joint annual reviews.
Principle 3: Customise the accountability framework and modalities of Bank support to country
circumstances
The joint budget support review will be aligned to the country’s budget cycle and will be held in September
each year. Disbursements are expected to be made in the next financial year based on progress in the agreed
realistic targets for the PAF. Disbursement for the proposed PRSP will be based on only targets and actions
relating to its selected areas, although the decision on progress will be made collectively by all members.
Principle 4: Choose only actions critical for achieving results as conditions for disbursement
One of the principles of the joint budget support is that the PAF should consist o f a few monitorable and
realistic targets. The targets for the proposed operation covering only four issues have been selected from the
twenty PAF targets.
Principle 5: Conduct transparent progress reviews conducive to predictable and performance-based financial
support
In order to improve predictability of budgetary support from donors, the Joint Budget Support (JBS) framework
requires donors to indicate levels of budgetary support that they are planning to disburse well in advance before
the start of the fiscal year, such that the amounts can be included in the Government Budget submitted to
Parliament. Once the main annual PAF review in September has been concluded, all the JBS donors in Lesotho
will indicate to the Government how much they’re planning to disburse in the following.

Source: Appraisal Report and other documents including World Bank PSRC.
                                                13

3.7    Application of Bank Group non-concessional borrowing policy

        Lesotho’s external and public debts are projected to be sustainable, it currently stands at
52.3% of GDP and there is a moderate risk of debt distress. The IMF-World Bank joint debt
sustainability analysis (DSA) report of January 2009 shows a decline of public sector debt to
43.1% of GDP at end of 2007. The decline is attributed to the authorities’ early repayment of non
concessional loans. Lesotho as a blend (loan/grant) country contracts concessional loans with a
grant element of 35% as a policy. The NPV of external debt stood at 21.9% at end of 2007 and
remained below the policy based indicative thresholds including the HIPC initiative threshold of
150% for PV of debt to export ratio. However, with a projected 10% budget deficit and reduced
SACU revenue this trend could change and therefore the country should be prudent in contracting
and managing new loans even if they are concessional. The programme design took into account
the Bank’s non concessional borrowing policy. However, the Bank has not adopted the hardening
of terms to Lesotho because it has not yet benefited from the HIPC and MDRI and it is not in
debt stress. Most of Lesotho’s debts (92%) are with multi-lateral creditors on concessional terms.

IV.    THE PROPOSED PROGRAMME

4.1    Programme’s goal and purpose

        The programme’s goal is to improve the living standard of the people in Lesotho through
enhanced delivery of public services. The programmes purpose is to improve governance in
public financial management and procurement. The expected outcomes of the operation are: (i)
improved poverty reduction responsiveness, credibility, comprehensiveness and transparency of
the budget; (ii) improved financial management in line with the PEMFAR recommendations; (iii)
a more efficient and professional procurement system that will ensure transparency, equity and
economy in government procurement; and (iv) an effective external auditing function and
scrutiny.

4.2    Programme Pillars, Specific Operational Policy Objectives and Expected Results

4.2.1 The PEMFAR highlighted deficiencies in budget execution, internal control, accounting
delays, inadequate cash flow and bank accounts management, audit backlogs and poor fiscal
reporting as well as inadequate legal framework. In order to address the above weaknesses, the
Government has embarked on a comprehensive PFM reform program. The identified areas of
weakness included areas of planning and budgeting, accounting and reporting as well as audit and
oversight. The Government established three Task Forces, covering these areas. The task forces
have each developed a program of deliverables and report to an overarching PFM Improvement
and Reform Steering Committee, chaired by the Principal Secretary of MFDP and comprising
senior officials of MFDP and some donors. The planning and budgeting task force focuses on
integrating planning and budgeting processes through a medium-term expenditure framework
(MTEF). The accounting and reporting task force aims to develop effective budget execution and
reporting systems while the work of the audit and oversight task force focuses on: (i) providing
technical support to the Auditor-General’s office to increase its technical capacity; and (ii)
providing technical support to upgrade the capacity of the Public Accounts Committee.

4.2.2 The pillar for this operation is public reforms in public finance management including
procurement. The operation focuses on the following policy areas under Public Financial
Management: (i) Budget process-improved poverty reduction responsiveness, comprehensiveness
and transparency of the budget; (ii) Procurement-efficient and professional procurement system
that ensures transparency, equity and economy in government procurement; (iii) Audits-effective
                                               14

external auditing; and (iv) Accounts- improved financial management in line with the PEMFAR
recommendations.

Public Finance Management

4.2.3 Budget Process: The Public Expenditure Management and Financial Accountability
Review (PEMFAR) conducted in 2007 by the World Bank indicated that there were some
improvements in the budgetary process. It further noted that Lesotho has a participatory budget
process, which involves both the spending agencies and the political leadership and follows a pre-
determined budget calendar. Following budget discussion and consolidation by respective
ministries the budget is submitted to a Cabinet Budget Committee, chaired by the Deputy Prime
Minister and comprising the Minister of Finance and eight other ministers. Lesotho has a low
absorption capacity although revenue outcomes are not significantly different from budget
estimates. Under-spending in many line ministries, especially on the capital budget, reflects lack
of implementation capacity within Government.

4.2.4 Efforts have been made to align the budget to public expenditure priorities of the PRS.
There has been noticeable increased participation and engagement of the public in the budget
process and budget information has been made available to the extent possible. Budget
comprehensiveness and delivery has also improved. The introduction of IFMIS will improve the
timely availability of budget implementation and accounting information to line Ministries. While
Budget framework papers have been prepared as part of the budget process for the 2009/10
budget, work is underway to introduce MTEF in all ministries beyond the six pilot ministries.
Budget preparation and execution reports are prepared but not published.

4.2.5 The proposed operation will support budget preparation and execution under the PFM
reform programme. The Budget execution will encompass budget preparation, execution and
outturn reporting. The operation will ensure a responsive budget to needy areas and alignment to
Government priorities and responsive to the needs of vulnerable groups including gender
mainstreaming in the budget preparation. The operation will also ensure that the budget is
comprehensive, transparent and credible by encouraging Government to continue involving other
stakeholders in budget discussions to enable them to demand accountability from Government
with regard to programme implementation and budget execution and overall Government
expenditures.

