Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. 17751 - LSO

MEMORANDUM OF THE PRESIDENT

OF THE

INTERNATIONAL DEVELOPMENT ASSOCIATION

TO THE

EXECUTIVE DIRECTORS

ONA

COUNTRY ASSISTANCE STRATEGY

OF THE

WORLD BANK GROUP

FOR

THE KINGDOM OF LESOTHO

MAY 21, 1998

Southern AfricaAfrica Region

This document has a restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization.

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The last Country Assistance Strategy for Lesotho was reviewed by the Executive Directors onJanuary 25, 1996

CURRENCY EQUIVALENTS

Currency Unit = Maloti (plural) Loti (Singular)

US $1 = M4.61 (Average 1997)

FISCAL YEAR

April 1 - March 31

ABBREVIATIONS AND ACRONYMS

AfDB African Development BankBCP Basotholand Congress PartyCBL Central Bank of LesothoCMA Common Monetary AreaDFID Department for International Development (UK)EU European UnionGDP Gross Domestic ProductGEF Global Environmental FacilityGNP Gross National ProductGTZ Gesellschaft fur Technische Zusammenarbert (Germany)IMF International Monetary FundLCD Lesotho Congress for DemocracyLCU Labor Construction UnitLHWP Lesotho Highlands Water ProjectLHRF Lesotho Highlands Revenue FundNGO Non-Governmental OrganizationPAP Poverty Action PlanPFP Policy Framework PaperPPA Participatory Poverty AssessmentSACU Southern Africa Customs UnionSADC Southern Africa Development CommunitySEOR Strategic Economic Options ReportUNDP United Nations Development ProgramUSAID United States Agency for International developmentWFP World Food Program

Vice President Callisto MadavoDirector Pamela CoxSector Manager Ataman AksoyStaff Member James Sackey

.i.

LESOTHO FOR OFFICIAL USE ONLYCOUNTRY ASSISTANCE STRATEGY

TABLE OF CONTENTS

EXECUTIVE SUMMARY. v

I. BACKGROUND.

II. MACROECONOMIC PERFORMANCE AND PROSPECTS . 3

Recent Economic Performance .3External Developments and Lesotho's Economic Prospects . 5

III. LESOTHO'S DEVELOPMENT AGENDA .6

Central Development Issues and Agenda .. 6A. Reducing Poverty .6B. Integrating into the Regional and Global Economy . 9

IV. THE BANK'S COUNTRY ASSISTANCE STRATEGY. I I

Implementation of the Last CAS .11Country Assistance Strategy .13Composition of Bank Assistance .14

V. LEVEL OF BANK SUPPORT AND RISK MANAGEMENT ................................ 17

BOXES:

Box 1: The Economic Impact of the LHWP .2Box 2: The National Environmental Action Plan (NEAP .8Box 3: Constraining Impact of Lesotho's Utilities .9Box 4: Administrative Barriers to Investment in Lesotho .10Box 5: Lesotho's Portfolio Overview .11Box 6: The Recent Client Survey .12Box 7: Poverty and the CAS .14Box 8: Cross-cutting Themes .16

TABLES:

Table 1: Triggers for Staying in the High-Case Scenario .17Table 2: Proposed IDA Program, FY99-00 .18

FIGURES:

Figure 1: Selected Social Indicators .IFigure 2: Selected Economic Indicators .3Figure 3: Lesotho's Growth Fundamentals and Linkages .5

iii

This document has a restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization.

ATTACHMENTS:

Attachment I: Lesotho: Poverty and the CAS ........................................ 21Attachment Il: Alternative Economic Growth Scenarios ...................................... 23Attachment III: CAS Consultation Process ............... ......................... 27Attachment IV: Client Feedback Survey ........................................ 28Attachment V: Lesotho: Activities of Principal Donors ........................................ 29Attachment VI: Lesotho Highlands Project ........................................ 31Attachment VII: Standard CAS Annexes ................. ....................... 33

MAP

iv

EXECUTIVE SUMMARY

i. The Bank's Country Assistance Strategy (CAS) for Lesotho, which was reviewedby the Board on January 25, 1996, focused on helping the Government to exploit theeconomic opportunities available through the Lesotho Highlands Water Project (LHWP)and the emerging export manufacturing sector, while pursuing poverty reduction byfostering labor-intensive growth, investing in human resource development, and improvinginstitutional capacity.

ii. What Worked Well: Bank support is a having afavorable development impact. Banksupport for population and health has led to a restructuring of the previous rudimentary healthdelivery system and a major expansion of health services in the rural areas. Through the multi-donor project in education, the Bank is credited for bringing about broad consensus betweenGovernment, churches and communities on education policy and decision-making. An ongoingIndustry and Agro-industry Project has introduced a range of investor-friendly reforms, and theBank is helping to address the distress in the two Government-owned banks through support forthe Government's privatization project. The ongoing Road Maintenance and Rehabilitation Projectis helping to prioritize future infrastructure investment and build the local capacity forinfrastructure maintenance. Bank's involvement in LHWP helped to ensure that the social andenvironmental aspects of the project are appropriately managed. The macroeconomic dialogue,through the joint IMF/Bank/Government Policy Framework Paper (PFP) has been responsible forsetting the broader framework for economic stabilization and fiscal prudence. Policy advice hasbeen more client focus and, through the broader participation of civil society, NGOs and others inthe CPPR, has helped improved the Bank's relation with Lesotho.

iii In general, the improvements in the Bank's portfolio continued. The current portfolio hasno problem projects. Past difficulties encountered in disbursements and procurement have beenproject specific and have been addressed. Two highly participatory Country Portfolio PerformanceReviews (CPPRs) have taken place in June 1995 and June 1997. A Country ProcurementAssessment Review was also carried out in early June 1997 and discussed at the June 1997 CPPR.The recent CPPR discussions focused on problems in disbursements and procurement. A responseto these discussions will be the proposed IDF grant that will include capacity building forprocurement and disbursements. Sufficient resources will continue to be allocated for supervision.Implementation capacity on the part of the Government continues to be a constraint. Support tocapacity building is provided in all projects.

iv. What Did Not Work Well: The impact of the Bank's program on poverty reduction inLesotho remains unclear, in part because of the lack of data. Poverty reduction remains a keychallenge despite substantial improvements in economic growth. The Bank was also not able toachieve the high lending growth scenario envisaged in the last CAS because of: (i) slow progress inprivatization, (ii) limited attention to private sector competitiveness (especially in the light of theproblems of the three utilities), and (iii) constraints on implementation capacity.

v. Challenges Ahead: Lesotho is at a crucial juncture in its political and economicdevelopment. The elections in May, 1998 constitute an opportunity to strengthen the ongoingdemocratization process. On the other hand, four developments in the economic arena are likely tochange fundamentally Lesotho's growth prospects. First, the declining profitability of the goldmining industry and ongoing technological changes in the sector have led to a significant reduction

v

in the overall demand for Basotho labor. Second, ongoing trade reform in South Africa will meansubstantial decline in customs revenues for Lesotho. Third, counteracting the two unfavorabledevelopments, is the emergence of the fast growing garment industry (which now accounts forabout 85 percent of total exports and has generated about 4,000 new jobs since 1991). Finally, theconstruction of LHWP to export water to South Africa has provided a unique opportunity forLesotho to capitalize on its main natural resource: beginning 1997, LHWP will provide an averageof $45 million in royalties per year (10 percent of Government Revenues).

vi. Government's Development Agenda: Lesotho's national development objectives andstrategies have been articulated in a number of policy documents during the past few years,notably the Sixth National Development Plan (1996/97 - 1998/99) and the Strategic EconomicOptions Report (SEOR, 1997). They stress:

* Government's commitment to reduce poverty based on sound economic growth, moreproductive use of labor, the country's (and especially the poor's) most abundant resource, andmanagement of poverty related natural environmental degradation; and

* the need to seek closer economic integration with regional and global economies, bymaintaining external competitiveness, promoting private sector development and buildinginstitutional capacity to support these efforts.

vii. Focus of Bank Assistance: Responding to the outcome of the participatory CASprocess, the objectives of the Bank's assistance for the next two years (FY 99-00) are to workwithin the context of Lesotho's development agenda by supporting the Government's strategy ofpoverty reduction and its efforts to sustain macroeconomic performance through greater integrationinto the sub-regional economy. In this context:

(a) The Bank will support the Government effort of poverty reduction through investingin human resource development: strengthen education and on-the-job/vocational training to dealwith Lesotho's severe capacity constraints and to make the work force more adaptable to labor-market changes in and outside the country, as well as, improve health delivery systems;providingtechnical assistance for the reform of the LHRIF: redefine the focus of the fund to be povertyoriented and to support capacity building; andpromoting a comprehensive approach to the naturalresource environment: ensure conservation of natural resources and protection of the environment,especially land degradation, through support for the Government's environmental action plan,agricultural sector development strategy, water management systems, and population planning.

(b) The Bank will also support efforts to improve Lesotho's competitiveness by providingassistance to ongoing efforts to improve the enabling environment for private sector development,including initiating reforms to reduce transactions costs associated with public utilities, enhancingfinancial sector activities, and expanding exports. Gender, governance and capacity building arethemes which will be reflected in all these areas.

viii. Partnership With Other Donors: The Bank and the EU are the major donors inLesotho, with the Bank's comparative advantage in lending and policy advice. However, over thepast few years, most project support for Lesotho has been multi-donor (especially given the movetowards sector investment programs), with leadership provided by different donors on the basis oftheir comparative advantage. The Bank and the IMF will continue to work hand-in-hand insupporting macroeconomic reforms through the PFP. In the areas of poverty reduction and humanresource development, the Bank will continue to work closely with the USAID, DFID, and AfDBon educational reform; with Ireland and DFID in supporting health care delivery; and take theleadership in the agricultural sector program by bringing together the EU and other donors. TheUNDP is responsible for donor coordination in Lesotho and has taken the leadership (with DFID

vi

and AfDB) in civil service, decentralization and natural environmental reforms. The Bank will usethe outcome of these interventions by other donors in its broader macroeconomic policy dialoguewith the Government.

ix. Risks: The level of Bank lending would be contingent on: (i) the implementation ofprograms to deal with poverty reduction (such as the establishment of the enhanced LHRF); (ii)improvements in project implementation; (iii) the continued maintenance of fiscal restraint andimproved macroeconomic performance; and (iv) improvements in external competitiveness(through concrete actions to deal with the public utilities and the financial sector). Under the base-case scenario, four operations involving support for the social fund, education, health andenvironment, averaging a commitment of $25 million a year for FY99-00, are proposed. There areno creditworthiness concerns as no IBRD loans are proposed for the CAS period. The main risk tothe Bank's program could come from a serious slippage in the Government's adjustment effort. Butthe likelihood of a radical departure from prudent management of the economy is minimized byprogress in Lesotho's ongoing democratization process and efforts to achieve good governance.Consultations with various segments of the society during the CAS preparation indicatedwidespread support for prudent economic management and progress in attaining fiscaltransparency.

x. Agenda for Board Consideration: A key element of this CAS is the proposal to buildon the main elements of Bank strategy as defined in the 1996 CAS, focus on the use of a widerblend of instruments now available to IDA and intensify attention to poverty reduction. Theproposed lending levels are much higher than those attained during the past two years (excludingthe enclave IBRD for LHWP), in part because the demand for Bank support is higher than beforesince the key development issues facing Lesotho are those for which the Bank has comparativeadvantage. Furthermore, Bank lending continues to serve as an important instrument forleveraging both official bilateral and private sector support for Lesotho. Lesotho is a highperforming country which has received less than its per capita share of IDA. The region hasidentified Lesotho as having the potential to absorb more IDA. The Board may wish to considerwhether:

- there exists sufficient implementation capacity in Lesotho to handle the proposed levels oflending at the base case; and

* the overall thrust of priorities and instruments proposed by the CAS, which focuses on povertyreduction, are appropriate and reflect the Bank's comparative advantage in Lesotho.

vii

MEMORANDUM OF THE PRESIDENT OF THEINTERNATIONAL DEVELOPMENT ASSOCIATION

TO THE EXECUTIVE DIRECTORS ON ACOUNTRY ASSISTANCE STRATEGY OF THE WORLD BANK GROUP

FOR THE KINGDOM OF LESOTHO

I. BACKGROUND

1. Resource Constraint and Poverty. Lesotho is in many respects a unique country. It is land-lockedand the only country wholly surrounded by a single country (South Africa). Its population of about twomillion people have been driven by the forces of history into the mountainous terrain (30,355 sq. km), withless than one-fifth that can be considered arable (it has no lowland below 1400m in altitude) and lacks naturalresources other than clay deposits and water. Thus deprived, the Basotho were among the first recruited whenmining began to boom in South Africa toward the end of the last century. At its peak year (1989), about 30percent of Lesotho's labor-force worked in the mines in South Africa.

2. Although declining, migrant earnings still constitute about 30 percent of Lesotho's GNP. Over 90percent of imports come from South Africa, and customs duties collected on these imports account for 50percent of Govemment revenues. Due to poor resource endowment, agriculture has remained asupplementary source of income, undertaken mainly by children (the male herdsmen) and women. Thepattern of limited domestic employment opportunities has meant that income inequality and poverty areprevalent. Despite data limitations, a 1993 survey estimated that about 49 percent and 26 percent of thepopulation could be classified as either poor or very poor. Poverty is worst in the rural and mountainousregions where the profitability of farming is low and dependence on miners' remittances high (Attachment I).Rural poverty is also a cause and consequence of the serious environmental problems confronting Lesotho.Unrelenting pressures on the fragile mountainous ecosystems have been exacerbated by population growthpressures (estimated at 2.1 percent per annum), expanding use of marginalized areas for agriculturalproduction, and over-exploitation of livestock grazing and fuelwood collection.

3. Substantial improvements, nonetheless, have been made in a number of social indicators over the pastdecade (Figure 1). In addition to improvements in social indicators, about 80 percent of the population hasaccess to health facilities, while 90 percent (urban) and 40 percent (rural) have access to safe drinking water.

Figure 1: Selected Social Indicators

100

m ~~~~~~~~~~~MLI]e

Male Female IM Male FemaleLE LE AL AL

Notes: 1. Life expectancy (LE) in years, base year: 1976; latest: 1995.2. Infant Mortality (IM) numbers/1000, base year: 1986; latest: 1997.3. Adult Literacy (AL) in percentage, base year (1986); latest: 1995.

4. Governance. Lesotho is at a crucial juncture in terms of a number of issues with respect to goodgovernance; namely, how government, broadly defined, can effectively and productively interact with andserve the Basotho society at large. With the ushering in of the Basotholand Congress Party (BCP) in 1993,party democracy was restored (after seven years of military rule); albeit effectively as a one-party democracysince the BCP won all 65 seats irn the lower house. But the fragility of the democratic process wasimmediately exposed by mutinies in the ranks of the defense force, labor unrest on the part of the police forceand teachers, and a Palace-led coup d'etat in August 1994, which was reversed a month later with theassistance of political intermediation by neighboring states. These developments and subsequent internalconflicts within the ruling government led to a major split in the government in mid-1997. It resulted in twoparties in parliament; the BCP was replaced by the Lesotho Congress for Democracy (LCD) as the rulinggovernment. An election is scheduled for May 23, 1998, the outcome of which is not clear. The impact of theevolving democratic environment, the inexperience of the new government and parliament in policy makingand implementation, and concerns about the future of the Government resulted in extended hiatus on the partof the Government in undertaking critical structural policy reforms. Good governance is also impeded by (i)inadequate capacity and incentive system in the public sector; (ii) weak privatization and private sectordevelopment; and (iii) evolving decentralization and local government process aimed at diversifying thedecision-making process.

5. At the same time, four developments in the economic arena are likely to change fundamentally theeconomic landscape and growth prospects in Lesotho. First, the declining profitability of the gold miningindustry and ongoing technological changes in the sector have led to a significant reduction in the overalldemand for Basotho labor. The number of Basotho workers employed in South African mines declined fromthe peak of 126,733 in 1989 to an estimated 97,000 in 1997; associated remittances declined from $365million per annum to $312 million per annum over the same period. This will mean continuous declines inincomes of poor households. Second, ongoing trade reform in South Africa will mean substantial decline incustoms revenues. Third, counteracting the two unfavorable developments, is the emergence of the fastgrowing garment industry (which now accounts for about 85 percent of total exports and has generated about4,000 new jobs since 1991). Finally, the construction of the Lesotho Highlands Water Project (LHWP) toexport water to South Africa has provided a unique opportunity for Lesotho to capitalize on its main naturalresource (Box I and Attachment VI): beginning 1997, LHWP will provide an average of $45 million inroyalties per year (10 percent of Government Revenues).

