At its meeting held on the 31st May 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 April 2005 to June 2005 will be left unchanged at (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 at this level, the target level of NIR is 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 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 first quarter of 2005

In making its decisions, the committee started by examining inflation developments during the previous period. The Committee noted that inflation rate declined during the first quarter of 2005 to end at 3.7 percent in March. 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 decline in inflation rate during the first quarter of 2005. The South African import price index declined by about 1percent during the final quarter of 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 the latter part of 2004 and part of 2005.

The Committee turned its attention to assessing inflation pressures emanating from the demand side of the economy. Real economic growth in Lesotho is anticipated to be 0.9percent in 2005. On the other hand real money supply as measured by M2 is estimated to have grown by 2.2 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 allowing it 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 3.2 percent in March 2005. The committee is convinced that in order for Lesotho to continue to benefit from this favourable South African inflation target, 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

The Committee recalled its earlier observation that Lesotho’s long-term balance of payments position appears to be unsustainable and measures are required to restore the position to a sustainable level. Specifically, the Committee noted that on a long-term basis, net capital inflows are not sufficient to finance the current account deficits. The long-term current account deficit has remained at 12 percent of GDP during the period 1998 to 2004 or 5 percent if one excludes Lesotho Highlands Water Project(LHWP) activities, which are transitory. From 2005 onwards,the deficit is expected to widen even further to around 6 percent of GDP as a result of Lesotho’s loss of competitiveness in the garments markets following the expiry of the system of quotas. At this new level, the current account deficit will exceed net capital inflows by some 3 percent of GDP. This means that there will be a financing gap of about 3 percent of GDP, which will be met from existing stock of foreign reserves.

The Committee reiterated its earlier view that monetary policy instruments are generally not suited to addressing the structural factors responsible for a long-term balance of payments problems. These factors can only be addressed through long-term reforms aimed at making Lesotho more competitive.In this regard, the Committee welcomed the efforts by Lesotho Government to address the problem. The Committee noted that, following the Private Sector Development (PSD) Forum held in April 2005 which examined the reforms needed to make Lesotho more competitive, the Government of Lesotho intends to sign Agreements with relevant Development Partners aimed at implementing the identified reforms. The Committee called upon the relevant Authorities to press ahead with the implementation of these reform measures and for appropriate monitoring measures to be put in place.

3.2 Balance of Payments Outlook

Regarding cyclical factors affecting the balance of payments outlook, the Committee noted that the 2005/06 government budget aimed at a budget deficit of about 2.6 percent of GDP. At this level, the budget deficit is likely to push the current account deficit from its long-term position of 6 percent of GDP to around 8 percent. If one adds up the anticipated net loan repayments equivalent to about 1.6 percent of GDP, the overall balance of payments position could worsen beyond a long term average of 3 percent to nearly 6 to 7 percent of GDP. This means that the existing stock of foreign reserves could decline by between 6 to 7 percent of GDP during 2005/06 fiscal year.

The Committee noted however that during the first two months of the fiscal year 2005/06, the situation remained favourable probably indicating lower momentum in government expenditure activities. This situation is likely to continue during the period to June.

Further, the Committee noted that the actual level of NIR has infact been higher than its target range of (United States) $350.0 to $400.0 million, by up to $117.0 million. This excess had however narrowed to $67.0 million at the end of March 2005. Under the circumstances, the Committee decided to leave the target range of NIR unchanged at $300.0 to $400.0 million for the period April to June 2005.

T. Foulo

Acting Governor

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[1] Net internal reserves of the Central Bank of Lesotho are defined as: liquid unencumbered foreign assets of the Central Bank less foreign liabilities.