4.2.6 The expected outcome of the above activities is a link of the budget to poverty reduction,
a transparent and comprehensive budget and publication of the budget execution reports. The
target/indicator to be monitored by the Bank as part of the common assessment framework by
members of the budget support group will be: preparation of a budget framework paper for
all ministries for 2008, 2009, 2010 and 2011; publication of MTEF documentation for 2009;
preparation of MTEF for 2010/11 by all ministries in 2009; and publication of the annual
budget execution reports in 2010. (Annex II).

4.2.7 Accounts: Lesotho has a backlog of financial accounts due to inadequate record keeping,
weak legal framework in financial management as well as the inadequacy of the GOLFIS, an old
no longer efficient GoL accounting system. The proposed programme will address these
inadequacies by supporting the reform programmes aimed at improving financial management,
control and record keeping. There is need for improvement of the financial management in line
with the PEMFAR recommendations to achieve better internal control, cash management and
accounting leading to transparent analysis of the financial performance. Introduction of IFMIS
will improve the public accounts management, record keeping and preparation of quarterly and
annual accounts.
                                                15

4.2.8 The current system (GOLFIS) does not provide adequate control, accounting and
reporting hence deficiencies in management of cash flows and bank accounts. The existing legal
framework is also inadequate and needs to be reviewed before introduction of IFMIS so that the
new regulations can be backed by an Act of Parliament. Preparation of annual accounts takes
time and is normally submitted after the stipulated period of six months after end of the fiscal
year.

4.2.9 The poverty reduction support programme will support improvements in the financial
management in line with the PEMFAR recommendations. The expected outcome is improved
internal control, cash management and accounting leading to transparent analysis of the financial
performance and easy preparation of public accounts. The outcome indicator for this activity is
implementation of the IFMIS by April 2009 while targets to be monitored during the programme
life period include: installation of IFMIS in all ministries and initial core team and end
users training completed; presentation of the Public Financial Management and
Accountability Act to Parliament for implementation in 2010; presentation of the draft
Public Accounts for 2007/2008 to Auditor General; and presentation of 2008/09 accounts to
Auditor General in 2010 (Annex II).

4.2.10 Audit: The main weaknesses of the public sector audit in Lesotho is the delay in
preparation of accounts and capacity. The Public Accounts Committee of Parliament is also weak
and needs strengthening so that it can efficiently review reports prepared by the Auditor General.
The existing situation has seen significant improvements in the auditing of public accounts, but
there are problems resulting from preparation of accounts and presentation of the accounts to
Parliament which takes time, as well as the capacity of the Public Accounts Committee to
effectively deliver on its oversight role.

4.2.11 The operation will support strengthening the external auditing and scrutiny to improve
management and accountability of public resources. The expected outcome is improved auditing
of public accounts for enhancement of fiscal transparency and accountability. The indicators to be
monitored in 2009 are: an audit of public accounts for 2006/7; and a review of the existing
Audit Act to determine whether amendments are required. In 2010, they are: audit of
accounts for 2007/08; and submission of audit accounts to Parliament. (Details in Annex I).

4.2.12 Procurement: Lesotho adopted the Public Procurement Regulations (PPR) in 2007,
which aimed at reforming and modernizing public procurement. The PPR is based on a
decentralized system which ensures transparency and accountability and aimed at ensuring
consistency with international practices and procedures. Procurement Units have been
established in ministries and districts to manage procurement issues in the respective institutions.
All procurement entities were required to establish Tender Panels and Tender Evaluation Teams.
The then Central Tender Board was disbanded and replaced by the Procurement Policy and
Advisory Division (PPAD), whose aim was to support, monitor and enforce compliance at
ministerial and districts levels. It was also to provide and develop relevant legislation, means of
controlling and enforcing compliance through audits as well as managing training and providing
an appeal mechanism. It provided guidance and advice to procurement units. Regulations were
introduced in 2007 and implementation commenced and some deficiencies in procurement
systems and practices were noticed.

4.2.13 The CPAR identified areas where further reforms were needed and these included
legislative and regulatory framework, institutional framework and improved management
capacity. The provisions of the constitution of the Appeals Panels were insufficient to establish an
independent institution. The procurement management, budgeting and financial management
were not integrated or linked because of lack of procurement plans which would make cash flow
management predictable.
                                                   16

4.2.14 The PRSP I will support activities towards establishment of an efficient and professional
procurement system that ensures transparency, equity and economy in government procurement.
The expected outcome of this reform is to establish a procurement process based on the action
plan drawn from the agreed reforms from the CPAR. The indicator to be monitored during the
implementation of the programme in 2009 is: a follow up on agreed actions based on the
CPAR and review of the Public Procurement Regulations and for 2010 is the
implementation of agreed follow up actions based on the CPAR recommendations. (PRSP I
targets in Annex II).

4.3     Financing needs and arrangements

4.3.1 The IMF Article IV Consultations which were concluded in November 2008 indicated
that the total revenues including grants were 59.3 % and 64.0% of GDP for 2007/08 and 2008/9,
respectively, against total expenditures for the same period of 48.9% and 55.5% of GDP leading
to a surplus budget (including grants) for the two years. However, the overall balance excluding
grants is projected to be negative for the financial years 2009/10 and 2010/11. The IMF took into
account a potential change in the SACU revenue-sharing formula; a further slow down in South
Africa’s economic growth; a reduction in the common external tariff rates due to trade
liberalization; and the creation of a SADC customs union in 2010, which may change Lesotho’s
share of SACU revenues. While Lesotho had significant budget surplus for the past two years
Table 5 below shows the next two years experiencing fiscal deficits.