Box 1: The Economic Impact of the LHWP

The Lesotho Highland Water Project (LHWP), construction of which began in 1992, is one of the mostambitious multi purpose projects presently under implementation in Lesotho. By exporting a portion of the water fromthe Senqu/Orange river system through a series of dams and tunnels into the Vaal river system, Lesotho can effectivelyutilize one of its most abundant resource to support its economic development goals. Phases IA and lB of this five-phase project is estimated to cost about US$ 4.0 billion alone, while further phases may be feasible with constructionpotentially continuing until 2020.Given the relatively small size of the Lesotho economy, a project of this magnitudemust have a dramatic effect on the country. A number of studies conducted in 1995 points to the following selecteddirect and indirect impacts of the project on the economy:

* A simulation analysis of the economy with and without LHWP expenditures suggests that, after taking into accountLesotho's dependence upon imports, the project directly and indirectly accounted for about 12.6 percent of real GDP in1990; 14.3 percent in 1994; and forecast estimates of 13.6 percent in 1998 and 5.9 percent in 2002.* The Government's budget has also been a net beneficiary, indirectly, of LHWP expenditures. It is estimated that in1994 about 20 percent of total government revenues (excluding grants) could be attributed to the effect of LHWP onimports (custom receipts) and the direct and indirect effects on income (personal and company taxes) and consumption(sales taxes).

2

6. In view of these trends and the structure of the economy, the development challenges facing thecountry are first, how to reduce poverty, and second, how to respond to the radical changes taking place in theregion at both the political and economic arena and deal with globalization. Dealing with Lesotho's highlevel of poverty has been the central policy objective of the Government since the Fifth NationalDevelopment Plan (1991/92 - 1995/96), the rationale behind the theme of "sustainable human development"underpinning the current Sixth National Development Plan (1996/97 - 1998/99), and it is the core theme ofthe Bank's Country Assistance Strategy (CAS) for Lesotho, which was reviewed by the Board on January 25,1996, and this CAS.

II. MACROECONOMIC PERFORMANCE AND PROSPECTS

Recent Economic Performance

7. Progress During 1995-97. The stabilization measures undertaken by the Government, under thePFP, continue to be successful. Reflecting largely the positive impact of the LHWP and prudent fiscalmanagement, real GDP growth averaged almost 10 percent during 1995-97, while inflation ranged from 6-10percent. Buoyed by the high growth rates and investment/GNP ratios, fiscal performance also improvedsubstantially (Figure 2). The overall fiscal balance (after grants) averaged a surplus of 3.5 percent of GDP.Improvements, in large part, reflected the extraordinary growth in customs revenues generated by the highlevels of imports associated with LHWP; custom revenues averaged 25 percent of GDP (compared to 10percent in the mid-1980s). In view of the transitory nature of this revenue surge, the Government built upsubstantial deposits as a hedge against less favorable conditions anticipated in the near future on account ofthe revision to the SACU formula and the winding down of LHWP.

Figure 2: Selected Economic Indicators

(Growth Rates of GDP, Exports, (SACU, Overall Budget and Currentand CPI, in percentages) Account of BOP as percent of GDP)

15<- ~~~~~~~~~~40 - § ..>S Wg

10 * 30'-4-Real 20

5 ~~~~~GDP 10 *SACU0 *- -u-Real 0 Receipts-6 | g 1 99f 1Q97 -*-Rt -10 .Overall

-10 CPI -20 Budget-10 -30 TJ D CurrentAcct.

________________ ~~~~~-40 K-15 / N ' : " 0niz -'? ^* ~~~~~~~~~~~~~~~~~-50-20 -60

1990 1995 1997

Notes: a/ Overall budget balance, including grants.b/ CPI: Consumer price index.c/ SACU: Southern Africa Customs Union.

8. Throughout the period, growth in domestic credit was moderated by the budget surpluses and theaccumulated official reserves of the CBL. The overall balance of payments position remained strong, asLHWP investments and moderate official borrowings exceeded the current account deficits, which averaged

3

33 percent of GDP (18 percent of GNP) for the three years. Official reserves improved from 6.8 months ofimports (excluding LHWP imports) in 1995 to 8.6 months in 1997.

9. The Unfinished Agenda. The structural reforms and sectoral policies are somewhat less impressive.Except for the Lesotho Highlands Revenue Fund (LHRF), the Government has not been able to makesignificant progress in implementing programs to radically address poverty that were outlined in the PovertyAction Plan (completed in early 1996) and further developed in the documentation for the 1997 Round TableConference (RTC). The Government's privatization program, initiated in 1995 with the establishment of thePrivatization Unit (PU), exhibited slow progress.1 By end-1996 only two small enterprises were liquidatedand one firm was sold outright in a scheme containing 35 enterprises earmarked for divestment. The programgained some momentum in 1997 with the selling of the Lesotho Airways Corporation and several enterprises,including the Lesotho Flour Mill and Loti Bricks, were brought to the point of sale. The earlier delays wereattributed to the lack of autonomy and clear authority of the PU, the limited scope of the domestic privatesector in participating in the program because of its small size; and Lesotho's sensitivity to foreign influence,especially that of South Africa. A major challenge is how Lesotho can integrate economically with SouthAfrica and still retain its national identity. The Government has recently increased the autonomy of the PUby reducing the time allowed for relevant ministries to sanction privatization proposals and streamlinedcabinet approvals, which were required at various stages of the privatization process. Closely related to thereforms of the public enterprises are the constraints posed by the continuing poor performance of the publicutilities (water, electric power and telecommunications) to industrial development. Reform proposals in thisarea have only recently been initiated and include, as part of the effort to privatize the three utilities: (i)resolution of fundamental management and capital adequacy problems for the electric power andtelecommunications corporations; (ii) dealing with serious operational and cost inefficiencies associated withall three utilities; and (iii) establishing an adequate regulatory environment by adapting a new legislativeframework and creating an independent regulatory body.

10. The anticipated reform of the civil service has not yet materialized and its objectives remain vague.As initially contemplated, the civil service reform emphasized skill development through intensive retrainingand did not sufficiently focus on containing wage costs and streamlining government functions. Littleprogress has been made in establishing a lean and efficient civil service, and the public wage bill continues torise at an unsustainable rate. Wages and salaries as a share of total current expenditures rose from 44 percentin 1992/93 to an estimated 51 percent in 1996/97. Most ministries thus have limited resources in their budget,after wage payments, to support development (and poverty reduction) activities. Furthermore, in light of thecontinuing weaknesses of the civil service, its capacity to design and implement programs to deal withpoverty reduction continues to be largely undermined. In the mean time, the Government has initiated(through the enactment of the Local Government law) the process of increasing grassroots participation ineconomic decision-making. Progress with structural reform has been hampered by the learning process of thenew Government and parliament in policy formulation and implementation occasioned by the break inparliamentary democracy. The success of the export manufacturing sector has also exposed the limitations inthe local labor market and weaknesses of the domestic private sector. Civil unrest in the early 1990s and therecent 1998 unrest of a number of garment industry workers were fueled by local resentment againstforeigners taking over certain economic activities and job positions considered to be the realm of localentrepreneurs and workers. The sustainability of reformn is also threatened by the pressure to deal withsignificant wage increases in the civil service as opposed to structural changes.

The Government's target was to privatize at least 5 public enterprises (PEs) per year over the next five years, beginning1995.

4

External Developments and Lesotho's Economic Prospects

11. Growth Determinants and Linkages: Lesotho's short to medium term growth prospects point tostructural decline in the external sources of revenue, which underpinned growth in the past: continuingdecline in migrant workers remittance,2 a fall in the Southern Africa Customs Union (SACU) receipts,3 andthe reduced scope of LHWP (Figure 3). These developments could trigger an economic slowdown in theshort-term that could put pressure on the fiscal system and further generate external imbalances. In themedium term, continuing rapid population growth and limited employment opportunities in South Africa, inturn, could exacerbate unemployment and poverty, leading to increased pressure on the limited land base (asagriculture remains a fall back source of income) and informal non-farm activities. Both developments couldaccentuate Lesotho's growing environmental degradation, which could further indirectly impact on furthereconomic slow-down.

Figure 3: Lesotho's Growth Fundamentals and Linkages

SHORT TERMMEDIUM TERM

Decline in Migrant RdcdSope ofn Workers LHWP+ Constraints 3 Receipts

Remittances to External Investments Rapid Population Growth +Limited SA Employment

Economic Slow-downIncreased Unemployment

and Poverty

Pressure on Limited LandIncrease in Increase in Fiscal Resources

External Imbalance Imbalance .T

Increased EnvironmentalDegradation

12. Three growth scenarios for Lesotho could be developed (Attachment II) based on assumptionsrelating to the Government's response to the evolving external environment sketched above:

- Base case scenario: The base-case scenario assumes that the Government will continue to pursueits stabilization policies but without substantial structural reforms in the critical areas of privatization, utilityand financial sectors. Assuming a conservative fiscal stance, it is anticipated that there would be a slight dropin investment (as a share of GDP), reflecting the impact of LHWP and the decline in SACU revenues after2000. Exports are expected to grow at a slower rate than in the past as the constraints of the utilities becomeincreasingly important. Further declines in workers' remittances could lead to a sluggish businessenvironment. As a result of this, the external current account deficit as a share of GDP is projected to slightly

2It has recently been estimated that 14 mines employing 130,000 workers are currently unprofitable and the NationalUnion of Mineworkers in South Africa has announced that nearly 300,000 jobs may be slated for retrenchment.

3 Botswana, Lesotho, Namibia, South Africa, and Swaziland are members of SACU.

5

increase. The economy is expected to grow at a modest rate of 1.5 percent in 1998, mainly because of theexpected drop in agricultural output resulting from the drought impact of El-Nino. GDP is, however,expected to recover during 1999-2000 and grow at an average annual rate of slightly less than 5 percentbecause of the recovery in agricultural output and the continuing positive impact of LHWP Phase 1 B.

- Low case scenario: The low case scenario assumes significant policy slippage (and is comparableto the pre-reform period of the mid-1980s). It is premised on a significantly high public wage concessionwithout compensating revenue mobilization, leading to substantial drop in public investment. The fiscalsystem is expected to come under substantial pressure. The resulting income effect due to fiscal expansionwill also put pressure on the external current account and weaken the foreign reserve position, as compared tothe base case scenario. Moreover, industrial sector performance is expected to be mediocre as a result ofcontinuing problems with the utilities and financial sectors. The projected average growth rate of about 2.5percent per annum would barely keep up with the population growth rate (2.1 percent).

- High case scenario: The high case scenario assumes buoyant growth in exports resulting fromresolution by 1999 of the constraints posed by the utilities sector and further improvements in the. generalbusiness environment. A strong recovery in the agriculture is predicated on policy reforms that would moveforward the agenda to deregulate the sector by removing the constraints posed by public enterprises andimproving the capacity of the public sector in service delivery. Strict adherence to a conservative fiscalstance, complemented by the proceeds from the sale of public enterprises, would help offset the anticipateddecline in investment/GDP during 1999-2000 and support a buoyant economy. Further opening up of theeconomy, together with aggressive implementation of structural reforms, such as those for the utilities and thefinancial sector may increase foreign direct investment and support the emerging export manufacturingsector. Economic recovery under this scenario will be sharp following low growth anticipated for 1998. It isprojected that real GDP growth rates for 1999-2000 could be in the range of 6-7.5 percent, on average.

III. LESOTHO'S DEVELOPMENT AGENDA

Central Development Issues and Agenda

13. Lesotho's national development objectives and strategies have been articulated in a number of policydocuments during the past few months, notably the Sixth National Development Plan (1996/97 - 1998/99)and the Strategic Economic Options Report (SEOR, 1997). They stress:

(a) the Government's commitment to reduce poverty based on sound economic growth and theestablishment of an enabling policy environment which encourages productive employment opportunities.The Government recognizes that any strategy to reduce poverty must promote a more productive use oflabor, the country's (and especially the poor's) most abundant resource; and

(b) the need to move towards closer economic integration with the regional and world economy. Inparticular, there is general consensus that there are benefits in close economic cooperation with South Africa(and other countries in the region).

A. Reducing Poverty

14. The Government's poverty reduction program focuses, among other activities, on three key elements:

6

* improving employment and income opportunities for the poor, including support for the informal sector,development of special employment programs and enhancing the poverty reducing impact of the LesothoHighlands Revenue Fund (LHRF);

* improving social services for the poor, including strengthening primary, vocational and non-formaleducation, undertaking health sector reform and expanding public assistance (safety net) programs; and

* managing poverty-related environmental degradation, including the development of rural environmentalprograms, and waste management systems.

15. Improving Employment and Income Opportunities: The informal sector constitutes a growingsegment in Lesotho as a result of the limited capacity of the formal sector to absorb the growing labor force.The 1995 Poverty Assessment estimated that close to 72 percent of the domestic labor force (those not inemployment in South Africa) are employed by the informal and agricultural sector. In the short to mediumterm, the productivity of the informal sector could be enhanced by removing the constraints it faces by: (i)strengthening the linkages between the formal and informal sectors; (ii) improving general infrastructurefacilities; (iii) providing opportunities to enhance entrepreneurial skills; and (iv) expanding marketopportunities and access to credit.

16. Furthermore, special government sponsored programs such as the LHRF could serve a useful role inbuilding capacity in the informal sector, especially in the rural and peri-urban areas. Lesotho has also hadsubstantial experience with the use of special funding mechanisms as a means of building local economic andsocial infrastructure using local contractors and employing the poor as short-term laborers. These schemesinclude the LHRF, the Labor Construction Unit (LCU) and the Civil Works Section of the Ministry of Works,the Small Scale Contractors Program run by the LCU, the Road Fund, and a number of WFP-assisted self-help initiatives and the GTZ-supported Mafeteng Development Project. The potential utility of these specialfunds, especially the LHRF, is that they represent a means for helping to empower economically andmanagerially the institutions most likely to have a direct impact on the lives of the poor.

17. Improving Social Services for the Poor: The social characteristics of the poor, notably in terns ofeducation and health, are significantly lower than the non-poor. Furthermore, there is a strong correlationbetween the location of the poor and the lack of quality and availability of social infrastructure and services.The Government's objectives for intervention are to correct this imbalance through a concerted effort aimedat those districts in the mountains and remote areas where the poor are mostly concentrated, and to build theinvestment necessary to position Lesotho's labor force for the changing economic landscape in the region.

18. The greater mobility of labor and investment within the sub-region, in the light of ongoing tradeliberalization and regional economic integration, will put pressure on Lesotho to upgrade its human resources.Lesotho will need to increase the supply of skilled workers both for the local economy and to capitalize onemployment opportunities that will develop within the sub-region. But while Lesotho's literacy and grossprimary enrollment rates are better than other countries in the low-income and Sub-Saharan Africa, they arestill low by international standards. Greater effort is needed to improve the quality and access of primaryand basic education and to train adequate technical and vocational personnel to meet the demands of theemerging industrial sector. International evidence also demonstrates that local entrepreneurs usually emergefrom the pool of skilled workers who work in the large export firms.

19. Complementing Government policy in education is the need to improve health service delivery. TheGovernment's approach for the development of the health sector is a primary care strategy which willfacilitate the implementation of selective package of health and social welfare interventions. Cost-effective

7

preventive interventions, both in health and social welfare services, are preferred over curative ones.Community participation in the organization and delivery of health and social welfare services is to bepromoted and so are public and private sector collaborations.

20. Managing Poverty Related Environmental Degradation: There are important differences betweenthe interaction of poverty and the environment of the urban poor and those of the rural poor. Urbandeprivation tends to predominantly affect the health status of the poor rather than their incomes and assets,while in the rural areas such deprivation puts pressure on the land, leading to further declines in personalincome. Thus, any poverty reduction program should seek to break the poverty-environment nexus bydeveloping specific intervention for both the rural and urban sectors. The Government's environmentalprogram is managed under the National Environmental Action Plan (Box 2). Urban environmentaldegradation is taken care under the Government's programs through the upgrading of the basic infrastructureof the poor -- potable water, sewerage, and solid waste disposal.

