At its
meeting held on the 2nd February 2005 ,
the Central Bank of Lesotho Monetary Policy
Committee (MPC) decided that the target range for
Central Bank of Lesotho Net International Reserves
(NIR) for the period January 2005 to March 2005
will be (United States) $350.0 and $400.0 million[1].
At this range NIR will be in excess of narrow
money (M1) by about 30 percent. The Committee is
satisfied that although the target level of NIR is
somewhat lower than that set in September when the
Committee last met, it is nevertheless still
sufficient to cope with the demands of the economy
. This in turn will allow the Central Bank to
continue to maintain the fixed exchange rate
arrangement between the local currency, loti,
and the South African currency, the rand. The
fixed exchange rate arrangement allows Lesotho to
benefit from lower South African imported
inflation, currently targeted at between 3 and 6
percent.
The
lower target range has been set in order to
accommodate the expected worsening of the overall
balance of payments situation as a result of
permanent structural changes in the international
trading environment. This accommodation is
necessary in order to give the economic players
and relevant Authorities time to put in place
necessary reform measures to arrest what is
seemingly an unsustainable balance of payments
situation.
Regarding domestically-generated inflation,
particularly inflation generated from the
demand-side of the economy, the committee noted
that there were no immediate threats. Accordingly,
no measures were taken in this regard.
2.
Inflation Developments During the third and
fourth quarters of 2004
In
making its decisions, the committee started by
examining inflation developments during the
previous period. The Committee noted that
inflation rate continued to remain at around 5
percent. Although data on Lesotho import price
index are not available, circumstantial evidence
suggests that declines in the costs of imported
goods are largely responsible for the observed
stabilisation of inflation during the quarter. The
South African import price index for example
declined by about 4 percent during the second
quarter of 2004. The South African producer price
index on the other hand reached 2.5 per cent in
November 2004. As Lesotho imports around 80
percent of goods from South Africa, declines in
South African key price indices would, to some
extent, be passed over to Lesotho. The above
developments are in turn driven by the strength of
the loti/rand during 2004.
The
Committee turned its attention to assessing
inflation pressures emanating from the demand side
of the economy. Real economic growth is
anticipated to be 3.5 percent in 2004. On the
other hand real money supply as measured by M2 is
estimated to have grown by 3 percent during the
same period. On the basis of these developments,
the Committee concluded that there were no
immediate inflation pressures from the demand side
of the economy.
3.
Prospects for the Maintenance of the Fixed
Exchange Rate Arrangement
The
present fixed exchange rate regime has served
Lesotho well by imposing monetary discipline and
allowing Lesotho to benefit from the low-inflation
environment in South Africa. The South African
Authorities are currently targeting an inflation
rate of between 3 and 6 percent with the latest
official measure of inflation, the CPIX, measured
at 4.3 percent in December 2004. The committee is
convinced that in order for Lesotho to continue to
benefit from this South African inflation target,
and additionally continue to observe monetary
discipline, it would be critical to maintain the
fixed exchange rate arrangement.
In
this regard, balance of payments developments are
a critical factor in determining the prospects for
Lesotho to continue in the fixed exchange rate
arrangement. Accordingly, the committee turned its
attention to balance of payments developments and
outlook.
3.1 Balance of Payments Developments
Lesotho’s long-term balance of payments position
appears to be unsustainable and urgent measures
are required to restore the position to a
sustainable level. The window of opportunity may
close within the next five years. On a long term
basis, net capital inflows are not sufficient to
finance the current account deficits. The
structural break occurred in 1998. Prior to this
time, capital inflows were sufficient to finance
current account deficits which averaged 12 percent
of GDP. Accordingly, the country accumulated net
international reserves from a level of 1.3 months
of imports in 1988 to a healthy level of 9.7
months in 1998. After, 1998, net capital inflows,
excluding LHWP activity, fell considerably to an
average level of 4.2 percent between 1998 and the
year 2004. Despite this structural break in the
long-term trends in net capital inflows, the
current account position failed to adjust to the
new realities on the capital account front. The
long-term current account deficit remained at 12
percent of GDP during the period 1998 to 2004. As
a result of these unsustainably high levels of the
deficit, official reserves have fallen from their
peak level of 9.7 months of imports cover in 1998,
to the present level of 5.0 months at the end of
2004.
The
Committee reiterated its earlier view that
monetary policy instruments are generally not
suited to addressing the structural factors that
have resulted in the unsustainable current account
deficits. These factors can only be addressed
through long-term reforms aimed at making Lesotho
more competitive. Accordingly, the Committee urges
the relevant authorities to implement necessary
reforms and wishes to add that the window of
opportunity may close within the next five years.