Table 5: Budget Projections (in percentage of GDP)
                                     2007/08   2008/09   2009/10   2010/11   2011/12   2012/13   2013/14
Total Revenue and grants             59.3      64.0      55.3      58.3      60.2      58.7      56.5
Grants                               1.5       2.2       4.1       5.1       6.0       4.6       2.4
Total expenditure and Net Lending    48.9      55.5      53.5      53.8      54.1      52.9      50.7
Overall Balance (including grants)   10.4      8.5       1.8       4.5       6.1       5.8       5.8
Overall balance (excluding grants)   8.9       6.3       -2.3      -0.6      0.1       1.2       3.4

Source: IMF and Lesotho authorities (Fiscal year April –March)

4.3.2 A decline of revenue and grants is expected due to reduction in the SACU revenue pool
resulting from reduced imports into the SACU area. The tax revenue is also likely to reduce
because of the low demand for products hence low purchases as well as closure of mining and
clothing companies. Remittances from South Africa are also projected to fall due to the ongoing
retrenchments in the mining and manufacturing companies. Government therefore needs
additional resources to implement its programmes.

4.4     Programme’s beneficiaries

        The PRSP I is designed to assist GoL to implement its PRS. Its indirect beneficiaries are,
therefore, the Basotho people through the reforms that will be undertaken during the programme
implementation. The direct beneficiaries are all ministries and procurement units in line
ministries, which will benefit from a more efficient and professional procurement system that
ensures transparency, equity and economy in government procurement following the review of
the procurement regulations. MFDP including Accountant General and the Auditor General will
benefit from improved financial management and better internal control, cash management and
accounting leading to transparent analysis of the financial performance as a result of introduction
of IFMIS. The proposed Public Financial Management and Accountability Act will be handy in
public resource management. The Auditor General will benefit from an improved public audit
system with enhanced transparency and accountability resulting into an effective external
auditing and scrutiny. Review of the audit act is expected to improve audit functions and
                                                17

reporting. This will improve service delivery and accountability. Alignment of MTEF to PRS
priorities will ensure implementation of programmes to benefit the vulnerable groups. The private
sector will also benefit from improved procurement system and financial management.

4.5    Impact on Gender

4.5.1 Lesotho is one of a few African countries with a gender gap in favour of women,
especially at school level and in terms of literacy rates. Gender disparity has decreased slightly
mainly in primary schools in recent years due to the introduction of Free Primary Education. It
could also be due to increased awareness of the need for child education. Although women are
educated and compete for employment with their male counterparts there are still more men in
decision making positions including political leadership positions due to the fact that Lesotho is a
patriarchal society which recognizes and empowers men over women. In the vocational education
level enrolment of males is higher than that of females. Lesotho adopted and amended all laws
that were in contradiction with the Legal Capacity of Married Persons Equality Act of 2006
which recognizes both spouses equally and empowers women to own land and open accounts
without the concern of their husbands. However, implementation is still a challenge especially in
the rural areas.

4.5.2 Lesotho is a signatory to the Convention on the Elimination of Discrimination against
Women (CEDAW) but it has not yet fully translated it into its national laws. Although there is a
Ministry of Gender, there is need to mainstream gender development in national development
agenda. GoL indicated that there is an ongoing gender sensitization project funded by the
Millennium Challenge Corporation (MCC) to the tune of US$ 1.0 million. The Bank will
continue to dialogue with GOL on the need to mainstream gender in development, including
gender budgeting, production of gender disaggregated data, as well as training all planners and
policy makers on gender mainstreaming and planning.

4.6    Environmental issues

         This programme is not expected to generate any negative impacts on environment since
it focuses on public finance management. The programme has been categorised in Category 3.
However Lesotho is undertaking a number of initiatives, through other programmes and projects
to protect and preserve the environment including: revision of Environment Act of 2001 to give
the National Environment Secretariat the legal basis to enforce regulations laid out in the Act;
encouraging soil conservation through improved production; raising public awareness and
promoting environmental education; and strengthening management of solid and water waste.
Lesotho has also ratified a number of United Nations conventions.

V.     IMPLEMENTATION, MONITORING AND EVALUATION

5.1    Implementation Arrangements

5.1.1 The Ministry of Finance and Development Planning (MFDP) is the focal point for donor
coordination and will be the implementing agency on the government side. The Ministry will
coordinate all budget support activities including monitoring the PAF and reporting to the DPs.
Negotiations for PAF policy coverage, formulation of targets and means of verification and
annual assessments with DPs are normally chaired by Principal Secretary of MFDP. There are
issues of capacity but DPs support capacity building in different programmes. At the moment the
European Commission coordinates the activities of JBS group while UNDP coordinates all donor
activities in Lesotho. The Joint Budget Support DPs have drafted a Memorandum of
Understanding which will be discussed with GOL and agree on the way forward in the next
                                                18

meeting in September 2009. However, all JBS participating donors have agreed with GOL to use
the PAF for purposes of financing the budget support. The annual review of the PAF which
assesses the performance of Government on the agreed indicators takes place in September each
year and DPs confirm their commitments for the following year after the assessment. Formulation
and confirmation of targets is undertaken in the same meeting. This was adopted to comply with
the budget cycle of the country and to disburse early in the year so that Government has time to
spend the resources within the year of release.

5.1.2 The disbursement will be based on the annual assessment of the PAF and underlying
principles. While assessment is done collectively, some development partners (DPs) use a two
component system for the release of their tranches. The Bank unlike others does not use the
whole PAF but has selected a subset of the PAF due to the need to be selective and capacity to
monitor progress. Lesotho will be required to open a special account in the Central Bank of
Lesotho into which budget support resources will be deposited before being transferred to the
treasury account. This operation will disburse in one tranche in 2009 and the Bank will remain
engaged and monitor the 2010 PAF indicators.up to closure of the project in March 2011.

5.1.3 The DPs have agreed to use the Auditor General’s report for purposes of auditing the
budget support programme. Both internal and external audits are being strengthened through the
ongoing reforms programme. Introduction of the IFMIS will improve public finance management
and accounts will be prepared in time and will be audited within the specified time.

5.1.4 The budget support does not raise any direct issues of procurement, however where there
is need to procure goods and services, the country’s procurement system will be used as it has
been accepted by the JBS Group.

5.2    Monitoring and Evaluation Arrangements

5.2.1 The PAF which has targets and means of verification for each year will be used to
monitor progress. The client Ministries will provide information for verification of targets before
the annual review meetings and DPs will verify data to determine whether targets have been met.