Box 2: The National Environmental Action Plan (NEAP)

Lesotho's NEAP was initiated in 1989 and was one ofthe first to be written in Africa. It is actively supporteby the Bank. It states that the most widespread environmental problems in Lesotho are related toverstocking of rangelands. The impact goes beyond deteriorating rangelands, as livestock also consumcrops residues that would have been usefully retained on cropland, thereby exacerbating the erosion problem.Limited attention, however, was given in the NEAP to the emerging industrial pollution problems and thtabsence of environmental regulation in:this area.

The NEAP proposed, inter alia, the development of grazing associations, enforcement of grazing regulationand the introduction of grazing fees. It also contained a plan for the creation of integrated environmentainstitutions that would be able to implement the recommendations of NEAP.

The implementation of NEAP has been slow. It was only in 1994 that a small National EnvironmentaSecretariat was created. A national action plan to implement Agenda 21 has been developed with theassistance of the UNDP, but it fails to effectively define a prioritized investment program for thenvironment. There is an ongoing effort to complete a Biodiversity Conservation Strategy for Lesotho. Igeneral, Government capacity to safeguard the environment remains weak.

21. Rural environmental degradation is a formidable challenge to poverty reduction in Lesotho. It ismanifested in severe soil erosion, resulting in diminished soil fertility and crop yields, deforestation andrangeland overgrazing. In addressing the problem, the nature and security of tenure (arable landholding,access and/or use rights to communal land) are the most important environmental entitlement available to thepoor. Past efforts to address land tenure and range management have not been successful. Nevertheless, theGovernment with the support of the Bank, the EU and other key donors is developing a comprehensiveagricultural sector investment program (ASIP) with the objectives to address these issues. Theimplementations of two components of the ASIP, the production through conservation (PTC) and the rangemanagement area (RMA) programs along with the ongoing National Environment Youth Corps program(NEYC), are intended to address institutional strengthening, improve income generation and the creation ofemployment opportunities, while encouraging the management and conservation of natural resources.

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B. Integrating into the Regional and Global Economy

21. In the light of recent developments in the regional economic landscape, the Government has adopteda three-prong strategy to strengthen its links with South Africa and the countries of the Southern Africa sub-region. This strategy involves the development of direct Lesotho/South Africa economic relation includinghuman resources, education, health services and the free movement of the factors of production;strengthening economic links between members of SACU and the Common Monetary Area (CMA); andexploring greater contacts with members of the Southern Africa Development Community (SADC).4 TheGovernment is cognizant that deriving the benefits of greater regional integration would require:

* maintaining external competitiveness;* promoting private sector development; and* building institutional capacity (especially in the public sector) to support these efforts.

22. Maintaining External Competitiveness: Over the past decade, export-oriented firms (especially inthe textile sector) have been attracted to Lesotho mainly because of its labor cost competitiveness (theproduct of wage levels and labor productivity) which compares favorably with South Africa and otherneighboring countries. Textile exports have increased from less than $5 million in 1990 to an estimated $125million in 1997, making Lesotho the highest garment-producing country in continental Africa. To sustainLesotho's competitiveness, the Government needs to deal with Lesotho's high cost of utilities (Box 3) andremove the remaining administrative barriers to investment (Box 4).

23. Promoting Private Sector Development: A complementary policy to maintaining Lesotho'sexteTal competitiveness is the need to create linkages between the emerging external capital and the localeconomy. This could be achieved by promoting domestic small and medium enterprises. But beyond theconstraints posed by high cost of utilities, the development of domestic entrepreneurs is constAined by the

4Lesotho, Swaziland and Namibia are members, with South Africa, of CMA. SADC involves 14 member states: Angola,Botswana, Democratic Republic of Congo, Lesotho, Malawi, Mauritius, Mozaibique, Namibia, Seychelles, SouthAfrica, Swaziland, Tanzania, Zambia, and Zimbabwe.

9

weaknesses of financial intermediation and inadequate legislative environment. The key issues affecting thefinancial sector include: the distress in the banking sector, the role of the legislative and regulatoryenvironment in contributing to the distress, the problems of bank supervision and related issues, and theeffectiveness of the instruments available to the Central Bank of Lesotho (CBL). The Bank, through theongoing Privatization and Private Sector Development Project, is assisting the Government to address thedistress of the two Government-owned banks; a management contract has been put in place for one bank withthe objective of seeking a strategic partner, while the other Bank would be closed by June, 1998. The Bankand the Fund are also in the process of providing assistance to the Government in revising existing legislationand enhancing its enforcement (including the training of legal personnel).

Box 4: Administrative Barriers to Investment in Lesotho

Lesotho's success in attracting foreign investment could be overshadowed by a number of policy andregulatory constraints, currently under review by Government. They include:

* cumbersome process of applications for company formation and registration and inadequate provision ofservices from the Office of the Registrar General;* the existence of separate applications for residence and work permits associated with procedures that areconfusing and characterized by long delays;* long delays associated with the allocation of land or lease land and the time and effort needed to be issuedpermits and hook-up services from the authorities for utilities. The process of obtaining a lease can takesometimes 5 to 10 years; and* a long list of specialized (sectoral) approvals required in licenses and permits to start a business andoperate in certain economic activities, such as hotels and restaurants.

Source: Lesotho: Administrative Barriers to Investment - The Red Tape Analysis, FIAS, June, 1997

24. Private sector development and Lesotho's external competitiveness need continued support of animproved enabling policy environment. Because of Lesotho's membership of the CMA, and given thelimitations of monetary and exchange rate policy instruments at its disposal, fiscal prudence becomes acritical policy requirement. A conservative fiscal stance in the form of expenditure prioritization and restraintand the build-up of substantial financial reserves to hedge against economic uncertainty are of paramountimportance. Despite the pursuit of prudent policies in the recent past, developments during 1997/98 point tothe emergence of an overall deficit (after grants) of about one percent of GNP, as a result of an anticipatedsharp rise in wage bill, expected initial outlays for the restructuring of two state banks, costs associated withthe coronation in September 1997, and preparation for the upcoming elections. Expenditure prioritization inthe context of budget management (which includes improving revenue mobilization) should constitute acritical element of policy agenda in Lesotho, if a positive fiscal balance is to be attained during FY99-00.

25. Building Institutional Capacity: A critical factor in the past which impeded structural reforms inLesotho has been the weaknesses of institutional capacity, especially in the government sector. There is,therefore, the need to improve capacity in the public sector by dealing with its goals, staffing requirementsand incentive structure, and the prospects for decentralizing the budget to permit the incorporation ofdecision-making inputs at the sub-national level.

26. The Government is currently undertaking a number of reviews, with the assistance of the UNDP,AfDB and the DFID (UK), to redefine the role and structure of the civil service. The outcome of thesereviews is likely to make the Government confront important policy choices, including limiting the total civil

10

service wage bill as a share of total current expenditures while improving the overall incentive structures, andrationalizing the composition of personnel by reducing redundancy at the lower grades and improvingstaffing at the middle and higher levels. The Government has also recently embarked on a broad-baseddecentralization program in which it is envisaged that expenditure decision-making at the local governmentlevel would be facilitated. The decentralization program is pivotal in the Government's strategic options forpoverty reduction.

IV. THE BANK'S COUNTRY ASSISTANCE STRATEGY

Implementation of the Last CAS:

27. The Bank's assistance in the Lesotho CAS, reviewed by the Board on January 25, 1996, aimed athelping Lesotho exploit the economic opportunities and minimize the risk of rapid regional change andinternal democratization. The level of IDA lending was made contingent on progress in key areas of structuralreform, improving portfolio performance and satisfactory implementation of critical aspects of ongoingprojects. The base-case was premised on compliance with the fiscal targets agreed with the Bank and theFund in the Government's PFP and resolution of social and environmental issues associated with LHWPPhase IA. The high case triggers involved the need to make accelerated progress on privatization, improveprivate sector competitiveness, achieve deregulation of agricultural trade and marketing, and improveimplementation capacity.

28. What Worked Well: Bank support is having Box 5: Lsotho's Portfolio Oveiew i

a favorable development impact. Bank support forpopulation and health (Cr.20590) has led to a No. o rjects:S5 IA, 1I BRDrestructuring of the previous rudimentary healthdelivery system and a major expansion of health Total US$2193 millionservices in the rural areas. Through the multi-donor Commitments: (US$ 110 millionproject in education (Cr.22870), the Bank is credited IBRD, US$ 109.3for bringing about broad consensus between miion iDA)Government, churches and communities on educationpolicy and decision-making. An ongoing Industry and Total US$ 84.6 millionAgro-industry Project (Cr.21590) has introduced a Undisbursed (as ofMarch5, 1998)range of investor-friendly reforms, and the Bank is bance:helping to address the distress in the two Government-owned banks through support for the Government's Avege age ofprivatization project (Cr.26120). The ongoing RoadMaintenance and Rehabilitation Project is helping toprioritize future infrastructure investment and build the local capacity for infrastructure maintenance. Bank'sinvolvement in LHWP helped to ensure that the social and environmental aspects of the project areappropriately managed. The macroeconomic dialogue, through the joint IMF/Bank/Government PolicyFramework Paper (PFP) has been responsible for setting the broader framework for economic stabilizationand fiscal prudence. Policy advice has been more client focus and, through the broader participation of civilsociety, NGOs and others in the CPPR, has helped improved the Bank's relation with Lesotho.

29. In general, the improvements in the Bank's portfolio continued (Box 5). The current portfolio hasno problem projects. Past difficulties encountered in disbursements and procurement have been projectspecific and have been addressed. Two highly participatory Country Portfolio Performance Reviews (CPPRs)have taken place in June 1995 and June 1997. A Country Procurement Assessment Review was also carriedout in early June 1997 and discussed at the June 1997 CPPR. The recent CPPR discussions focused on

11

problems in disbursements and procurement. A response to these discussions will be the proposed IDF grantthat will include capacity building for procurement and disbursements. The constructive dialogue at CPPRsand intensive supervision of projects have contributed to the strengthening of the current portfolio. Sufficientresources will continue to be allocated for supervision. Implementation capacity on the part of theGovernment continues to be a constraint. Support to capacity building is provided in all projects. Attentionin future will be paid to local ownership and implementation capacity vis-a-vis project size and scope indesigning future interventions.

30. What Did Not Work Well: The impact of the Bank's program on poverty reduction in Lesothoremains unclear, in part because of the lack of data. Poverty reduction remains a key challenge despitesubstantial improvements in economic growth. The Bank was also not able to achieve the high lendinggrowth scenario envisaged in the last CAS because of: (i) slow progress in privatization, (ii) limited attentionto private sector competitiveness (especially in the light of the problems of the three utilities), and (iii)constraints on implementation capacity.

Box 6: The Recent Client Survey:

A client feedback survey was conducted in Lesotho for the first time in 1997 (Attachment IV). Governmentprivate sector, civil society and the local donor community participated. The main messages from the surve)were that the respondents did not see much impact from the Bank's lending program on poverty alleviatioand environmental improvement, although they were more positive about the Bank's effectiveness inpromoting economic growth and employment, investing in people and supporting private sector developmentThe Bank's non-lending services, especially economic and sector work (ESW) and economic advice gotvery high marks, as did the Bank's commitment to quality. The responses on the Bank's performance inconsulting clients and other development partners were less straightforward: the Bank seeks the participationof beneficiaries, but not that of other stakeholders. Since then, the Lesotho Country Team (CT) has takennumber of actions in response to the above findings. First, the Bank has established a liaison office inMaseru at the UNDP offices; second, the CT undertook feedback sessions on the theme during the recentannual CPPR, conducted a public day in which the functions and activities of the Bank in Lesotho wereexplained, and had a meeting with members of the local donor community on the results of the client surveyand third, a series of CAS consultations with stakeholders in Lesotho was initiated (Attachment III).

31. Lessons Learnt. The lessons learnt from the implementation of the 1996 CAS indicate that the Bankhas played, and can continue to play, a major role in helping the Government to strengthen its economicmanagement capacity, support labor-intensive development activities, and help harness the full potential ofexisting human resources through education and health care promotion. These conclusions are supported bythe results of a client survey conducted in 1997 (Box 6). In particular, the key lessons are:

* the Bank should continue to be selective in its choice of sectors to focus, based on its comparativeadvantage, thereby facilitating closer collaboration with other donors such as for the agriculture and healthSIPs;

* capacity building and institutional strengthening must still underpin the Bank's development assistance toLesotho. However, in this area, the Bank should facilitate participative dialogue mainly by bringing theexperience of other countries and sectors, but it should not set the pace of reform; and

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* while portfolio management performance has been generally satisfactory, project implementation andassociated structural reforms can be facilitated if reform programs are packaged, with institutional capacityconcerns adequately dealt with.

Country Assistance Strategy

32. Framework for the Current CAS: Like the 1996 CAS, the present CAS process has beenparticipatory (Attachment III). The first phase of the consultation process was initiated in June 1997 duringthe CPPR discussion in Lesotho. Subsequent CAS workshops and meetings took place during September toDecember, 1997 involving central and local government officials, donors, representatives of NGOs,representatives of business community, civil society and private sector organizations. The Government alsoorganized a day-long community meeting in a rural district. The exercise was a joint endeavor of theGovernment and the Bank to ascertain which strategies are likely to be more effective in supporting thecountry's development goals and are broadly supported. The second phase of consultations was initiated inMarch 1998 and involved discussion with government officials, donor representatives and key stakeholders.

33. Selectivity of Bank Assistance: Although there are many donors operating in Lesotho, in partbecause during the period of apartheid donor support was provided in an effort to reduce Lesotho's highdependence on South Africa, aid flows are declining in real terms. South Africa's entry into the worldcommunity has resulted in the reduction of aid flows to Lesotho. The Bank and the EU are the major donorsin Lesotho (Attachment V). However, over the past few years, most of project support for Lesotho has beenmulti-donor (especially in the move towards sector investment programs), with leadership provided bydifferent donors on the basis of their comparative advantage. The Bank's comparative advantage lies insupporting structural reforms in critical sectors (such as health and education), engaging in general policydialogue (including macroeconomic reforms with the IMF) with international comparative experience, andleveraging resources from other donors to support Lesotho's development needs (such as in infrastructure andagriculture). In this context, the focus of Bank assistance during FY99-00) will be to support theGovernment's effort to:

* reduce poverty through investing in human resource development; improving health servicedelivery; providing technical assistance for the reform of the LHRF; and promoting a comprehensiveapproach to the natural environment.

* improve Lesotho's competitiveness by providing assistance to ongoing efforts to improve theenabling environment for private sector development, including initiating reforms to reduce transactionscosts, enhance financial sector activities, and expand exports.

34. Partnership With Other Donors: The Bank and the Fund will continue to work hand-in-hand insupporting macroeconomic reforms through the PFP. The Fund has met the country's limited needs for directshort-term balance of payments support through the SAF/ESAF process; while the Bank has providedresources for structural reforms through project lending and ESW. In the areas of poverty reduction andhuman resource development, the Bank will continue to work closely with the USAID, DFID and AfDB oneducation reform; with Ireland and DFID in supporting management reform in health; and has taken theleadership in the agricultural sector program (ASIP) to bring together the EU and other key donors. TheBank will also continue to use its leverage in promoting the maximization of the poverty-reducing impact ofLHWP by coordinating South Africa, the EU, DFID and UNDP on key policy issues. The UNDP isresponsible for donor co-ordination in Lesotho and organizes the country's periodic Round TableConferences. It has also taken the leadership in civil service and decentralization reforms, with support fromDFID and AfDB. The Bank will use the outcome of these interventions in its broader macroeconomic policy

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dialogue and in executing selective assistance for projects in agriculture, education, health, and infrastructurefor which these issues would be important.