Short-term cyclical factors continued to influence
balance of payments developments. Key among these,
can be mentioned fiscal developments. The
narrowing of the current account deficit, from its
long-term structural level of 12 percent of GDP to
the level of 7 percent in 2003 and a further
improvement to 0.5 percent in 2004, is largely a
result of fiscal prudence witnessed during the
same period. Measured on a calendar-year basis,
the fiscal balance narrowed considerably to a
deficit equivalent to 0.3 percent of GDP in 2003
and an expected surplus of 1.9 percent in 2004.
The positive contribution of fiscal policy towards
a more sustainable level of the current account
deficit is a welcome development.
The
Committee noted that Lesotho couldn’t rely on
fiscal policy alone to bear the brunt of the
adjustment process. Considerable fiscal tightening
would be required to bring the current account
deficit to a more sustainable level of 4 percent
of GDP[2].
The Committee noted that for example in 2003, it
took a balanced budget, to bring the current
account deficit to 7 percent of GDP. Yet, even
with a balanced budget, the current account
deficit of 7 percent of GDP was still
unsustainable because it was in excess of net
capital inflows of 4.2 percent of GDP. Further,
the Committee noted it has taken a budget surplus
to bring the current account deficit to a
sustainable level. Given weakening government
revenues and other pressures on the fiscus, the
Committee deemed it unlikely that fiscal policy
will continue to bear the brunt of the required
adjustment. To this end, the Committee urged
relevant Authorities to examine additional measure
for arresting the unsustainable current account
deficit.
3.2 Balance of Payments Outlook
The
Committee is of the view that the long-term
balance of payments prospects look worrisome. The
structurally-determined current account deficit,
estimated at 12 percent of GDP and deemed to be
unsustainable, is expected to widen even further
to around 13 percent of GDP in the medium-term.
There are principally, two factors for this
outlook. The first is the expiry, in December
2004, of the system of quotas under the WTO
arrangement[3].
As a result, other more competitive countries such
as China and India, will also enjoy a quota-free
access to North America- Lesotho’s traditional
market for exports. Lesotho exporters will
hence-forth face stiff competition from these
countries. In fact, about six companies have
already closed their operations in Lesotho
following the expiry of the quota system leaving
about 13 percent of the manufacturing-sector
labour force without jobs.
The
second factor is the continuing weakness of the
American dollar (or strength of the rand/loti).
The strength of the loti further reduces the
competitiveness of Lesotho’s exports. The
Committee noted that even with the elimination of
the quota system, Lesotho’s exports would continue
to enjoy a degree of advantage as they would enter
these markets free on import tariffs. However, the
margin of advantage would be small and therefore
sensitive to small changes in loti/dollar exchange
rate.
Regarding cyclical factors affecting the balance
of payments outlook, the Committee noted that the
fiscal deficit during the 2005 calendar year is
likely to be in the region of 0.5 percent – a
level more or less similar to that seen during the
2003 calendar year. Were this situation to
materialise, fiscal policy would contribute
positively and significantly towards a more
sustainable current account deficit. However, the
Committee noted that it would be important to
closely follow developments in this regard, in
particular, the unveiling of the budget speech
during February 2005. Depending on the outcome of
the budget speech, adjustments to the NIR target
may have to be made.
With
regard to the expected worsening of the balance of
payments situation as a result of structural
factors, the Committee noted that the expiry of a
system of quotas represented a permanent change in
international trading environment that is unlikely
to be reversed. With regard to the strength of the
loti, the Committee took the view that the future
direction of loti was unclear at this stage but
noted that any further strengthening would be
detrimental to Lesotho’s exports. Taking these
developments into account, the Committee
re-affirmed its earlier view that monetary policy
is generally not suited to counteracting the
effects of permanent structural factors.
Specifically, the Committee noted that it would be
futile to accumulate additional reserves in order
to deal with what are essentially structural
problems. Consequently, the Committee decided to
provide accommodation to the expected worsening of
the balance of payments situation by setting a
lower target range for NIR for the period January
to March 2005. The Committee recalled its
September decision to set the target range for NIR
at (United States) $400.0 to $450.0 million.
Noting that it would be necessary to accommodate
the expected worsening of the balance of payments
position, the Committee decided that the new
target range of NIR for the period January to
March 2005 should be between (United States)
$350.0 to $400.0 million.
The
Committee noted that continued erosion of the NIR
would ultimately jeopardise the fixed exchange
rate arrangement. Accordingly, the Committee urged
that investigations be undertaken by the Bank, in
consultation with other relevant Authorities, on
possible policy responses to the rising and
unsustainable current account deficit. The
Committee implores the relevant Authorities to
treat this matter with the urgency it deserves.
E. M.
Matekane
Governor
[1]
Net internal reserves of the Central Bank of
Lesotho are defined as: liquid unencumbered
foreign assets of the Central Bank less foreign
liabilities.
[2]
At 4 percent of GDP, the current account deficit
would be sustainable because it would be fully
financed by net capital inflows which at present
are at 4 percent of GDP.
[3]
WTO stands for World Trade Organisation.