5.2.2 The Bank will monitor the programme in accordance with the PAF framework. The
annual assessment will be used to monitor and review progress and trigger disbursement The
Bank will monitor progress by fielding missions since it does not have an office in Lesotho.

5.2.3 The Government has several committees that monitor progress in related areas. The
Public Financial Management Programme has a monitoring committee namely the PFM
Improvement and Reform Steering Committee (IRSC) chaired by the Principal Secretary of
MFDP and includes relevant stakeholders and donors. Monitoring will be based on agreed targets
and base line data in the PAF. Information collection will depend on the GoL data sources for
each target and both desk and field supervisions will be used to monitor the operation. Evaluation
will be done by both DPs and GoL information will be shared based on the agreed means of
verifications as contained in the PAF matrix for each year.

VI.    RISK MANAGEMENT

6.1     Lesotho’s development programme faces many risks including the effects of the global
financial crises. One of the risks that can affect this programme is the declining SACU revenue
which accounts for about two thirds of the GoL revenues resulting from deterioration of
economic activities in the SACU region and the global financial crisis. The risk can be mitigated
by increasing internal revenue sources like expanding the tax base as well as developing the
                                                   19

private sector which will increase the tax base. Prudent macroeconomic management will also
mitigate this risk.

6.2    The inadequate institutional capacity to implement the reforms could also affect
achievement of the intended targets. This risk will be mitigated by the provision of resources by
development partners to develop capacity through the budget support operation. The Bank like
other donors has supported human development through an institutional support programme
which will be completed this year.

6.3      Lesotho’s economy is integrated into the South African economy and it cannot implement
trade liberalization on its own. It is therefore necessary in the long term for Lesotho to increase
economic activities and improve linkages within its borders. The developed growth strategy has
identified some growth drivers that will help the economy to reduce dependence on the South
African economy.

6.4     There is a potential risk that current political tension may exacerbate and negatively
impact the investment climate. Facilitation of the post-election dialogue between the Government
and the opposition parties by the SADC Organ on Politics holds the promise of mitigating this
risk.

VII.         LEGAL INSTRUMENTS AND AUTHORITY

7.1          Legal Documentation

         The Fund will enter into the Grant and Loan Agreements with the Government of the
Kingdom of Lesotho for the purposes of the proposed poverty reduction support programme.
Both the Government of the Kingdom of Lesotho and the Fund will accept all the provisions of
the General Conditions Applicable to the African Development Fund Loan Agreements and
Guarantee Agreements (Sovereign Entities) and the General Conditions Applicable to Protocols
of Agreement for Grants of the African Development Fund. The total amount of the programme
will be UA 6.38 out of which UA5.64 million is a grant and UA 0.74 million is loan. The charges
and payments arrangements will be according to the policy and financing guidelines provided in
the ADF XI report. The Government will use its procurements system subject to the list of non
eligible items.

7.2          Conditions associated with Bank Group Interventions

7.2.1 Entry into force of the grant and loan parts shall be subject to fulfillment of the provisions
of section 10.01 for the loan and 12.01 for the grant of the General Conditions.

Conditions precedent to first disbursement shall be conditional upon submission by the
Government of the Kingdom of Lesotho of:

      (i)       Evidence of having opened a foreign currency account with the Central Bank of
                Lesotho to receive budget support resources, including proceeds of the ADF grant and
                loan.

      (ii)      Satisfactory performance assessment of the Fund’s 2009 PAF focus areas (indicated
                in paragraph 4.2.2), confirmed by the report of the Joint Assessment to be undertaken
                in 2009 by the Development Partners.

7.2.2 Undertaking: The Government of the Kindom of Lesotho undertakes to implement the
Fund’s 2010 Performance Assessment Framework focus areas (indicated in paragraph 4.2.2), the
                                                20

fulfilment of which shall be confirmed by the report of the joint assessment to be undertaken in
2010 by the Development Partners.

7.3    Compliance with ADF Policies

       This programme complies with all applicable Guidelines on Development Budget
Support Lending (DBSL), the ADF-11 financing guidelines provided in the Report on the
Eleventh General Replenishment of the Resources of the Fund and other Bank policies”.


VIII. RECOMMENDATIONS

        It is recommended that the Board of Directors approve that an African Development Fund
grant not exceeding UA 5.64 million and a loan not exceeding UA 740,000 be made available to
the Government of Lesotho for purposes and subject to the conditions stipulated in this report and
the loan and grant agreements.
                                                                                 Annex I
                           LESOTHO
          POVERTY REDUCTION SUPPORT PROGRAMME (PRSP)
                               Appraisal Report

ANNEX I    Letter of Development Policy


                           Office of the Minister of Finance
                        P.O. Box 14966, Maseru 100, Lesotho
      Tel: (+266) 22310826 Fax (+266) 22311041 E-mail: thahanet@finance.gov.ls
                                             Annex I
                 LESOTHO
POVERTY REDUCTION SUPPORT PROGRAMME (PRSP)
              Appraisal Report
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                                                                                                                                                                         Annex II
                                                                     LESOTHO
                                                    POVERTY REDUCTION SUPPORT PROGRAMME (PRSP)
                                                                               Appraisal Report

     ANNEX II- Programme Indicators for 2009 and 2010 (Extracted from the PAF)