Composition of Bank Assistance

35. Supporting Poverty Reduction: Box 7 highlights poverty reduction as a cross-cutting theme of theBank's lending program. The Bank is also currently specifically preparing a Social Fund Project as a LIL tosupport reforms of LHRF. The LHRF is a special fund established in 1992 to manage the revenues fromLHWP (Attachment VI). Since actual operations began in 1995, a number of concerns has been expressedabout the size of the fund; the appropriateness of its targeting mechanism (i.e. whether the activities andprojects supported are appropriately targeted at the poor); and the exact role the fund should play instabilizing and supplementing government revenues. The LIL will pilot innovative approaches forrestructuring LHRF into a true social fund. It will seek to direct about 60% of the LHWP royalties into theGovernment's general revenues to supplement expected decline in SACU receipts; the remainder willsupport the activities of the social fund. The project will promote capacity building and serve as aninstrument for pursuing decentralized delivery of support services and participatory planning for povertyreduction. It will provide assistance in monitoring progress in poverty reduction and setting performancetargets. It will also provide assistance to building partnership between NGOs and Govermnent, throughrevising relevant legislation and providing capacity building support for NGOs. The project would becomplemented by the rural development components of the LHWP Phase lB.

Box 7: Poverty and the CAS

Government Poverty Action Plan: The PAP, developed in 1996, through a participatory process andwith the assistance of the Bank, focuses on reducing poverty through: fostering labor-intensive growth,investing in human resources, strengthening the safety net, and improving institutional capacity in delivery oservices to the poor. A follow-up program was prepared in 1997 as documentation for the Lesotho RoundTable Conference in Geneva.

Bank Support to Government Strategy: The Bank's lending program has targeted the key areas oGovernment's strategy. The Roads Rehabilitation and Maintenance project (Cr. 28570), the Industry andAgro-Industry project (Cr. 21950) and the Privatization and Private Sector Development project (Cr. 26120)were developed to support labor-intensive growth. The Education Sector Development project (Cr. 22870)and the Health and Population II project (Cr. 20590) target investment in human resources. The Bank usedits support for the Lesotho Highlands Water Project (Ln. 33930) to assist the Govermment formulate animplement a rural development program and explore means to maximize the poverty reducing impact of thproject. The proposed Social Fund Project (under preparation) would support the strengthening of the socialfund mechanism by building institutional capacity for delivering services to the poor. The Bank's broadepolicy dialogue and support through ESW are directed at improving institutional capacity. For example, thpurpose of the proposed Policy Reform and Capacity Building Project for Agriculture would be to support thdecentralization of agricultural support services, improve public expenditure targeting and enhancbeneficiary participation in rural development.

36. In addition, efforts to maximize income generating opportunities for the rural poor will be pursuedthrough the proposed Policy Reform and Capacity Building Project for Agriculture in FY98. This is the firstphase of a long-term agriculture sector investmnent program which would focus on policy reformn, institutionaldevelopment and capacity building. The main goals of the operation are to support the Government's effortto: build capacity for planning and program implementation; increase the client-focus of the public agenciesin the sector (by privatizing activities best performed by the private sector); increase the efficiency in the use

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of public resources and through a more holistic budgeting process for sector-wide priorities, and provide acommon framework for donor assistance.

37. Investing in Human Resource Development: To prepare the Lesotho labor-force for the challenges ofthe future, the Bank intends to follow-up on the ongoing Education Sector Development Project (Cr. 22870),which is due to close in March 1998, with a new project. The Education II Project, for FY99 will continue toprovide support to primary education in the form of an APL. It will also provide support for thedevelopment of guidelines for non-formal education and the co-ordination of NGOs, and the Ministries ofAgriculture and Health in their training and outreach programs. Efforts would also be made to focus ontraining and technical education, working closely with the business community. As part of projectpreparation, a strategy review on vocational education would be carried out, focusing on labor demand inLesotho and employment prospects for migrant workers. To supplement these efforts, the Bank, through EDI,is exploring the development of teacher education programs which will be delivered through educationtechnology in collaboration with other African countries. In the health sector, as a follow-up to the ongoingHealth and Population II (Cr. 20590), the Bank, working with key donors in the sector, is preparing a HealthSector Project (an APL), which will help define the long-term strategy and institutional issues in the sector.

38. Promoting a Comprehensive Approach to the Natural Environment: The UNDP is currentlyproviding support for the implementation of the Government's national environmental action plan (NEAP)through its assistance to the National Environmental Secretariat, established in 1994. The Bank's support forthe Government's environmental action plan will therefore be selective. First, assistance would be giventhrough the proposed Maluti/Drakensberg Trans-border project (which would be supported by IDA and GEFand would be a joint project with South Africa). This project will promote Biodiversity conservation and alsohelp capitalize on the scenic beauty of Lesotho, which is currently a poorly exploited source of touristincome. An innovative complementary activity would be the capacity building initiatives through the NatalParks projects. Second, support will be provided in the form of a Water Supply Project to improve waterquality and availability in both peri-urban and rural areas, as well as sanitation (which is key to soundenvironmental management and health). The Policy Reform and Capacity Building Project for Agriculture(FY98) will also handle issues of range management and land reform.

39. Supporting Closer Integration into the Regional Economy: Closer integration into the regionaleconomy can be attained through improving Lesotho's external competitiveness. The Bank's support forLesotho to gain the benefits of greater regional integration would be essentially in two forms: assistingLesotho to improve the enabling macro-policy environment and to support the Government program ofprivatization and private sector development. Support for improving the enabling macro-policy environmentwill be attained through the PFP and selected ESW on public expenditure and budget management review,financial sector review, and an analysis of the dynamics of labor markets. Through regional work on tradereforms, the Bank will provide policy advice to support the Government's reform program. To supportreform of the two critical impediments to Lesotho's competitiveness, the Bank, through the ongoingPrivatization and Private Sector Development Project (Cr. 26120) has initiated the reform of the bankingsector through management support programs and privatization. It is intended to follow-up this program, inthe short-term, through an IDF Grant (FY99) that will deal with legislative reform (including the training andcapacity building for legal/regulatory personnel and reform of laws) and capacity building in procurementand disbursements. Follow-up assistance for the deregulation of the financial sector (including helpingstrengthen the supervisory role of the Central Bank of Lesotho) will be pursued through a future operation.Similarly, the Bank would provide support for strengthening the management of the three utilities, reform theregulatory environment and assist in their privatization with the proposed new project (FY99) for PrivateSector Development. Support for institutions of private sector development would be provided through afuture operation.

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40. Supporting the Bank's lending activities will be sector specific ESW, continued assistance forcapacity building in macroeconomic management through the joint IMF/World Bank PFP, and analyticassistance to the Government's public expenditure and budget management review. A review of labor marketdynamics in Lesotho (in collaboration with ILO in Lesotho and within a sub-regional context) will deal withissues of migrant workers, the labor code and employee association. Assistance for the Government'sdecentralization program and civil service refor.n is envisaged in the context of multi-donor co-operation,through the Government's PFP. Cross-cutting themes, such as gender and capacity building, will be reflectedin all these areas (Box 8).

Box 8: Cross-cutfting Themes

Gender: Women in Lesotho play a major role in the economy. It is estimated that 53 percent of households areheaded by women, women dominate farming and rural small holdings, and about 72 percent of small enterprises arefemale owned. But despite this seemingly dominant role, they suffer from gender discriminatory legislation: womenwhose marital status fall under the community of property in civil law are considered legally minors and cannot enterinto contract without the consent of their husbands. The Bank will assist the Government (through the CapacityBuilding Project in Agriculture and the IDF Grant for Capacity Building) in its effort to reform the laws and removeobstacles to women participation in economic activities, including access to fmancial resources for investment andoperation of their businesses.

There is also evidence of gender bias favoring girls over boys, regardless of the gender and other characteristicsof the head of household. For all measures of malnutrition - stunting, wasting, and underweight - boys under five faresubstantially worse than girls under five. Basotho boys also get less primary schooling than girls, independent ofincome group, region and head of household. The most common explanation offered for this is the practice in the ruralareas of sending young boys with older brothers to tend family livestock. The Bank, through the Education Project, willsupport Government effort at increasing male primary school enrollment, thereby helping to address this issue.

Governance and Capacity Building Strengthening institutional capacity is crucial to poverty reduction.Similarly, good governance, defned as public accountability, citizens' participation, government responsiveness,transparency, and efficiency is an increasingly important concern for equitable development. The Bank's policydialogue (supported by each investment operation) will seek to support the Government's effort to:* reform of the civil service;* decentralize political, fiscal and administrative authorities;* privatize activities better performed by the private sector; and merge fragmented program management units.

In this context, capacity-building will continue to be integral part of all Bank operations. The Bank will focuson human resource development through projects in education and health. Capacity building will also be central inpolicy dialogue and support for civil service reform, the ongoing decentralization program and the proposed PolicyReform and Capacity Building Project for Agriculture (FY98).

41. Role of IFC and MIGA: IFC, through FIAS, contributed to the design of the ongoing IDA-supported Industry and Agro-industrial Development Project and the Privatization and Private SectorDevelopment Project, especially in regard to investment incentives and reform measures. During the lastCAS period, FIAS provided assistance to the Government in the review of administrative barriers toinvestment (1997) and in the drafting of the proposed new investment promotion law. IFC has no operationin Lesotho because the domestic private sector is very small and undeveloped; the scope for IFC's servicesremains limited in the medium term. IFC is, however, exploring the prospects of complementing IDAoperations in education, financial sector reform, privatization and SME development for which substantialprivate sector activities are likely to emerge in the near future. Lesotho is a member of MIGA, but theAgency has not yet issued a guarantee, although one preliminary application in agribusiness is pending.

16

Lesotho is an active beneficiary of technical assistance services provided by MIGA's Investment MarketingServices (IMS) department since 1993. A number of entities in Lesotho are also active users of MIGA'sInternet-based marketplace, IPAnet, which promotes investment in emerging markets by serving as an on-lineinformation exchange among public and private organizations.

V. LEVEL OF BANK SUPPORT AND RISK MANAGEMENT

42. Level of Bank Support: In continuing dialogue with the Govemment, it is understood that the levelof Bank lending would be contingent on (Table 1): (i) implementation of a program to deal with povertyreduction (such as the establishment of the enhanced LHRF and better implementation and monitoring of thePAP); (ii) further improvements in project implementation; (iii) the continued maintenance of fiscal restraintand improved macroeconomic performance; and (iv) addressing external competitiveness (through concreteactions to deal with the three utilities and the financial sector). Adherence to the above framework wouldconstitute the measure of Govemment's commitment. Because of Lesotho's good past performance and theneed to build up the Bank's portfolio to meet short and medium-term pressing reform needs in Lesotho, threelending scenarios are envisaged: high, base and low cases.

Table 1: Triggers for Staying in the High Case Scenario

MiteHoanceo Extralt . Z Cabinetd 'ppoval # ~in atbthe secndhafqol198of wthe utiit iesbrefom propots ansCompetitiveness agreed durIn Rind-tr eiei December 1997ig.Oe* anA

Re-P}>diitii dmpti Establish socian d of mangem e n,fancnsiawkt piions

43. The High CaseScenarI on(Tablee2) is peiae ncniun mrvmnsi otoi

managment wit no pojec at iskolr wfmithpoblems. PP!n It asvsumes godpogesin implementation_ ofb

rMeiftor ndfcer tExternal tiztio a Pri vatein the sProc half and enham of them Lpr.poslstspecifically iencludes (i)the adoptino omlicieaigmreeintemerm review in December,99 1997 ofth

Privatization and Privat Se lctr Deeopmnth6 Prjetilto drs h cntansoetetreuiite;ad(

h enactroemonoftiche relevat lgoncilsionti(h LeTglNwiotic)ofafistalhestaint b on& fahenks)hanceFY99 i wit

43. The High Case Scenario (Table 2) is predicated on continuing improvements in portfoliomanagement, with no project at risk or with problems. It assumes good progress in implementation ofreforns under the Privatization and Private Sector Development Project and enhancement of the LHRF. Itspecifically includes (i) the adoption of policies agreed during the mid-term review in December, 1997 of thePrivatization and Private Sector Development Project to address the constraints of the three utilities; and (ii)the enactment of the relevant legislation (the Legal Notice) and the establishment of the enhanced LHRF witha clear poverty reduction focus and implementation of PAP and poverty monitoring systems. Under thisscenario, the lending program will consist of six operations, totaling US$ 70 million during FY99-00.Included are the Social Fund Project, Private Sector Development Project, and Education II Project for FY 99;and the Water Supply Project, the Maluti-Drakensberg (GEF) Project, and the Health Sector Project forFY00.

17

Table 2: Proposed IDA Program, FY99-00

Year High Case Base Case US$ Supporting ESW

1999 - Social Fund (LIL) - Social Fund (LIL) 5.0 - Public expenditure review- Education II - Education II 15.0 (with GOL)- Private Sector - Education sector overview

Development 10.0 - Health Sector overviewProject

2000 -Health Sector Project - Health Sector Project 20.0 - Review of labor-market-Maluti-Drakensberg - Maluti-Drakennsberg 10.0 dynamics (part of regional(GEF) (GEF) study)

-Water Supply 10.0 - Poverty monitoring systemsupport

44. If the key high-case triggers are not met, the Base Case Scenario will apply. Under this case, onlythree IDA projects and a GEF project, with strong poverty-reduction effect, would be considered. The basecase is not without continuing performance improvements. It assumes improvements in portfoliomanagement, but short of what is expected under the high case scenario; progress on programs for povertyreduction but with some delays; and some slippage in addressing the issues of external competitiveness andbroader macroeconomics. Under this scenario lending will focus on the social sectors and more effort will bedevoted in maintaining the quality of existing portfolio and completing key analytic work to support policydialogue. It is envisaged that under this scenario there would be two IDA operations (the Social Fund and theEducation II Projects) for a total of US$ 30 million in FY99 and two operations (Health Sector Project andthe Maluti/Drakensberg Project (GEF)) for $30 million in FY00. Finally, in the unlikely event of total failureto comply with all the high case trigger conditions, a Low Case Scenario, based essentially on policydialogue, is envisioned. Under this scenario, the Bank may support one project in the social sectors, everyother year, as a strategy to leverage Government commitment to reforms.

45. Risk Management and Exposure: There are no creditworthiness concerns as no IBRD loans areintended in the program for the CAS period. The IBRD loans for LHWP Phases IA and B are in effect beingserviced by South Africa. On the other hand, Lesotho has followed a prudent debt management, andoutstanding debt in 1997 constitutes 51 percent of GNP (75 percent of GDP) with debt service ratio at 5.2percent of exports of goods, services and factor income. These ratios are low by international standards butmust be considered in the context of the vulnerability of Lesotho's balance of payments to external shocks.About 34 percent of Lesotho's external debt is held by IDA/IBRD and this is not likely to rise significantlyover the proposed CAS period.

46. The main risks to the Bank's program could come from:

* a serious slippage in the Government's adjustment effort, especially with respect to the structuralreforms outlined above. The main opponents to reform include the public sector (civil servants and publicenterprise employees) who have the difficult task of adopting and implementing reforms that directly impacton themselves. Hence, the civil service reform and privatization program have been adopted and implementedhalfheartedly, yet knowing that continued donor support depended on these reforms. The trade unions,

18

although currently weak, are increasingly questioning issues related to Lesotho's low wage advantage toSouth Africa and the domination of the economy by foreign private capital; and

* unsettled internal political environment. As in many African countries, elections have beenaccompanied by political tension. The outcome of the upcoming elections (May 23, 1998) is not clear. If anew government is ushered in, there is a likelihood for the learning process usually associated with newgovernment to stall and delay policy formulation and implementation of existing reform programs.

47. But the likelihood of a radical departure from prudent management of the economy is reduced byprogress in Lesotho's ongoing democratization process and efforts to achieve good governance.Consultations with various segments of the society during the CAS preparation process indicated widespreadsupport for prudent economic management and progress in attaining fiscal transparency. Thus, it is unlikelythat substantial backtracking on key economic reform will occur.