Policy Objective        Activity                  Indicator        Base line situation   Target                            Target (to 8/2010)           Verification            Agency
                                                                                         (to 08 2009)
1. Improved poverty     Implementation      of    Annual           Budget framework      MTEF documentation for            Ministry of Finance and      MTEF                    MFDP
reduction               MTEF in order to          MTEF             papers         now    2009/10      to    2011/12        Development Planning         documentation and       (Budget
responsiveness,         improve the budgeting     process          prepared as part of   published as part of the          ensures the preparation of   annual   ministerial    Controller)
credibility,            process;    including     successfully     the budget process.   budget.                           annual reports by Line       performance reports.
comprehensiveness       increasing       links    completed        Budget execution      All ministries commence           Ministries covering
and transparency of     between the budget                         reports         are   preparation of MTEF for           physical and financial       Publication        of
budget                  and national growth                        prepared but not      2010/11 to 2012/13                performance.                 budget      execution
                        and poverty reduction                      published                                               Annual budget execution      reports
                        objectives                                                                                         reports published on the
                                                                                                                           Government website.
2. More efficient and   Improvement       of      Procurement      Regulations           Agree on follow-up actions        Implementation of agreed     Annual reports of       MFDP
professional            regulations and the       units adhere     introduced in 2007;   based        on         CPAR      follow-up actions based on   the      Procurement    Private
procurement systems     procurement process       to regulations   however,      some    recommendations.                  CPAR recommendations.        Policy and Advisory     Sector
ensure transparency,    based     on  agreed                       deficiencies     in   Review and revise the                                          Division      (PPAD)    Development
equity and economy      reforms from the                           procurement           coverage and provisions of                                     tabled in Parliament.   )
in        Government    Country Procurement                        systems         and   public           procurement
procurement             Assessment Review                          practices remain      regulations in light of CPAR
                        (CPAR)                                                           findings

3. Improved financial   a) Introduction of        IFMIS            Deficiencies    in    Phased roll out of IFMIS.         Online utilization of        Independent quality     MFDP
management in line      IFMIS to improve          Implemented      management      of    Installation certificate issued   IFMIS by key PRS             assurance report.       (Accountant
with           PEFA     internal control, cash    and              cash flows and        for all Ministries.               ministries                   Monthly Financial       General)
recommendations         management         and    operational      bank accounts as      Bank accounts rationalised.       Independent quality          Reports, including
                        accounting to enable                       existing GOLFIS       Initial core team and end         assurance review carried     bank reconciliations,
                        better    and     more                     system does not       users training completed          out.                         generated by IFMIS
                        transparent analysis of                    support adequate                                        All bank accounts
                        financial performance                      control accounting                                      recorded in IFMIS and
                                                                   and reporting.                                          reconciled on a monthly
                                                                                                                           basis.
                                                                                                                                                                         Annex II
                                                                      LESOTHO
                                                     POVERTY REDUCTION SUPPORT PROGRAMME (PRSP)
                                                                               Appraisal Report
                        b) Improvements in          Improved       Legal framework        Presentation of PFM&A Act     Implementation of provisions     PFM&A Act and          MFDP-
                        the       legal      and    PFM    legal   inadequate             to Parliament                 of PFM&A Act                     review            of   Accountant
                        institutional               framework                                                                                            implementation         General.
                        framework            that   implemented                           Continued implementation      Continued implementation of      progress.
                                                                                                                        PFM reform process.
                        promotes        financial                                         of PFM reform process                                          Quarterly reports on   MFDP (PFM
                        accountability       and                                                                                                         PFM reform process     Unit)    and
                        transparency                                                                                                                     submitted to IRSC.     GBS partners
                                                                                                                                                         PFM       assessment
                                                                                                                                                         reports.

4. Effective external   Improvement of the          Timely         Existing situation     Audit of Public Accounts      Audit of public accounts         Submission to Public   MFDP
auditing and scrutiny   auditing of public          completion     has seen significant   2006/07.                      2007/8.                          Accounts Committee     Auditor
                        accounts to enhance         and audit of   improvements in        Submission of audit reports                                    and publication of     General
                                                                                                                        Submission of audit reports to
                        fiscal   transparency       accounts       the auditing of        to Parliament.                                                 Auditor   General’s
                                                                                                                        Parliament.
                        and accountability                         public    accounts,    Adequacy of existing Audit                                     Reports.
                                                                   but       problems     act reviewed to see if
                                                                   remain.                amendments required.

     Source: Appraisal Report (extracted from the PAF Matrix)
                                                                                                                                                                 Annex III
                                            LESOTHO
                           POVERTY REDUCTION SUPPORT PROGRAMME (PRSP)
                                                                     Appraisal Report

ANNEX III                     Lesotho: Selected Economic and Financial Indicators, 2004–2013
                                                                                                          Est.                               Projections

                                                                   2004       2005        2006            2007      2008           2009            2010             2011    2012          2013

                                                                                        (Annual percentage change; unless otherwise indicated)
National income and prices

Real GDP                                                             4.6       0.7       8.1         5.1          3.9         2.1           5.5            4.5                    4.3       4.2
Real GNP                                                             2.2       0.0      10.7         5.0          4.7         -2.0          4.2             3.8                   3.9       4.0
Consumer price index (period average)                                5.0       3.4       6.1         8.0          12.0         8.5          6.6          6.1                   5.5           4.9
Consumer price index (end of period)                                 5.0       3.5        6.4       10.5           13.9        8.2           7.0         6.6                   5.4           4.9
GDP (millions of maloti)                                         8,332       8,750     10,269     11,778         13,418     14,899        17,012     18,741                20,523        22,203
GNP (millions of maloti)                                        10,240       10,683    12,844     14,722         16,898     17,998        20,298     22,224                24,244        26,178


External sector
Exports, f.o.b. 2/                                                  49.2       -7.3     7.5         14.9         -11.4        -8.9          1.5            -0.3               -0.7         -0.2
Imports, f.o.b. 2/                                                  31.0        1.0     4.6         17.3           5.2        -5.9          2.0             3.5                2.6          2.3
Nominal effective exchange rate 3/                                   0.5       -1.8     -3.6         0.6            ..         ...           ...             ...                   ...        ...
Real effective exchange rate 3/                                      0.7       0.0      -2.2         3.6            ---        ---           ---              ---                  ...        ...

Money and credit
Net foreign assets 4/                                               22.4       12.4     73.2         66.0                                                                          ...        ...
Net domestic assets 4/                                           -19.1         -3.3     -37.9        -49.7
Credit to the government                                         -23.7         -8.3     -22.7        -52.0                                                                         ...        ...
Credit to the rest of the economy                                    2.5       10.3     4.3           9.4                                                                          ...        ...
Broad money                                                          3.4       9.1      35.3         16.4                                                                          ...        ...
Velocity (GNP/average broad money)                                   4.4        4.3     4.2             3.9                                                                        ...        ...
Interest rate 5/                                                     8.5        7.2     6.9               7.8                                                                      ...        ...

                                                                                                     (In percent of GDP; unless otherwise indicated)
Investment and saving

Investment                                                          24.8       24.7     24.3        24.3          28.2       9.0          31.0            32.8              32.6           31.2
Public                                                               7.5       7.8      7.1         9.8           10.8       3.1          14.1            14.9             14.6            13.1
Private                                                             11.2       15.5     17.2        14.5          17.4       15.9         16.9            17.9              18.0           18.1
Lesotho Highlands Water Project                                      6.0        1.5     0.0          0.0           0.0        0.0          0.0             0.0                 0.0          0.0
Gross national savings (including remittances)                      19.1       17.2     28.6        37.0          24.4       20.5         24.4            27.2              27.3           26.2
Public                                                              13.4       12.7     19.7        26.2          19.6       16.4         17.9            20.6              20.4           18.9
Private                                                              5.6        4.5     8.9         10.8           4.9        4.1         6.6             6.6                  6.8          7.4


Government budget
Revenue                                                             47.8       50.4     57.6        63.5           60.7       54.0        52.5            53.9              54.1           54.2
Total grants                                                         2.7       2.2      1.1 1        1.3            2.0       3.7         4.8              5.8               4.9            2.9
Total expenditure and net lending                                   44.7       47.6     45.9        48.3           53.9       54.5        53.5            54.0              53.1           51.3
Overall balance (excluding grants)                                   3.1        2.8     11.7         15.2           6.8        -0.3        -1.0           -0.1                    1.0       2.9
Overall balance (including grants)                                   5.8        5.0     12.7         16.5           8.9         3.4        3.9             5.7                    5.9       5.8


Government debt                                                     57.4       54.5     50.3         42.9           52.4       43.1        39.6            37.3             36.1           35.5
Domestic debt                                                        9.1       9.3      8.1           6.7            5.6       4.8          4.3             4.2                3.9          3.8
External debt                                                       48.3       45.2     42.1         36.2           46.7      38.3         35.3            33.2             32.1           31.6
External debt-service ratio 6/                                       8.2       10.0     6.4           5.0            2.8       4.5          4.5            4.9              4.8             5.0

Balance of payment
        Current account balance (excl. official transfers)       -24.2        -28.6     -20.2         -24.8        -37.5      -36.9         -34.3         -34.8             -34.4         -33.8
Current account balance (incl. official transfers)                -5.7         -7.5     4.3            12.7          -3.7      -8.5          -6.5          -5.6                -5.3        -4.9

Gross official reserves (end of period)
Millions of U.S. dollars                                            458        501      693               958       982        885           848           861                    876       882
Months of imports of goods and services                             4.0        4.3      5.7                6.7       6.6        6.3           5.9           5.7                   5.6        5.5

Sources: Lesotho authorities; and IMF staff estimates and projections.

1/ Fiscal year beginning in April. All fiscal data are reported on a calendar basis.
2/ U.S. dollars.

3/ Based on partner-country data, new trade weights from 2004; a minus sign indicates a depreciation.

4/ Change in percent of broad money at the beginning of the period.

5/ The average effective rate on three-month treasurybills.
                                                                                                      Annex IV
                                 LESOTHO
                POVERTY REDUCTION SUPPORT PROGRAMME (PRSP)
                                          Appraisal Report

ANNEX IV         Prerequisites Conditions for PRSP


Prerequisites           Focus
General prerequisites       Political stability:
                        Lesotho political stability has been tested several times in the past. Recently there are political
                        tensions arising from the dispute on allocation of proportional parliamentary seats. However,
                        there is peace and rule of law.
                        Economic Stability
                             • There is macroeconomic stability in Lesotho:
                             • growth averaged over 6% for the last three years;
                             • Inflation averaged 6.15% in the last two years (2006-2007).
                             • Overall balance (including grants) was 16.5% of GDP in 2007 and was estimated to
                                  be 8.9% of GDP in 2008, and 3.4% in 2009 by IMF. However the 2009/10 GOL
                                  budget puts it at a deficit of 10.6% of GDP partly due to global financial crisis.
                             • current account balance (including official transfers) was 12.7% of GDP in 2007 and
                                  estimated at negative 3.7% in 2008.
                                 -2.5% in 2007
                             • total external debt was 36.2% in 2007 and 46.7% in 2008.

Technical                  Existence of well designed PRSP
Prerequisites                   • Vision 2020, PRS prepared in a broad consultative process being implemented
                                • MTEF, and ministerial budget framework papers prepared for the 2009/10
                                    budget
                                • Poverty Reduction Budget Support (PRBS) framework anchored on a
                                    collaborative effort between donors and GOL and agreed to undertake annual
                                    performance assessment reviews on the agreed reform policies and targets.
                                • Five donors have participated in the meetings for GBS namely: African
                                    Development Bank, DFID, European Union, Irish Aid, and the World Bank.
                                    World Bank provided budget support last year, AfDB and EU are preparing for
                                    approval this year.
                                • The World Bank undertook studies on Managing Public Finances for Growth
                                    and Poverty Reduction (2007); Public Expenditure Management and Financial
                                    Accountability Review (PEMFAR) (2007); Country Procurement Assessment
                                    Review (CPAR) 2007/08. PEFA review by some of the donors will be
                                    undertaken in 2009.
                                •    Development Partners agreed to use the country system for the budget support
                                    programme

Source: Appraisal Report
                             BRIEFING NOTE TO THE BOARD


1.      The Poverty Reduction Budget Support Program (PRSP) was appraised in February 2009
and is scheduled for presentation to the Board on June 17, 2009. The proposed operation will be
implemented over two years with a single disbursement for both the grant of UA 5.64 million
and a loan of UA 740 000. The Program has been designed as part of a program supported by the
Joint Budget Support (JBS) group in Lesotho comprising five members namely: Irish Aid, DFID,
EU, World Bank and the Bank. Irish Aid and DFID will not provide budget support this year;
EU signed a financing agreement in May 2009 and is yet to disburse while World Bank is
preparing its second operation for this year having provided one last year.