James D. WolfensohnPresident

Attachments

Washington, DC byMay 21, 1998 Sven Sandstrom

19

LESOTHO CAS: ATTACHMENTS AND ANNEXES

Attachment I: Lesotho: Poverty and the CASAttachment II: Alternative Economic Growth ScenariosAttachment III: CAS Consultation ProcessAttachment IV: Client Feedback SurveyAttachment V: Lesotho: Activities of Principal DonorsAttachment VI: Lesotho Highlands Water ProjectAttachment VII: Standard CAS AnnexesAnnex Al: Key Economic and Program IndicatorsAnnex A2: Country at a GlanceAnnex B2: Selected Indicators of Bank Portfolio Performance and

ManagementAnnex B3: Bank Group Program Summary (Page I of 3)

Bank Group Fact Sheet-IBRD/IDA Lending Program (Page 2 of 3)Bank Group Fact Sheet-IFC and MIGA Program (Page 3 of 3)

Annex B4: Summary of Non-lending ServicesAnnex BS: Poverty and Social Development IndicatorsAnnex B6: Key Economic IndicatorsAnnex B7: Key Exposure IndicatorsAnnex B8: IBRD Loan/IDA Credits in the Operations Portfolio (Page I of 2)

Statement of IFC Investment (Page 2 of 2)Annex B9: CAS Program MatrixAnnex B1 0: CAS Summary of Development Priorities

20

Attachment 1LESOTHO: Poverty and the CAS

1. Poverty is Lesotho's major development problem. Although GDP has grownrapidly (6.9 percent per annum during 1990-97), nearly half of Lesotho's population isstill poor. Rural areas are the poorest and it is difficult to see where opportunities toreduce poverty lie, as poor rural people are dependent on low quality agricultural land anddeclining worker remittances. Poverty is aggravated by continuing high levels ofunemployment (the official unemployment rate is 35 percent) and underemployment.The labor force is growing faster than jobs are being created. Nor is the outlookpromising: demand for Basotho workers in South African mines is declining (indeedmines are shedding workers), and Lesotho remains vulnerable to South Africa's ownlabor market problems.

2. Pattern of Poverty: Poverty is greater in rural than in urban Lesotho (Figure 1).About 82 percent of Basotho households are rural. Poverty is worse in the mountainousregions. The incidence of poverty is deeper and far more severe in the mountain andSengu valley zone than in the foothills and lowlands.

Figure 1: Incidence of Poverty

-50.l 0i00x X40- h ~~~~~~~~~~X 0~~~ Rural0. E ~~~~~~~~~~~Maseru

20. E0 Other UrbanDAII

Poor Ultra Poor

3. Causes of Poverty: Surveys in 1991 and 1993 provided different rankings for themain causes of poverty in Lesotho.' In the 1991 study, the four causes of poverty mostfrequently mentioned were:

* Unemployment.* Environmental disaster (including drought, floods, and hailstorms as well as loss of

soil fertility and productive pasture land).* The lack of adequate agricultural land and inputs.* Ill health or disability.

'The 1991 study took a "needs assessment" approach to causes of poverty, trying to link poverty with the- lack of access to economic services or opportunities or to social services. In the 1993 study, the

researchers used a list of 42 pre-selected concepts to elicit participants' rankings of a range of issues -- including theft, adultery, alcoholism, and corruption --that they felt contributed to or affectedpoverty.

21

In the 1993 study, the causes of poverty most frequently mentioned were:

* Alcoholism, which participants considered to be the most common cause of poverty.* Unemployment (which moved from first to second place).* The drought.* Personal failings, such as laziness.* Political factors such as injustice, oppression, and corruption, especially in local

government.* Social issues such as conflict, hatred, and witchcraft.

4. Targeting the Poor: It is difficult in Lesotho to target the poor. Education levelsare lower in poor households, for example, but they are low in many non-poorhouseholds, too. What this means from a policy standpoint is that directly targetedassistance programs that require administrators to identify the poor or ultra-poor willprobably not be an efficient or effective means of reducing poverty in Lesotho. Moreemphasis must be placed on self-targeting approaches, such as public employmentschemes.

5. Policy response: Although poverty has been a central preoccupation ofGovernment policy, progress is not being made. The focus on poverty reduction in thepast rightly advocated policies to improve living standards through increased income,generated by growth and expansion of public services. Priority was given to agricultureand industry, the two economic sectors with the highest potential to increase theproductive base of the economy. But past performance in both sectors was belowexpectation and the poverty impact was minimal. Efforts in promoting agriculturaldevelopment in the past failed because of government policies of food self-sufficiencywhich distorted the incentive framework and led to expansion in crops in which thecountry had no comparative advantage. In industry, past government policies led to theestablishment of numerous parastatals, some of which have now become a burden to thebudget. The Bank is assisting the Government, through the Privatization and PrivateSector Development Project, to privatize and reform these public enterprises.

7. The Bank's dialogue with Lesotho on poverty reduction is directed at rectifyingdeficiencies in past efforts at reducing poverty. It is built upon the Government's PovertyAction Plan (PAP), which was formulated with the assistance of the Bank. The PAPoutlines cross-sectoral policy actions for reducing poverty in Lesotho. Bank's lendingprograms support the policy of labor intensive growth and human resource developmentembodied in the PAP. Bank support to budget management (through PFPs and policydialogue) are meant to improve expenditure prioritization in favor of poverty reduction.Finally, Bank support for the Lesotho Highlands Water Revenue Fund (through theproposed Poverty Fund LIL) aims at building capacity at the national and sub-nationallevel for dealing with rural poverty through community generated programs anddeveloping instruments for poverty monitoring.

22

Attachment IIPage 1 of 4

Alternative Economic Growth Scenarios

1. Lesotho's dependence on the external environment makes it very vulnerable toexternal shocks. Its reliance on SACU revenues and migrant income makes it crucial thatclose attention is paid to them when examining the medium-term macroeconomicoutlook. In addition, the investment and income-generating activities of LHWP andexport performance is also of importance. The following focuses on the key variablesthat need to be monitored closely.

Basic assumptions

2. Migrant income: There has been a general decline in employment opportunitiesin South Africa resulting in lower migrant income flowing into Lesotho. This trend isexpected to continue mainly because of three reasons: a) the decline in the world price ofgold has affected the profitability of gold mines, b) SA is moving to a more capital-intensive production structure in the mining sector, hence there is less demand for labornow than in the past, and 3) worsening of SA's own unemployment situation (estimatedto be around 32 percent) imply giving job preference to SA residents. It is estimated that14 mines employing 130,000 people are currently unprofitable and the National Union ofMineworkers has announced that nearly 300,000 jobs may be under threat. All this willlikely lead to further retrenchment of Basotho miners in SA.

3. SACU revenues: SACU revenues are expected to decline as a result of theanticipated changes in the revenue-sharing formula and a fall in LHWP-related imports.This is going to put a burden on government finances as taxes on international tradeaccount for about 50 percent of total government revenues. In addition, the potential togenerate revenue from other sources is limited.

4. Export growth: Lesotho's labor cost competitiveness, compared to SA, has leadto a surge in manufactured exports, especially textiles. Exports were also driven by theinflows of private foreign investment resulting from improved macro environment andother investment promotion activities. However, the likelihood of higher wages and laborunrest in Lesotho might erode this advantage and drive out investors from the exportmarket. To maintain its competitiveness and attract foreign investors, Lesotho needs tofurther develop its labor force and manage effectively labor relations, which calls formore training and capacity building activities. Diversif,ving the export base and creatingmore linkages between the export sector and the local economy is also important. Inaddition, as SA becomes increasingly global and strengthens ties with EU, Lesothoexports will have to compete with EU exports in the SA market.

5. Drought impact of El-Nino: The need to drought-proof the economy is strongerthan ever. During the 1991/92 drought, agriculture production declined on average by 20percent. However, it rebounded in 1993 with a growth rate of 27 percent. Similarly,during the most recent drought, production in this sector declined by 20 percent in 1995,but grew at an annual rate of 55 percent in 1996. Historically, this sector has been proneto wide fluctuations. If the economy is hit hard by the drought in 1998 and if agricultural

23

Attachment IIPage 2 of 4

output declines substantially, there is a likelihood of escalating prices and an increase inthe food import bill. Agriculture production is however expected to bounce back in 1999.

6. LHWP: The expected downturn in LHWP investment (including LHWP-relatedimports), is going to have an adverse effect on economic growth and government finances(through lower international trade taxes). Since growth in early 1990s was drivenprimarily by LHWP activities, as these activities slow down, there is a need to developnew sources of growth. But non-LHWP private sector investment will fall short ofcompensating for LHWP investment in the short to medium term.

7. Utilities and financial sector: Finally, continued inefficiencies in the utilitiessector and weaknesses in the financial sector are likely to hinder private sector investmentand put an extra burden on government finances. Both factors adversely affect the cost ofdoing business in Lesotho because of the high utility costs and high transactions cost.The poor capacity of the financial sector also constraints export promotion. In addition,the Lesotho Bank and the Lesotho Agriculture Development Bank are going throughsome major reforms and this might have a significant impact on the financialintermediation activities.

Growth Scenarios

8. Given these anticipated developments (most of which are determined by theexternal environment), it is imperative that Lesotho maintains a conservative fiscalstance, integrates more closely with SA, maintains external competitiveness, and payscloser attention to external reserves. The pressing question is whether the economy isflexible enough to respond quickly and with least market disruptions to all these changes.As a CMA member country, it has limited scope for using monetary/exchange rate policyand has to rely solely on public expenditure/revenue policies.

9. With all these facts in mind, one can develop three macroeconomic scenarios forLesotho based on the assumptions for some key variables mentioned in the previousparagraphs that have the most impact on its medium-term economic growth anddevelopment.

10. Scenario I - Base case scenario: The base-case scenario assumes that structuralreforms will continue and appropriate policies will be in place: conservative fiscalstance, slight drop in investment (as a share of GDP), and financial stability. Exports areexpected to grow at a slower rate (9 - 12 percent), and so are migrant income and SACUrevenues. As a result, the external current account deficit as a share of GDP is projectedto increase from 35 percent in 1998 to 40 percent by 2000. The economy is expected togrow at a modest rate of 1.5 percent in 1998. It is expected to recover in 1999/2000 andgrow at an average annual rate of 5 percent (recovery in agricultural output and goodperformance in industrial sector).

11. Scenario 2 - Low case scenario: The low case scenario is one of policy slips.This assumes a higher wage bill with no necessary adjustment and a much significant

24

Attachment IIPage 3 of 4

drop in investment level. Combined with lower customs revenues, projected deficit willincrease from 2 percent of GDP in 1997 to about 3 percent in 2000 (compared to asurplus in base case scenario). The resulting income effect due to fiscal expansion willalso put pressure on the external current account and will weaken the foreign reserveposition as compared to the base case scenario. Moreover, industrial sector performanceis expected to be mediocre as a result of continuing problems in the utilities and financialsector. These problems will also spill-over in the export sector resulting in a muchslower export growth (7 - 8 percent). The average growth rate of 2.5 percent during1999-00 would barely keep up with the population growth rate of 2.1 percent.

12. Scenario 3 - High case scenario: The high case scenario assumes a buoyantgrowth in exports (11 - 14 percent), strong recovery in the agricultural sector, andsignificant improvements in the financial and utilities sector. Strict adherance to aconservative fiscal stance, complemented by the proceeds from the sales of publicenterprises, would help offset the anticipated decline in investment during 1998-99.Implementation of structural reforms will increase foreign direct investment and furtherboost the export sector. The fall in migrant income will also not be that sharp. Theprojected real GDP growth rates for 1999-00 under this scenario are 6 and 7.5 percentrespectively.

25

Attachment 11Page 4 of 4

Macroeconomic Scenarios - Key Economic Indicators

W " ^'1 " X t i ',' ;~~~~~~~~~~~~~~~~~~~~~~.' C ., . ... A .. .. ,,?,,s

Economy (CY) Base Case 1ri> 'Case High Case

1997 1998 1999 2000 I I 19 : 1997 1998 1999 2000

GDP 8.0 1 .5 5.0 50 4 80 1. 6. .Exportsa 14.4 9.0 9.2 12.3 )2 f f %7V-D 14.0 10.9 12.6 14.3Importsa 4.4 -0.2 2.5 2.7 >44 010t^ Qi 4.4 -0.2 3.3 4.5

INfationaacu( (%) 9.6 8-7 |8.3 80 ,X 2 9.6 8.8 8-5 8-.2

Current account balance -35.5 -38.0 -41.9 -44.4 -%$ t.;>4 I ........... -95 41 36.2 -37.6 -40.1 -42.4Gross investment 85.5 84.9 83.2 84.0 T t &t4 1$ 85.5 85.1 86.2 87.0

Public finance (% GDP) S ,S. .. . . ...

Fiscal balance 2.7 3.4 3.6 3.4 30 - v 4.7 8.4 12.0 14.7

Migrant income (US $ m) 309 306 303 297 )0 t. 28 .2.7 311 309 308 306International reserves 6.1 6.7 7.1l 7.4 13Ml 6.1 6.7 7.1 7.4(as months imports goods)

a. Merchandise, f.o.b.b. Period average

Attachment III

CAS CONSULTATION PROCESS1997C SActv ty. 0 .0 . k d Involvedi X :

May-June 1997 Client Feedback Survey - to gain Public Sector, Private Sector,feedback on the Bank's activities in Donors, NGOs, HQ staffLesotho to strengthen dialogue andas input to the CAS.

June 1997 Country Portfolio Performance Ministry of Finance and EconomicReview - to assess protfolio, agree Planning and Implementingon next steps, sharing CFS results, Agency staff, HQ staffinitiate CAS discussions.

June 1997 Public Awareness Day organized Members of parliament, Principalby Government of Lesotho to Secretaries, individuals fromintroduce a cross-section of implementing agencies, NGOs,influential groups in lesotho tot he Church Groups, National Univ. ofWorld Bank and the services it Leostho, donors, the private sector,provides to Lesotho. differing political parties, and civil

service, HQ staff (about 130people).

November 26, 1997 Interal Inter-ministerial meeting Core ministry staff, selectedconducted on November 26 to parastatals and specialized agenciesreview the nature of Bank supportin Lesotho.

November 26, 1997 Workshop held at the Office of the Local Government officials, civilDistrict Secretary at Thaba Tseka society, NGOs, chiefs, DDC andon November 26, 1997. VDC members.

November 28, 1997 Meeting with select group of NGOs NGOs, Government, HQ staffthat reviewed the role of the Bankin lesotho, the scope forGovernment NGO partnership, andareas of Bank assistance for whichthe NGOs could play a substantiverole

December 9, 1997 Meeting with private business Ministry of Trade and Industrycommunity staff, LMA, BEDCO, LCCI, NTB

and other members of the privatesector, HQ staff.

December 9, 1997 Thaba Tseka Meeting - a pitso-type Government poverty task-force,gathering focused on poverty chiefs, members of the DDC andreduction, reformulation of the VDC, local government officials,LHWRF and the role of the World various members of the civilBank in Lesotho. society, HQ staff

December 10, 1997 Meeting with key donors - dealt Representatives of key donorwith issues related to the nature and agencies, HQ staffobjectives of the CAS, the state ofdonor coordination in Lesotho anddevelopment specific concerns suchas environmental degradation.

December 11, 1997 Meeting with core ministries, Staff of core ministries, selectedselected parastatals and specialized parastatals and specializedagencies. Follow-up to November agencies, HQ staff26, 1997 meeting.

December 12, 1997 General CAS Workshop initiated Government officials, NGOs,by Government and held in private organizations, civil society,country. HQ staff

27

Attachment IV

CLIENT FEEDBACK SURVEY

Overview:* One of 10 client feedback surveys (CFSs) carried out in Africa in 1997.* Took place from May - June 1997* 200 surveys mailed out and 47 were returned. 21 people were interviewed on-on-one by an independent

consultant. Banks staff working on Lesotho also filled out the same survey.

Survey Results:

What is going well: What is not going well:Impact * World Bank is effective in promoting economic * The impact of the Bank's

growth and employment; investing in human lending and its effectivenessdevelopment; promoting private sector and are not good in improving thestrengthening public administration. status and life of the poor or

improving or safeguarding the* World Bank provides good (non-lending) services: environment.

i.e. its economic and sector studies; advice ondevelopment strategies; and private andenvironmental assessments are judged as beinguseful.

* World Bank is committed to quality.

Staff * staff is technically competent and has skills which * do not understand existingare relevant to Lesotho local institutional constraints

* knows international best practices, has good well; don't adapt theinterpersonal skills and is knowledgeable about international knowledge to theLesotho. needs of Lesotho and don't find

* seeks participation of beneficiaries; is accessible new solution.and responds in a timely manner to questions * don't try to develop joint

* is straightforward and speaks with one voice and solutions with stakeholders andcoordinates with donors. seek their contributions and

involvement.The Bank * In the last two years, the Bank has become * does not listen to its clients

somewhat more client focused. * is very slow and has policies* Overall the respondents are satisfied with Bank and practices which are not

and see the relationship between Bank and country easy to understand oras one of partnership and where the Bank adds implementvalue and knowledge. * is not flexible (except when

implementation goes well)

Country Team (CT) follow-up to Client Feedback Survey:* Feedback survey and results were discussed at the Lesotho Country Portfolio Performance Review in Maseru.* Feedback survey and results were discussed at the Public Awareness Day in Maseru (about 130 participants).* Feedback survey and results were discussed with donors.* In response to our clients' desire for increased access to Bank staff and information, we are opening a small

office in the UNDP building in Maseru and have arranged for regular visits from staff in the South Africaresident mission (these staff have also joined the Lesotho country team) as well as more frequent supervisionmissions.