2.      The negotiations were held successfully on May 19, 2009 in Tunis. At the time, the IMF
Article IV Consultations of November 2008 staff report was not published because of the
ongoing discussion on the macroeconomic framework. Government was informed that an
assessment letter of the macroeconomic situation will be requested from the IMF, as per the
Bank rules. Government promised to provide macroeconomic indicators including the financing
of the fiscal gap. It was agreed that relevant sections of the appraisal report will be updated upon
receipt of the required information before presentation to the Board.

3.     The IMF letter received by the Bank on 1 June 2009 raised issues of fiscal sustainability,
revenue sources in view of the declining SACU revenues, high wage bill, and the need to
broaden growth. GoL indicated that the IMF macroeconomic estimates are based on the previous
budget estimates and not on their revised projections addressing issues raised by the IMF. The
two sets of figures differ significantly (e.g. GoL projects a deficit of 0.2% of GDP in 2009/10
and -9.0% in 2010/11 while IMF projects a deficit of 4.9% of GDP for 2009 and -17.2% for
2010). GoL and IMF are still discussing the budget figures and relevant macroeconomic
framework and the resolution may take some time.

4.      The original budget estimates approved by Cabinet and Parliament in February 2009
were based on appropriation while the revised estimates which have been endorsed by the
Cabinet Budget Committee on June 5, 2009 are based on the budget outturn and include
expenditure cuts in wages and salaries. In addition to the proposed expenditure cuts in both
capital and recurrent budget, line ministries have been requested to identify areas of further
expenditure reduction. GoL intends to present the revised budget to full Cabinet in a week’s
time. IMF has indicated that they will review the Government’s proposal only after confirmation
by the full Cabinet.

5.      In view of the ongoing discussion between the IMF and GoL on the macroeconomic
projections, which is expected to take some time, management has requested for a postponement
of the presentation of the operation to the Board from June 17, 2009 until reception of a revised
IMF assessment letter and/or information on an agreement reached between the Government and
the GOL on the macroeconomic framework. Please note that the disbursement of the ADF
resources is currently planned after the joint assessment of the program in September 2009.
                                                  1

         LESOTHO : POVERTY REDUCTION SUPPORT PROGRAMME (PRSP)

                                        CORRIGENDUM

BACKGROUND

Withdrawal of the Poverty Reduction Support Programme (PRSP) Appraisal Report from
the Board Agenda: The Lesotho-PRSP was originally scheduled for Board presentation on 17 June
2009. The presentation was postponed due to ongoing discussion between the IMF and Government
of Lesotho on fiscal projections and macroeconomic management issues which could not be
resolved    before the prior scheduled Board date (Board                    Information  Note
ADF/BD/WP/2009/74/Add.1 of June 15, 2009). GoL and IMF have now concluded their
discussions and a revised positive assessment letter has been received from the IMF (Technical
Annex III).

IMF Revised fiscal projections: At appraisal and through the review process up to the loan and
grant negotiation there was an estimated fiscal deficit of 11.7% and real GDP growth rate was
estimated at 2.1% in 2009. The revised assessment letter estimates a surplus of 1.9% of GDP in
2009 and a deficit of 4.8% in 2010, while real GDP growth rate is expected to be 1.4% in 2009. It is
in view of significant differences between information available at the time of Appraisal and current
information that this Corrigendum has been prepared to replace section 2.2 paragraphs 2.2.1 to 2.2.4
and section 4.3 paragraphs 4.3.1 and 4.3.2 of the Appraisal Report.

The IMF letter noted that with the corrective measures taken by Government, the medium
term fiscal sustainability risks have been reduced substantially. The reforms supported by the
program will further contribute to improve public expenditure and financial management.

2.2    Recent Economic and Social Development, Perspectives, Constraints and Challenges

2.2.1 Recent growth trends and macroeconomic performance: Lesotho has ensured prudent
macroeconomic management and economic stability since 2000. However, in 2008, the economy
started to be severely affected by the global economic downturn. Manufacturing activity slowed
down due to reduction in textile exports to the U.S. by about 11% year-on-year in December 2008,
while mining production and exports also fell due to weak prices for diamonds. By the end of 2008,
one mining company had suspended production in response to rapid fall in prices. It is estimated
that the economic growth momentum will further slow down to 1.4% in 2009 compared to 4.1% in
2008. Economic growth is however expected to improve in 2010 to 3.2% as mining and textile are
expected to recover. Consumer price inflation has continued to decline from 12% in September
2008 to 5.6% in August 2009 on account of lower fuel and food prices and a decline in inflation in
South Africa. The consumer price inflation period average is estimated to remain around 7% in
2009 and 2010.

2.2.2 Balance of payments deficit: The current account balance (excluding official transfers) is
projected to register huge deficits more than the last four years (2005-2008) in 2009 (-36.6%) and
2010 (-36.7%) of GDP. Including official transfers, the current account balance will also register
deficits in 2009 (-3.3%) and 2010 ((-9.0%) unlike in the last three years when it registered surpluses
(2006-2008). The deficit is due to reduced diamond and textiles exports, and remittances as well as
declining SACU revenues resulting from reduced economic activity in South Africa and the SADC
                                                          2

region. In addition, the implementation of the SADC Trade Protocol will have the potential to
further reduce the SACU revenue due to the agreed 85% tariff reduction of some traded goods and
services to zero tariffs in the region.