* At a Country Team (CT) retreat, the CT compared the results from staff responses vrs. client responses anddiscussed the divergence of views and how these could be addressed.

* Agreed with donors (at donor meeting) that we would do more donor briefing/debriefing with our missions.* CT is including poverty and the environment more prominently in its work program and CAS. These were

two areas where the CT was not perceived to be doing well in the CFS.

28

Attachment VPage 1 of 2

Lesotho: Activities of Principal Donors

Donor | Current ActivitiesDenmark Support for the environmental sector.

Germany (GTZ) 1. Support for small scale enterprises, community empowerment,livestock production in agriculture, and extension services.2. Support for the ongoing decentralization process through thestrengthening of existing staff of the District Planning Unit (DPU).3. Support to the National Forestry Action Program.

Ireland 1. Support to the Central Government in the area of infrastructuredevelopment (rural water supply, roads, foot-bridges, etc.).2. Assistance to CHA hospitals by bringing the private sector andgovernment together.3. Working with the World Bank in providing assistance to theMinistry of Education in dealing with school buildings in remoteareas.

UK 1. Support for education and good governance.2. Assistance for ongoing civil service reform program.

USA 1. Through the Initiatives for Southern Africa (ISA), providesassistance for agriculture, environment, natural resource management,HIV/AIDS, trade and investment, and water and human resourcedevelopment.2. US Peace Corps volunteers assist primary school agriculture toadvance improved food security, afforestation efforts, environmentaleducation, and health sector.3. Provide assistance in education, small development projects,military education, human rights, and voter education.

European Union 1. Health sector support - rehabilitation of Christian HealthAssociations (CHA) hospitals.2. Health mapping exercise: dealing with policies for medicalsupplies (especially procurement).3. Support for structural adjustment facility: tended to financeshortfalls in capital budget.4. Road transport infrastructure - part of EU's community programssupported by the Roads Rehabilitation & Maintenance Fund.5. Micro-project financing.6. Agricultural support for crop diversification, tourism developmentand environmental programs.

29

Attachment VPage 2 of 2

Lesotho: Activities of Principal Donors

Donor Current ActivitiesIFAD Support for agriculture, especially the commercialization of

agriculture, as well as civil service reform in the relevant sector.

ILO Support for labor force survey.

UNDP 1. Through the Rural Development Program, strengthen communitycapacity to formulate development plans for income generation.2. Provision of assistance to VDC's to address literacy and generalawareness.3. Provision of assistance through LHDA for environmentalassessment.4. Support to community organizations through the development ofarea teams.5. Support for civil service reform.

UNEP 1. Provision of technical and advisory services, in-house training andfellowships.2. Assistance in environmental legislation, environmental health,capacity building and natural resource management.

UNCDF Supports small scale enterprises through (i) micro loans (M 0 -M6000) and (ii) medium loans (> M6000) through Lesotho Bank.

UNICEF 1. Development of community organization, (Butha Buthe, Leribe,Mokhotlong) to support its primary health care and nutrition, basiceducation and training in primary environmental care programs.2. Local Govermment and decentralization (through capacity building,local empowerment and the establishment of a range of localinstitutions.3. Support for household food security and assistance to rural andperi-urban water supply and sexual and reproductive health.

WFP 1. Support for feeder road construction, soil conservation andforestry.2. Working with community groups for the assessment of needs andin program implementation.3. Support for the Government's school feeding program (andalleviation of the effect of drought).

WHO Support for health sector reform process.

30

Attachment VIPage 1 of 2

Lesotho Highlands Water Project

Overview:

* The Lesotho Highlands Water Project (LHWP) will transfer water to Gauteng, the water-shorteconomic heartland Region of South Africa (which has 60% of South Africa's GDP and just 8%of its water, and which ran out of water in the mid 1980's). The project is the lowest costalternative, by about US$1 billion, to meet the water needs of Gauteng.

* Phases IA and 1 B of this five-phase project are governed by a treaty signed between Lesotho andSouth Africa in 1986.

* Both governments (now democratically-elected) fully support the project, and as a riparian state,Namibia re-affirmed its no objection to the project after independence.

* Phase IA is estimated to cost about US$2.5 billion, 85% of which is to transfer 18m3/sec ofwater to Gauteng, and 15% to install 72 MW of hydropower capacity.

* South Africa bears the full cost and associated debt of the water transfer portion of the project,which is financed mainly through contractor arranged export credits and commercial finance.

* The Bank supported Phase LA with total financing of $90 million ($110 million approved and$20 million canceled). A loan of $45 million for Phase IB is scheduled for Board Presentation inMay 1998.

Economic Impact on Lesotho:

* Lesotho will receive an average of about US$40 million per annum (1995$) in royalties fromSouth Africa (for both Phases 1A and IB). Between 1990 and 2044 these royalties are expectedto account for 20% of Lesotho's export revenues, 10% of public revenues and about 4% p.a. ofGDP. The royalties were determined as 56% of the cost savings realized by South Africa. Thebalance (44%) is passed on to the South African water users in the form of lower water tariffs.

* In addition to royalties, Lesotho benefits from increased taxes and customs revenues of aboutUS$200 million as well as from roads, clinics, telecommunications and about 35-40,000 annualjob equivalents. It is estimated that about 20% of total government revenues (excluding grants)could be attributed to LHWP.

* It is estimated that LHWP accounted for 12.6% or real GDP in 1990, 14.3% in 1997 andestimated forecasts are for 13.6% in 1998 and 5.9% in 2002.

* The LHWP multiplier on real GDP is estimated at 0.53.The building and construction sector was the primary beneficiary of LHWP expenditures. Realincome in this sector grew at an average rate of about 18% per annum in 1987 and 1994 andaccounted for 43% in real GDP at factor cost. In 1994, LHWP accounted for an estimated 53.5%of the value added for this sector (projected to be 49% and 22% in 1998 and 2002 respectively).

Development Fund:

* Cumulative deposits to date from Customs Union Revenues and the first of the fixed annualwater royalty payment amount to M335 million.

* The Fund was initially plagued with delays in disbursements and an initial lack of transparentcriteria and procedures for utilization of the money. The Government of Lesotho (GOL) has nowplaced the Development Fund at the center of its poverty alleviation strategy. To date it hascommitted M215 million and has disbursed over M150 million on labor based, poverty targetedinfrastructure works - including 1,100km of rural roads, 210 small dams, 60 foot bridges andassorted community forestry and soil conservation projects. This has created 15,000 jobequivalents. While this has been relatively successful in starting a poverty focused public worksprogram, the Fund has suffered from weaknesses in technical review (raising questions about thesustainability of some investments), transparency and accountability.

31

Attachment VIPage 2 of 2

* The government is now taking actions (with the support of the Bank group) to make the fundmore transparent and accountable, to ensure the sustainability of investments and to ensure thatthe funds are directed at poverty reducing investments. Technical audits will be completed byend-November and a range of consultative workshops are being undertaken to shape the future ofthe Fund, within the broad framework of converting the fund into a Social Fund building oninternational best practice. In the interim operations of the Fund have been suspended.

Social and Environmental Issues:

* Both governments are committed to ensure that no household is worse off due to the project.* Phase IA required the resettlement about 75 families from the Katse Reservoir (25 involuntary,

50 voluntary), all of whom have been satisfactorily resettled. In addition about 200 houses havebeen replaced, after initial delays, due to advance infrastructure.

* For phase IA about 1,800 ha of arable land and 3,000 ha of grazing land will be appropriated forproject works, affecting about 3,000 households (many only losing access to grazing land).

* Grain and pulses have been provided for the loss of arable land, and fodder has been provided forlost grazing land. Cash compensation is provided for smaller losses. After initial delays incompensation deliveries, and other related problems, direct compensation is now on target. Arevised compensation policy has been approved for phase lB and will be retrofitted to phase IA.The new policy will ensure an option of an annuity (for 50 years) equal to the full value of lostcrops. Land for land and, under certain conditions, a cash payout are also included as alternativecompensation options.

* In addition to direct compensation, the rural development program has, after initial delays,completed 35km of new feeder roads, with another 54km planned to be in the next 2 years.Village water supply and sanitation has been supplied to 17 villages, with supply underway inanother 35. Advance installation of 157 latrines in project area schools is complete. Communityinfrastructure in six villages worth US$3 million has been completed.

* Compensation for small ad-hoc damages caused by the project was initially delayed, but most ofthese issues have since been resolved and LHDA has put in place decentralized field teams and aconflict resolution mechanism to resolve such issues in the future.

* Although specific income restoration plans have been developed, training has taken place and anumber of short-term jobs have been found, progress remains slow in restoring incomes acrossthe board.

* The project is making good progress dealing with the natural environment impacts of the projectand progress is also satisfactory in the Public Health program.

* For phase lB, about 400 households will probably be resettled (about 100 of which would bevoluntary). About 1,300 ha of arable land and 1,600ha of grazing land will be lost to the project(affecting an additional 300 households). Significant public consultation has taken place todevelop the resettlement and compensation options for the effected communities.

* A comprehensive Environmental Action Plan has been prepared and approved, costing about$125 million and covering compensation, resettlement, natural environmental rehabilitation andprotection, community infrastructure and a full public health program.

32

Attachment VII

LESOTHO: STANDARD CAS ANNEXES

Annex A 1: Key Economic and Program IndicatorsAnnex A2: Country at a GlanceAnnex B2: Selected Indicators of Bank Portfolio Performance and

ManagementAnnex B3: Bank Group Program Summary (Page I of 3)

Bank Group Fact Sheet - IBRD/IDA Lending Program (Page 2 of 3)Bank Group Fact Sheet - IFC and MIGA Program (Page 3 of 3)

Annex B4: Summary of Non-lending ServicesAnnex B5: Poverty and social Development IndicatorsAnnex B6: Key Economic IndicatorsAnnex B7: Key Exposure IndicatorsAnnex B8: IBRD Loan and IDA Credits in the Operations Portfolio (Page I of 2)

Statement of IFC Investment (Page 2 of 2)Annex B9: CAS Program MatrixAnnex B IO: CAS Summary of Development Priorities

33

Annex AlPage 1 of t

Key Economic & Program Indicators

Forecast in Last CAS Actual Current CAS Forecast

Economy (CY) 1994a 1995b 1996b 1997b 1995c 1996c 1997a 1998b J999b 2000b

Growth rates (%)GDP 16.7 8.9 10.8 7.5 9.1 12.7 8.0 1.5 5.0 5.0Exportsd 14.8 15.5 17.8 18.0 -0.8 20.8 14.4 9.0 9.2 12.3Importsd 10.0 5.6 5.0 5.0 -7.8 -0.2 4.4 -0.2 2.5 2.7

Inflation (%) 7.0 6.3 7.7 7.2 9.3 8.5 9.6 8.7 8.3 8.0

National accounts (% GDP)Currentaccountbalance -15.9 -10.4 -8.2 -6.7 -33.3e -32.1e 35,5e -38.0e -41.9e 44,4eGross investment 85.8 87.3 63.1 60.9 83.2 89.2 85.5 84.9 83.2 84.0

w Public finance (% GDP)Fiscal balancef 19.0 16.8 15.5 16.6 17.8 21.3 22.8 23.4 23.1 22.4Foreign financing 7.4 11.9 9.4 7.0 5.8 7.6 12.1 8.5 5.5 3.6

International reserves 6.8 5.8 6.1 6.7 7.1 7.4(as months of imports)

Program (Bank's FY) FY96 FY97b FY98b Fyggb FY96c FY97c FY98a Fy99b FYQOb FYOlbLending ($ million) 40.0 0.0 140.0 22.0 40.0 0.0 67.0 20.0 30.0 -

Gross disbursements 12.8 19.3 12.3 1.0 21.1 18.9 20.3 20.0 25.0 -

($ million)

a. Estimated yearb. Projected yearc. Actual outcomed. Merchandise, f.o.b.e. Based on new national account numbers and tentative definition of balance of payments.f. current account.

Annex A2Page 1 of 2

Lesotho at a glanceSub-

POVERTY and SOCIAL Saharan Low-Lesotho Africa income Development diamond*

Population mid-1996 (millions) 2.0 600 3,229GNP per capita 1996 (USS) 670 490 500 Life expectancyGNP 1996 (billions US$) 1.4 294 1,601

Average annual growth, 1990-96

Population (%/6) 2.1 2.7 1.7Labor force (°%) 2.3 2.6 1.7 GNP Gross

Most recent estimate (latest year available since 1989) capita enrollment

Poverty: headcount index (% of population) 49Urban population (% of total population) 23 31 29Life expectancy at birth (years) 61 52 63Infant mortality (per 1,000 live binths) 76 92 69Child malnutrition (%/o of children under 5) 21 .. .. Access to safe waterAccess to safe water (% of population) 57 47 53Illiteracy (% of population age 15+) 29 43 34Gross prmary enrollment (% of school-age population) 99 72 105 Lesotho

Male 93 78 112 - - - Low-income groupFemale 104 65 98

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1975 1985 1995 1996 . E riEconomic ratios*

GDP (billions US$) 0.1 0.2 0.9 0.9Gross domestic investmenVGDP 18.7 49.4 83.2 89.2Exports of goods and services/GDP 13.2 12.7 21.5 25.5 Openness of economyGross domestic savings/GDP -70.4 -76.6 -16.9 -1.8Gross national savings/GDP 14.2 46.3 59.8 72.9

Current account balance/GDP -12.3 -5.0 -33.3 -32.1Interest payments/GDP 0.1 1.7 1.7 1.6 Savings - ----- InvestmentTotal debt/GDP 9.4 70.8 77.4 95.4Total debt service/exports 0.8 6.8 6.3 5.5Present value of debtlGDP .. ..Present value of debt/exports

Indebtedness1975-85 1986-96 1995 1996 1997-05

(average annual growth)GDP 4.2 6.9 9.1 12.7 5.9 - LesothoGNP per capita 1.8 0.9 4.7 9.8 2.3 -- Low-income groupExports of goods and services 5.0 7.3 2.1 30.7 14.0 _

STRUCTURE of the ECONOMY

(% of GDP) 1975 1985 1995 1996 Growth rates of output and Investment (%)

Agriculture 32.5 21.4 11.3 14.3 30 Industry 13.2 29.7 39.0 41.2 20

Manufacturing 5.7 11.2 16.2 16.5Services 54.2 48.9 49.7 44. 1

Private consumption 151.2 152.0 96.1 85.2 110 9 92 93 94 95 99General government consumption 19.3 24.6 20.8 16.6Importsof goods and services 102.4 138.7 121.6 116.5 - GDI -- GDP

1975-85 1986-96 1993 1996 rt t(average annual growth) ~~~~~~~~~~~~Growth rates of exports and Imports(%(average annual grovvth)

Agrculture -4.7 0.3 -20.1 54.7 40-Industry 11.0 13.8 18.2 11.7 30

Manufacturing 15.5 9.0 20.4 14.1 j 20Services 5.1 5.5 9.5 6.2

Pnvate consumption 3.1 -2.5 -6.4 0.2 °General government consumption 9.9 3.7 5.4 -13.7 [ 10o 91 92 95 96Gross domestic investment 7.9 17.1 27.8 19.2 -20 -Imports of goods and services 4.8 2.2 8.6 5.3Gross national product 4.6 3.3 6.9 12.2 Exports Imports

Note: 1996 data are preliminary estimates.The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond willbe incomplete. 35

Annex A2Page 2 of 2

Lesotho

PRICES and GOVERNMENT FINANCE

Domestic prices 1975 1985 1995 1996 Inflatlon ({Y)(% change) 20

Consumer prices 14.2 13.3 9.3 8.5 '5Implicit GDP deflator 30.5 10.6 5.1 6.3 10

Govemment finance S(% of GDP) 0oCurrent revenue 25.8 42.2 52.6 52.6 91 92 93 94 95 96

Current budget balance 3.9 5.8 17.8 21.3 GDP def - P--CplOverall surplus/deficit -7.3 5.8 -0.8 -0.6

TRADE

(millions USS) 1975 1985 1995 1996 Export and import levels (mill. US$)Total exports (fob) 14 22 154 180 1,200 -

Commodity 1 .. .. .. 126 100C-ommodity 2 .. . . 24

Manufactures .. . 8000-Total imports (cio 151 324 1,013 1,003 t0 11

Fuel and energy . .. . .. 200Capital goods .. .

Export price index (1987=t00) .. .. .. 0.. so 91 92 93 94 95 98Import price index (1987=100) .. .. .. .. CExports gn ImportsTerms of trade (1987=100) ..

BALANCE of PAYMENTS

(millions US$) 1975 1985 1995 1996 Current account balance to GDP ratio (%)Exports of goods and services 26 41 205 256 o0 --------- -.Imports of goods and services 171 360 1,083 1,073 090 91 92 93 94 9S 98

Resource balance -145 -319 -878 -816-20 -

Net income 101 233 351 313Net current transfers 25 74 244 227 .30.

Current account balance, before official capital transfers -18 -12 -283 -276 -50

Financing items (net) 19 18 391 388 40 - L

Changes in net reserves -1 -6 -108 -112 70 -

Memo:Reserves including gold (mill. US$) .. 44 457 461Conversion rate (local/US$) 0.7 2.2 3.6 4.3

EXTERNAL DEBT and RESOURCE FLOWS1975 1985 1995 1996

(millions US$) , Composition of total debt, 1998 Imill. US$)Total debt outstanding and disbursed 14 175 659 821

IBRD 0 0 54 57IDA 8 62 153 159 F:34 G:AI 57

Total debt service 1 19 40 35 --IBRD 0 0 3 4 E12IDA 0 1 2 2 B:159

Composition of net resource flows ,Official grants 0 0 0 0Official creditors 4 35 33 23Private creditors 0 -6 9 10Foreign direct investment 0 0 0 0 C-34Portfolio equity 0 0 0 0 0:250

World Bank programCommitments 0 4 A-laRD E - BilateralDisbursements 2 8 20 19 B - IDA D - Other multilateral F - PrivatePrincipal repayments 0 0 1 1 C - IMF G -Short-termNetflows 2 8 19 18Interest payments 0 1 4 5Net transfers 2 8 15 13

Development Economics 3/31/98

36

Annex B2Page I of I

Lesotho - Selected Indicators ofBank Portfolio Performance and Management

Indicator 1995 1996 1997 1998as of

4114/98Portfolio Assessment

Number of Projects under implementationa 8 8 7 6Average implementation period (years)b 4.61 4.60 5.09 5.88Percent of problem projects".c

by number 25.00 12.50 0.00 0.00by amount 11.81 1.65 0.00 0.00

Percent of projects at riska d

by number 14.29 0.00 0.00 16.67by amount 2.54 0.00 0.00 10.54

Disbursement ratio (/o)e 11.07 16.09 13.29 15.46

Portfolio Management

CPPR during the year (yes/no) yes no yes noSupervision resources (total US$ thousands) 562.63 520.19 392.79 238.56Average Supervision (US$/project) 70.33 65.02 56.11 39.76

Memorandum item Since FY80 Last five FYs

Projects evaluated by OEDby number 18 7by amount (US$ millions) 145.15 46.20

Percent rated U or HUby number 27.78 28.57by amount 36.85 43.00

a. As shown in the Annual Report on Portfolio Performance (except for curTent FY)b. Average age of projects in the Bank's country portfolio.c. Percent of projects rated U or HU on development objectives (DO) and/or implementationi progress (IP).d. As defined under the Portfolio Improvement Program.e. Ratio of disbursements during the year to the undisbursed balance of the Bank's portfolio at the beginning of the

year: investment projects only.

37

Annex B3Page I of 3

Lesotho - Bank Group Program Summary, FY 1998-2000

Proposed IBRD/IDA Base-Case Lending Program, FY 1998-2000a

Strategic rewardsb ImplementationbFY Project US$(M) (H/M/L) risks (HIMIL)

1998 AG POL & CAP BLDG (APL) - IDA 22.0 M HHILAND WATER IB - IBRD 45.0 H M

Subtotal 67.0

1999 EDUCATION II 15.0 H LSOCIAL FUND (LIL)- IDA 5.0 H L

Subtotal 20.0

2000 HEALTH SECTOR PROJECT (APL) - IDA 20.0 H MMALUTI/DRAKENSBURG (GEF) - IDA 10.0 M M

Subtotal 30.0

Total, FY 1998-2000 117.0

a. This table presents the proposed program for the next three fiscal years.b. For each project, indicate whether the strategic rewards and implementation risks are expected to be high (H),

moderate (M), or low (L).c. LIL - Learning and Innovation Loan

SIP - Sector Investment Program

38

Annex B3Page 2 of 3

Lesotho - IBRD/IDA Lending Program

Past Current Planned'Category 1995 1996 1997 1998 1999 2000 2001

Commitments (US$m) 0.0 40.0 0.0 67.0 20.0 30.0 40.0

Sector (%o)hAgriculture 0.0 0.0 0.0 32.8 0.0 0.0 0.0Education 0.0 0.0 0.0 0.0 75.0 0.0 0.0Environment 0.0 0.0 0.0 0.0 0.0 33.3 0.0Multisector 0.0 0.0 0.0 0.0 0.0 0.0 100.0Popultn, Hith & Nutn 0.0 0.0 0.0 0.0 0.0 66.7 0.0Social Sector 0.0 0.0 0.0 0.0 25.0 0.0 0.0Transportation 0.0 100.0 0.0 0.0 0.0 0.0 0.0Water Supply & Santn 0.0 0.0 0.0 67.2 0.0 0.0 0.0

TOTAL 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Lending instrument (%)Adjustment loansc 0.0 0.0 0.0 0.0 0.0 0.0 0.0Specific investment loans and others 0.0 100.0 0.0 100.0 100.0 100.0 100.0

TOTAL 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Disbursements (US$m)Adjustment loans' 0.0 0.0 0.0 0.0 0.0 0.0 0.0Specific investment loans and others 17.6 21.1 18.9 15.4 0.0 0.0 0.0

Repayments (US$m) 1.4 1.4 1.5 3.3 0.0 0.0 0.0Interest (US$m) 4.2 4.9 4.9 2.7 0.0 0.0 0.0

a Ranges that reflect the base-case (i.e., most likely) Scenario. for IDA countries, planned commitments are not presented by FY but as athree-year-total range; the figures are shown in brackets. A footnote indicates if the pattern of IDA lending has unusual characteristics(e.g., a high degree of frontloading, backloading, or lumpiness). For blend countries, planned IBRD and IDA commitments are presentedfor each year as a combined total.

b For future lending, rounded to the nearest 0 or 5%/o. To convey the thrust of country strategy more clearly, staff may aggregate sectors.c Structural adjustment loans, sector adjustment loans, and debt service reduction loans.

Note:Disbursement data is updated at the end of the first week of the month.

39

Annex B3Page 3 of 3

Lesotho - IFC and MIGA Program, FY95-98

PastCategory 1995 1996 1997 1998

IFC approvals (US$m)a 0.00 0.00 0.00 0.00

Sector (%/o)

TOTAL 100.00 100.00 100.00 100.00

Investment instrument (%)Loans 0.00 0.00 0.00 0.00Equity 0.00 0.00 0.00 0.00Quasi-Equity b 0.00 0.00 0.00 0.00

Other 0.00 0.00 0.00 0.00

TOTAL 100.00 100.00 100.00 100.00

MIGA guarantees (US$m) 0.00 0.00 0.00 0.00MIGA commitments (US$m) 0.00 0.00 0.00 0.00

aExcludes AEF projects.blncludes quasi-equity types of both loan and equity instruments.

40

Annex B4

Page 1 of 1

Lesotho-Summary of Nonlending ServicesProduct Completion Cost Audiencea Objectiveb

FY (USSOOO)

Recent completionsImproving the Focus of the Lesotho 98 Government, knowledge generation,Highlands Revenue Fund: Issues and Bank consensus buildingReform Options

UnderwayCountry Assistance Strategy 98 Bank, knowledge generation,

Government, consensus building,Donors, Public public debateDissemination

Public Expenditure Review (with GOL) 99 Govemment, knowledge generation,Bank, Public public debate

Dissemination

Financial Sector Overview (with GOL) 98 Govt., Bank, knowledge generation,Public public debate, sector

Dissemination reform program

Education ESW 99 Govt., Bank, knowledge generation,Public public debate, sector

Dissemination reform program

Health ESW 99 Govt., Bank, knowledge generation,Public public debate, sector

Dissemination reform program

Planned

Policy Dialogue on Civil Service Reform 99 Govt. sector reform program(under PFP)

Labor Market Dynamics (as part of a 00 Govt., Donors, knowledge generation,regional study) Bank, regional public debate, sector

stakeholders reform program.

Poverty Monitoring Systems Support 00 Govt., Donors, knowledge generation,Bank, regional public debate, sectorstakeholders reform program

Country Dialogue/General ESW 00

Country Assistance Strategy 00

a. Government, donor, Bank, public dissemination.b. Knowledge generation, public debate, problem-solving.

41

Annex B5page 1 of 1

Lesotho Social IndicatorsLatest single year Same region/income group

Sub- Lower-Saharan middle-

1970-75 1980-85 1990-95 Africa income

POPULATIONTotal population, mid-year (millions) 1.2 1.6 2.0 583.4 1,152.6

Growth rate (% annual average) 2.5 2.6 2.1 2.8 1.3Urban population (% of population) 10.8 15.9 23.1 31.1 55.6Total fertility rate (births per woman) 5.7 5.5 4.6 5.7 3.0

POVERTY(% of population)National headcount index .. 49.2

Urban headcount index .. 27.8Rural headcount index .. .. 53.9

INCOMEGNP per capita (US$) 250 370 770 490 1,670Consumer price index (1990=100) .. ..

Food pnce index (1990=100) .. 56 171

INCOMEICONSUMPTION DISTRIBUTION(% of income or consumption)Lowest quintileHighest quintile

SOCIAL INDICATORSPublic expenditure(% of GDP)

Health .. .. 3.5Education 5.6 8.0 7.4Social security and welfare 0.9 0.5 0.8

Net primary school enrollment rate(% of age group)

Total .. 71 65 .. 92Male .. 61 59Female .. 81 71

Access to safe water(% of population)

Total 17.0 17.6 57.0 47.0Urban 65.0 37.0 90.0Rural 14.0 14.0 40.0

Immunization rate(% under 12 months)

Measles .. 63 82 60 87DPT .. 69 56 58 89

Child malnutrition (% under 5 years) .. 13 21Life expectancy at birth(years)

Total 49 54 61 52 67Male 48 52 57 51 64Female 52 56 60 54 70

MortalityInfant (per thousand live births) 130 100 76 92 41Under 5 (per thousand live births) .. .. 121 157 56Adult (15-59)

Male (per 1,000 population) . 347 433 253Female (per 1,000 population) .. .. 258 359 148

Maternal (per 100,000 live births) 1,600 .. 598

World Development Indicators CD-ROM, World 6ank, February 1997

42

Annex B6Page 1 of 3

Lesotho - Key Economic Indicators

Actual Estimate Projected

Indicator 1992 1993 1994 1995 1996 1997 1998 1999 2000

National accounts(as % GDP at currentmarket prices)

Gross domestic product 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 101.0

Agriculturea 7.0 10.5 11.6 9.5 12.2 9.9 14.4 14.7 14.7

Industry' 28.3 29.7 31.3 32.8 35.1 36.3 38.8 39.5 41.7

Servicesa 43.1 41.1 40.5 41.7 37.9 39.4 32.1 30.9 28.6

Total Consumption 145.5 133.2 114.6 116.9 101.8 109.4 111.0 112.6 110.1Gross domestic fixed 78.7 75.0 80.3 83.2 89.2 85.5 84.9 83.2 84.0investment

Government investment .. .. .. .. .. 15.5 15.5 15.5 15.5

Private investment .. .. .. .. .. 70.0 69.4 67.7 68.5

(includes increase instocks)

Exports (GNFS)b 20.1 22.4 22.0 21.5 25.5 32.9 37.4 40.6 44.6Imports (GNFS) 143.9 130.6 116.9 121.6 116.5 127.8 133.3 136.3 138.7

Gross domestic savings -45.5 -33.2 -14.6 -16.9 -1.8 -9.4 -11.0 -12.6 -10.1

Gross national savingsc 16.5 21.1 55.4 59.8 72.9 50.0 46.9 41.3 39.6

Memorandum itemsGross domestic product 661 700 759 852 860 950 975 1046 1130(US$ million at currentprices)Gross national product per 580.0 580.0 620.0 650.0 670.0 670.0 640.0 640.0 660.0capita (US$, Atlas method)

Real annual growth rates(%, calculated from 1980prices)

Gross domestic product at 3.5% 4.0P/o 12.90/o 9.1% 12.7% 8.0% 1.5% 5.0%/o 5.0%market pricesGrossDomesticIncome 8.2% 3.8% 12.9% 9.1% 12.5% 9.8% 1.6% 5.1% 5.1%

Real annual per capitagrowth rates (%, calculatedfrom 1980 prices)

Gross domestic product at 1.4% 1.8% 10.6% 6.8% 10.3% 5.4% -0.6% 2.8% 2.8%market pricesTotal consumption 1.1% -7.4% -5.5% -5.5% -5.6% 11.5% 2.0% 5.8% 1.4%Private consumption 0.8% -10.0% -9.5% -8.3% -1.9% 14.6% 2.7% 6.6% 1.1%

(Continued)

43

Annex B6Page 2 of 3

Lesotho - Key Economic Indicators(Continued)

Actual Estimate Projected

Indicator 1992 1993 1994 1995 1996 1997 1998 1999 2000

Balance of Payments(US$m)

Exports (GNFS)b 150.5 171.0 181.2 204.8 256.4 312.5 364.8 424.4 503.7Merchandise FOB 109.2 134.0 143.5 153.8 180.5 224.5 263.1 307.4 369.2

Imports (GNFS)b 1015.4 938.5 874.4 1082.5 1072.6 1214.1 1300.3 1425.9 1566.3Merchandise FOB 932.6 868.1 810.2 1013.1 1002.6 1092.0 1171.5 1285.4 1412.5

Resource balance -864.9 -767.6 -693.2 -877.8 -816.3 -901.6 -935.5 -1001.5 -1062.6Netcurrenttransfers -16.6 -25.6 151.5 244.1 227.1 232.8 233.0 233,3 233.7(including official currenttransfers)Current account balance -417.8 -371.5 -211.5 -283.2 -276.2 -292.4 -325.9 -392.8 -456.0(after official capital grants)

Net private foreign direct 2.7 15.0 18.7 31.8 26.0 20.0 22.0 24.2 26.6investmentLong-term loans (net) .. .. .. .. 0.0 ..

Official 63.0 45.5 40.2 32.6 23.0 61.0 35.0 9.0 -7.0Private .. .. .. .. -23.0 ..

Other capital (net, including .. .. .. .. 362.1 ..

errors and omissions)

Change in reservesd -49.8 -102.2 -120.8 -108.3 -111.9 -65.4 -97.3 -93.1 -106.7

Memorandum itemsResource balance (% of -130.8% -109.7% -91.4% -103.1% -94.9% -94.9% -95.9% -95.8% -94.1%GDP at current marketprices)Real annual growth rates(1980 prices)Merchandise exports .. .. .. .. .. 14.4% 9.0% 9.2% 12.3%(FOB)Primary .. .. .. .. .. 14.6% 9.1% 9.3% 12.4%Manufactures .. .. .. .. .. .. ..