  2.2.3    Downward trend in overall fiscal balance: The surpluses of the overall fiscal balance
  recorded in 2005-2008 were due to both high economic activity in South Africa and the impact of
  a new SACU revenue sharing formula that became effective in 2005. The overall balance is
  projected to register a lower surplus of 1.9% of GDP in 2009 and decline to a deficit of 4.8% in
  2010. While Government has undertaken measures to improve revenue collection through the
  Lesotho Revenue Authority as well as the tax administration, this will not immediately offset the
  gap created by the reduction of the SACU Revenue.
  Table 2: Macroeconomic and Financial Indicators (calendar year)
                                                     2005    2006              2007     2008      2009    2010
                                                                                                  Proj.   Proj.
  Real GDP growth (%)                                     1.3      7.7         3.9      4.1       1.4     3.2
  Fiscal balance (incl. grants) (% of GDP)                4.5      16.7        11.2     3.6       1.9     -4.8
  Fiscal balance (excl. grants) (% of GDP)                2.4      15.7        9.6      2.0       -2.8    -11.5
  Non SACU fiscal balance                                 -23.0    -23.9       -25.3    -33.9     -33.3   -29.0
  Consumer price index ( period average)                  3.5      6.1         8.0      10.7      7.2     7.0
  Current account balance (incl. off. trans) (% of GDP)   -8.2     4.8         14.0     12.7      -3.3    -9.0
  Current Account balance(excl. off. Trans) % of GDP      -31.0    -22.1       -27.3    -20.1     -36.6   -36.7
  External debt (% of GDP)                                48.4     50.0        52.8     51.3      48.2    43.6
  Gross official reserves (months of imports)             4.4      5.8         6.8      6.2       6.1     5.5
   Source: IMF, ESTA and GoL
2.2.4 Fiscal Sustainability Challenges: Fiscal
                                                              Box 1: Impact of the Global Financial Crisis and
management is likely to become more                           Economic Downturn
challenging in the near future due to lower SACU              Lesotho is facing significant downside risks arising from
revenues, and GoL needs to strengthen non-                    the global financial crisis and economic downturn mainly
SACU revenues while containing overall                        because of the country’s high dependency on:
                                                              insufficiently diversified textile-based exports to the U.S.;
expenditures and shifting the allocation of                   diamond mining; SACU revenues; and remittances from
resources      towards    development     oriented            migrants workers employed in South African mines.
activities that support growth. GOL is committed              Consequently, the following knock-on effects of the crisis
                                                              are being felt:
to taking measures to raise non-tax and non-                  •    real GDP growth is projected around only 1.4% in
SACU revenues to ensure fiscal sustainability.                     2009,essentially due to falling demand for its textile
Development Partners including the IMF are                         exports to the U.S. and a reduction in mining
                                                                   production and exports;
helping Lesotho to improve revenue collection by              •    some of the Asian owned garment factories are
broadening the tax base and defining new areas                     finding it hard to obtain credit for input financing from
of growth. One of the Pillars of the Performance                   their countries’ banks due to the global credit
                                                                   crunch;
Assessment Framework used to monitor progress                 •    SACU receipts, which account for over 50% of
on agreed development indicators is Governance                     public revenue, are projected to fall significantly
and Public Financial Management which                              following a recession in South Africa’s growth
                                                                   prospects; and the global financial crisis
monitors             budget           creditability,          •    remittances from migrant mineworkers in South
comprehensiveness, and transparency; as well as                    Africa, which account for about 20% of GDP, are
external audit and financial recording through the                 expected to decline due to the fall in the number of
introduction of the Integrated Financial                           migrant mineworkers, which is likely to exacerbate
                                                                   Lesotho’s unemployment rates.
Management Information System (IFMIS) in
April 2009.
                                                    3

2.2.5 Prudent Management of External Debt: GoL’s accumulated gross international reserves
reached 6.8 months of import cover in 2007 and 6.2 months of import cover in 2008 and are
expected to slightly decline to 6.1 months in 2009. The foreign reserves are likely to decline further
if GoL draws them down to finance the expected budget deficit in 2010. The maintenance of high
international reserves depends highly on the continued pursuit by Government of a prudent fiscal
stance in the face of falling levels of exports and remittances. Lesotho’s external debt increased to
52.8% of GDP in 2007 from 48.4% in 2005 and is expected to decline to 48.2% in 2009 and further
to 43.6% in 2010. GoL was able to limit external debt by adopting a policy to use part of the SACU
revenue windfalls to retire its non-concessional debt as well as its policy to contract concessional
loans with a grant element of 35% and above. This prudent debt management will need to be
strengthened in the context of decreased SACU revenues. Some of the impacts of the global
financial crisis that are affecting Lesotho are shown in Box 1.

4.3     Financing needs and arrangements

4.3.1 Fiscal gap in 2010/2011, originated by declining fiscal revenue and fiscal stimulus to
counteract the impact of economic slowdown: As a percentage of GDP, revenue are expected to
decline to 66.3% and 57.4% respectively, in 2009/10 and 2010/11. This is due to reduced SACU
revenue resulting from low economic activity in South Africa and the region. GoL expenditure is
expected to increase to 64.5% of GDP in 2009/10 due to a stimulus projects/programmes
established by the GOL and aimed at creating employment for citizens retrenched from local and
South African mines and manufacturing companies affected by the financial crisis. The authorities
are however committed to take corrective measures to reduce expenditure, that are expected to
decline to 62.2 % of GDP in 2010/11, as indicated in paragraph 2.2.4 above.

Table 5: Budget Projections (in percentage of GDP)
                                      2005/06   2006/07   2007/08   2008/09   2009/10   2010/11
 Total Revenue and grants             55.6      66.7      64.4      67.4      66.3      57.4
 Grants                               2.0       1.0       1.6       1.6       4.6       6.6
 Total expenditure and Net Lending    51.1      50.0      53.2      63.8      64.5      62.2
 Overall Balance (including grants)   4.5       16.7      11.2      3.6       1.9       -4.8
 Overall balance (excluding grants)   2.4       15.7      9.6       2.0       -2.8      -11.5
 GDP (millions of maloti)             8,061     9,384     10,703    12,767    13,632    15,117

 GDP (approximate USD $1=M10.05)      802.09    933.73    1064.98   1270.35   1346.42   1504.18
Source: IMF and Lesotho authorities (Fiscal year April –March)

4.3.2 Financing the 2010/11 budget deficit: The overall fiscal balance of 1.9% of GDP in
2009/10 takes into account expected budget support resources from Development Partners (DPs)
estimated to an amount of USD 49.96 million which is 3.7% of GDP, leaving 0.9% to other sources
of funding. In 2010/11, even with increased grants (6.6% of GDP) the overall fiscal deficit is
estimated at 4.8% of GDP. The Bank’s contribution (USD9.36) will be about 0.7% of GDP. The
Bank resources are aimed at reducing the expected financing gap in the fiscal year 2010/11.

				
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