Merchandise imports .. .. .. .. .. 4.4% -0.2% 2.5% 2.7%(CIF)

Public finance(as % of GDP at current

market prices)e

Current revenues 50.8 52.6 51.8 52.6 52.6 49.1 49.0 48.1 47.0Current expenditures 35.7 34.6 34.9 34.8 31.3 26.3 25.6 25.0 24.6

(Continued)

44

Annex B6Page 3 of 3

Lesotho - Key Economic Indicators

(Continued)

Actual Estimate Projected

Indicator 1992 1993 1994 1995 1996 1997 1998 1999 2000

Current account surplus (+) 15.1 18.0 16.9 17.8 21.3 22.8 23.4 23.1 22.4or deficit (-)

Capital expenditure 19.6 18.4 16.3 18.6 21.9 20.1 20.1 19.5 19.0Foreign financing 8.5 6.9 4.3 5.8 8.4 12.1 8.5 5.5 3.6

Monetary indicatorsM2/GDP (at current market 38.3 40.9 38.5 36.3 35.8 35.7 35.7 35.7 35.7prices)Growth of M2 (%/6) 9.8 29.4 10.9 8.2 18.1 18.0 10.4 13.7 13.4Private sector credit growth! .. .. .. .. .. -69.6 34.7 8.2 32.1

total credit growth (%)

Price indices( 1980 =100)Merchandise export price

indexMerchandise import price

indexMerchandise terms of trade

indexReal exchange rate 115.6 114.3 109.3 108.8 99.6 92.1 93.1 94.0 94.1

(US$/LCU),

Real interest ratesConsumer price index 17.2% 13.1% 8.2% 9.3% 8.5% 8.6% 7.7% 7.2% 7.1%(% growth rate)GDP deflator 11.2% 16.6% 4.4% 5.1% 6.3% 9.6% 8.7% 8.3% 8.0%(% growth rate)

a. If GDP components are estimated at factor cost, a footnoote indicating this fact should be added.b. "GNFS" denotes "goods and nonfactor services."c. Includes net unrequited transfers excluding official capital grants.d. Includes use of IMF resources.e. Should indicate the level of the government to which the data refer.f. "LCU" denotes "local currency units." An increase in US$/LCU denotes appreciation.

45

Annex B7Page 1 of 1

Lesotho - Key Exposure Indicators

Actual Estimate ProjectedIndicator 1992 1993 1994 1995 1996 1997 1998 1999 2000

Total debt outstanding and 493 530 602 659 655 721 847 1035 1297

disbursed (TDO) (US$m)a

Net disbursements (US$m)a 66 50 39 39 30 66 126 187 262

Total debt service (TDS) 35 32 35 39 35 59 69 69 78

(US$m)a

Debt and debt service indicators

(O)

TDO/XGSb 76.3 86.2 109.2 104.6 103.0 188.2 193.0 206.0 221.5

TDO/GDP 74.6 75.8 79.3 77.4 76.1 75.9 86.8 98.9 114.8

TDS/XGS 5.4 5.2 6.3 6.3 5.5 15.4 15.7 13.6 13.3

Concessional/TDO 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

IBRD exposure indicators (/o)

IBRD DS/public DS 0.9 3.4 7.2 7.6 11.4 15.3 17.4 17.5 14.2

Preferred creditor DS/public 40.3 39.1 53.3 65.2 57.1 50.8 55.0 54.0 48.9

DS (%)C

IBRD DS/XGS 0.0 0.2 0.5 0.5 0.6 2.3 2.7 2.4 1.9

IBRD TDO (US$m)d 5 26 42 54 57 63 64 62 59

Of which present value of

guarantees (US$m)

Share of IBRD portfolio (%) .. .. .. .. .. ..

IDA TDO (US$m)d 127 134 143 153 159 187 208 222 229

IFC (US$m)

Loans

Equity and quasi-equity /c

MIGA

MIGA guarantees (US$m)

a. Includes public and publicly guaranteed debt, private nonguaranteed, use of IMF credits and net short-

term capital.

b. "XGS" denotes exports of goods and services, including workers' remittances.

c. Preferred creditors are defined as IBRD, IDA, the regional multilateral development banks, the IMF, and the

Bank for International Settlements.

d. Includes present value of guarantees.

e. Includes equity and quasi-equity types of both loan and equity instruments.

46

CAS Annex B8Generated: 04/14/98

Status of Bank Group Operations in LesothoIBRD Loans and IDA Credits in the Operations Portfolio

Difference Betweenexpected

Original Amount in USS Millions and actual Last ARPPLoan or Fiscal disbursements a/ Supervision Rating b/

Project ID Credit Year Borrower PurposeNo. IBRD IDA Cancellations Undisbursed Orig Frm Rev'd Dev Obj Imp Prog

Number of Closed Loans/credits: 20

Active Loans c/

LS-PE-1391 IDA 21950 1991 GOVERNMENT OF LESOTHO INDUSTRY AND AGRO-IN 0.00 21.00 0.00 2.85 2.71 0.00 S SLS-PE-1396 IBRD 33930 1992 LES H/L DEV. AUTH. HIGHLAND WTR.I 110.00 0.00 20.00 21.64 39.86 7.14 S SLS-PE-1392 IDA 22870 1992 GOVT OF LESOTHO EDUC. SECTOR DEVELOP 0.00 25.20 0.00 13.53 11.79 9.94 S SLS-PE-1401 IDA 26120 1994 GOVERNMENT PRIVATISATION/RESTRU 5.00 11.00 0.00 7.40 -. 39 0.00 S sLS-PE-1403 IDA 28570 1996 GOVERN4MENT ROAD REHAB. & MAINT .C00 40.00 0.00 34.05 10.71 2.33 S S

Total 110.C0' 97.20 20.00 79.47 64.68 19.41

Active Loans Closed Loans TotalTotal Disbursed (IBRD and IDA): 104.69 137.16 241.85

of vihich has been repaid: 2.31 10.96 13.27Total now held by IBRD and IDA: 184.89 121.55 306.44Amount sold : 0.00 0.00 0.00

Of which repaid : 0.00 0.00 0.00Total Undisbursed : 79.47 2.47 81.94

a. Intended disbursements to date minus actual disbursements to date as projected at appraisal.b. Following the FY94 Annual Review; of Portfolio performance (ARPPP, a letter based system was introduced (HS - highly Satisfactory, S = satisfactory, U = unsatisfactory, HU

highly unsatisfactory): see proposed Improvements in Project and Portfolio Performance Rating Methodology (SecM94-901), August 23, 1994.c. Second Population and Health Project w/as closed on March 31,1998 (total IDA commitment US$12.1 million).

Note:Disbursement data is updated at the end of the first week of the month.

CAS Annex B8

LesothoSTATEMENT OF IFC's

Committed and Disbursed PortfolioAs of

(In US Dollar Millions)

Committed DisbursedIFC IFC

FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic

Total Portfolio: 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Approvals Pending Commitment

Loan Equity Quasi Partic

Total Pending Commitment: 0.00 0.00 0.00 0.00

48

ANNEX B9LESOTHO: Country Assistance Strategy Program Matrix (FY99-00)

Development Objectives and Government Strategy Actions Performance Benchmarks Bank Group Instruments and Activities of Other DonorsDiagnosis Timing

A. Support Poverty Reduction:

(i) Reform and enhance Reform LHRF into a poverty- - Enact revised Legal Notice to the - FY99, with WN assistance DFID financial and technicalLHRF focused social fund with well- LHRF by August 1, 1998. through Poverty LIL assistance.(ii) LRRF is not well poverty- defined operational manual and - Complete the recruitment andfocused and its poverty Secretariat (which embodies staffing of social fund by end-FY99.reducing impact is limited to administrative, analytic,rural employment generation monitoring, and evaluativeand construction of rural functions)infrastructure

Strengthen the capacity of local - Identify the fiscal implication of Strengthening of the LHRF - Local Government reforms,communities to undertake project ongoing Local Government supported by Poverty LIL supported bypreparation, implementation and restructuring by FY99. (FY98-O0). DFID/AfDB/UNDPmonitoring, and establish the - Prepare comprehensive Local - Proposed Policy Reform and - Other Donors include theframework for increased local Government budget by FY00. Capacity Building for EU, USAID, GTZ and WFP,responsibility for maintenance and Agriculture (FY98). IFADrepair of rural infrastructure

Strengthen GOL partnership with - review of legislation concerning WB through NGO componentNGOs NGO, and develop more supportive of Poverty LIL to support both

enabling environment activities- Support capacity-building of NGOs

Improve instruments for safety net, - target special programs to - Supported by WB and other - Other donors include EU,promote labor intensive vulnerable groups through social donors through Road Ireland, GTZdevelopment activities; and fund. Rehabilitation and Maintenance - Local task-force forimprove targeting of vulnerable project (Ongoing). Drought Relief with supportgroups, including programs of WFP (FY98-00)drought-relief.

(ii) Poverty Monitoring: Establish regular poverty survey by - Put in place by December, 1998 a - WB support to CWIQ surveySince a 11993 Poverty Survey, improving the Central Bank of system for data collection that will through Poverty LILit has not been possible to statistics and other agencies for data permit monitoring of povertydetermine the status of poverty collection

Development Objectives and Government Strategy Actions Performance Benchmarks Bank Group Instruments andDiagnosis Timing

Give higher priority to the - Reflect monitorable poverty action - Support by WB for - ILO to collaborate throughimplementation and monitoring of plans in FY00 national budget undertaking a labor market labor force surveypoverty-reduction portfolio dynamics study

(iii) Invest in Human Resource In Education: Improve access to - target a teacher: pupil ratio of 1:47 - Strategic Support by WB toDevelopment: Lesotho is education by promoting cost and a 3% annual increase in the local task force (FY98-00).essentially a labor supply efficiency, strengthening school number of classrooms. - Proposed Education Sector -USAID, DFID, AfDB, andeconomy. But the demand for management, and increasing - increase male primary school Project (FY99, to be supported UNICEF/UNEPlabor in the future within and resources to education. Improve enrollment by by WB).outside the economy will non-formal andrequire a highly skilled labor vocational/technical education.than in the past.

In Health: Reallocate expenditures Allocate 40 % of Ministry's budget to - Strategic support by WB to - Ireland, DFID and WHOfrom tertiary towards more cost- essential health services. Sign MOU local task force (FY98-00).effective services; increase equity with South Africa and PHAL by end - Proposed Health andof access to basic services; FY99. Reduce case fatality of TB Population project to beimprove staff distribution; improve and malnutrition by 70 % by FY00. developed through SIP (FY00,the technical efficiency and quality Reduce child mortality to 20 per 1000 to be supported by WB).of health services; and formulate by FY01.policy on coordination with PHALand South Africa.

(iv) Promote Comprehensive Ensure conservation of natural - increase water and sanitation Capacity Building project for - Other Donors include theApproach to Natural Resource resource and protection of the coverage to 50% of households in the Agriculture (FY98, WB) EU, USAID, GTZ WFP andEnvironment: Rural environment, especially with rural area over the next 5 years. - Proposed Maluti-Drakensburg IFAD, RSAenvironment degradation is a respect to deforestation, land - Reduce over-grazing by developing (GEF) project (FY99).formidable challenge as it degradation, and water enforceable policy. - Proposed Water Supply - UNDPaffects returns on agriculture contamination. Project (WB, FY00).

- Environmental and Rural - UNDPDevelopment components ofthe LHWP (FY99-00) with WBassistance.

Development Objectives 1 Government Strategy Actions Performance Benchmarks Bank Group Instrumentsand Diagnosis l and Timing

B. Promote External Competitiveness:(i) Improve Enabling Policy Pursue prudent fiscal policy -Maintain expenditures at 30 % of - PFP (FY99, 00) - IMF and EU assistanceEnvironment: Government has consistent with the maintenance of GNP; improve spending to social - Public Expenditure Review - IMFmade substantial progress in financial stability while providing sectors (health and education) and (FY99) with WB assistance.attaining economic essential public goods and basic sustain overall fiscal balance through - Review Tax Policy & - IMFstabilization, but sustainability social, physical, and informational FY2000. Introduce VAT (FY99) withand improvement in external infrastructure. WB assistance.competitiveness requiremaintenance of fiscal prudence.

Achieve a leaner and more - Initiate civil service reform by FY99 - PFP (FY99,00) assistance from UNDPeffective public sector by by targeting reduction in the share of - Privatization Project (WB). DFID/AfDB.rationalizing and restructuring the expenditures on wages and salaries to - Procurement Reform (WBcivil service; and enhancing the under 50% by FY2000. through IDF Grant).ongoing privatization effort.Initiate a financial sector reform Enact revised Financial Institutions -PFP (FY99,00)by: consolidating ongoing bank Act during FY99 and initiate the - Privatization Project (withreform, improving the effectiveness liberalization of the financial sector. VB assistance).

_ of the Central Bank, updating - Financial Sector Review, withexisting financial legislation and VWB assistance (FY98)improving their enforcement, and - Financial Sector Reformencouraging the development of operation, with VB assistancenew financial instruments of (FY0 1).intermediation.Maintain an open and liberal - Eliminate remaining exchange - PFP (FY99,00) - Assistance from WTOexchange regime supported by a controls relating to travel allowance Secretariat and DFID (FY99,liberal trade system free of and transfer of foreign exchange for 00).quantitative restrictions. education purposes by FY00.

(ii) Promote Private Sector Seek management support for -Improve financial outcome of three - WB, Privatization and Private Support from DFIDDevelopment: The private WASA, LEC and LTC in order to utilities by FY00 and reduce in cost Sector Development Projectsector in Lesotho is very improve quality and efficiency of of operation. (ongoing) and Supplementalundeveloped although, given services. (FY99).the country's narrow resourcebase, constitute the potentialengine of growth.

Development Objectives Government Strategy Actions Performance Benchmarks Bank Groupand Diagnosis Instruments and

Timing

Amend the regulatory and legal - Establish a Utilities Commission byframework for public utilities. end FY99.Accelerate and expand divestiture - Attain the privatization of at threeprogram with the view of reducing PEs per year over the next two yearsGovernment dominance in the (FY99-00).commercial sector.

(iii) Build Institutional Complete civil service review, - Cabinet to review report by FY99 - Policy requirement of PFP - UNDP & DFIDCapacity: In order to support outlining its function, appropriate with the objective of approving technical support (FY00-the Government's agenda of size and incentive framework reform program. 01).reducing poverty andintegrating the economy intothe sub-regional economy,there is the need for anefficient public sector tosupport the facilitatingenvironment. Current publicsector capacity in policy

S formulation andimplementation is weal.

Incorporate and privatize - Complete listing and cabinet - WB assistance through Capacitycommercially oriented services now clearance by end-FY99. Building Project in Agricultureperformed in the Ministries of (FY98) and Health Sector SIPAgriculture and Health. (FY00).Undertake procurement and legal -Parliament to debate and amend World Bank assistance through IDFsector reforms (including training of Financial Institutions Act by end- Grant for Procurement, legal andlegal personnel and revision of FY99. Finance Management (FY99).existing legislation). - Mount a series of training programs

for procurement and Legal personnelin FY99-00.

Annex BIO

Page I of 1

Lesotho-CAS Summary of Development Priorities

Reconciliation ofComntry Conntry Bank countrnvand Bank

Network area performan Major issuleb priorityC prioritvC prioritiesdcea

Poverty Reduction & EconomicManagement* Poverty reduction fair High poverty level. high high

essentially of the ruralarea.

* Economic policy excellent High economic growth high highand prudent fiscal policy

* Public sector fair Weak civil service moderate moderate* Gender fair low male enrollment; low high ongoing dialogue

women legal status as & EU activelyminors. involved.

Human Resource Development* Education good Low primary school high high

completion; weaknonformal & TVETsystem

* Health, nutrition & population good weak intrasectoral budget high highallocation, equitableaccess & collaborationwith RSA/PHAL.

* Social protection fair Need for well defined moderate high Institutionalinstitutions of safety nets. weaknesses on

part of Govt.Environmentally & SociallySustainable Developmente Rural development fair Lack of clear rural moderate moderate

development policy* Environment fair Over-grazing and land moderate high other donors

degradation taking the lead.e Social development good community participation. high highFinance, Private Sector &Infrastructurei Financial sector fair Financial distress of high high

major banks includingdeepening of sector.

• Private sector good Private sector high highdevelopment constrainedby cost, quality &coverage.

* Energy & mining good High enegy cost because moderate moderateof managementdeficiency

* Infrastructure good Expansion and high highmanagement of ruralinfrastructure

a. Use "excellent," "good," "fair," or "poor."b. Indicate principal country-specific problems (e.g., for poverty reduction, "rural poverty;" for education, "female secondary

completion;" for environment, "urban air pollution").c. To indicate priority, use "low," "moderate," or "high."d. Give explanation, if priorities do not agree; for example, another MDB may have the lead on the issue, or there may be ongoing

dialogue.

53

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