PROGRAM INFORMATION DOCUMENT (PID) APPRAISAL STAGE April 9, 2013 Report No.: AB7260 (The report # is automatically generated by IDU and should not be changed) Operation Name LS- First Growth and Competitiveness DPC Region AFRICA Country Lesotho Sector Central government administration (50%);General industry and trade sector (30%);Other social services (20%) Operation ID P128573 Lending Instrument Development Policy Lending Borrower(s) KINGDOM OF LESOTHO Implementing Agency Ministry of Finance Date PID Prepared February 27, 2013 Estimated Date of Appraisal April 8, 2013 Estimated Date of Board May 28, 2013 Approval Corporate Review Decision Following the corporate review, the decision was taken to proceed with the preparation of the operation. Country and Sector Background Lesotho is a lower middle-income country with per capita gross national income of US$1,210.1 It is small, mostly mountainous and largely rural country of about 2 million people completely surrounded by South Africa. Lesotho has an open economy traditionally centered on trade. Its main exports are textiles, water, and diamonds. Lesotho’s main trading partners are the United States and South Africa. It is a member of the Southern African Customs Union (SACU) and the Southern African Development Community (SADC) and, as a member of the Common Monetary Area (CMA), its currency is pegged to the South African rand. Lesotho’s National Strategic Development Plan (NSDP) FY2012/13-FY2016/17 recognizes the country’s key challenge—inclusive growth. The plan identifies strong, sustainable, and private sector-led economic growth, with faster job creation, as the most effective way out of poverty. Achieving these goals will not be easy, but it is feasible through a four-pronged approach. First and foremost, a more attractive business environment will be essential to lure new FDI. Second, a leaner and more effective public sector will be critical for poverty reduction. Third, investments in key infrastructures will be needed to propel the country’s regional development. Finally, it will be important to reduce the HIV/AIDS prevalence rate and improve levels of human capital. This operation will focus on addressing the first two areas; the others are being supported by other Bank operations and activities. 1 2011 Atlas GNI per capita. 1 The new Government that took office in June 2012 has initiated measures to improve the country’s external competitiveness (with emphasis on investment climate reforms), strengthen its social safety nets, and improve the effectiveness of public spending. These three areas are key to promoting inclusive growth. On the investment climate reforms, the Government has submitted to Parliament the Industrial Licensing Bill, further streamlining the process of starting a new business. On the effectiveness of public spending, the Government has introduced measures to strengthen the financial management and public procurement systems. On reforming social safety nets, the Government has established a pilot platform for the National Information System for Social Assistance (NISSA) on its Childs Grant Program. Operation Objectives The operation’s Development Objective is to assist the Government in implementing a reform program aimed at promoting growth, competitiveness and public sector efficiency. The DPC supports progress towards the Country Partnership Strategy objectives of fiscal adjustment and public sector efficiency; human development and service delivery; and enhanced competitiveness and diversification. Rationale for Bank Involvement The programmatic series, which includes two subsequent credits, is designed to assist the Government in implementing a reform program aimed at promoting growth, competitiveness and public sector efficiency. Specifically, the operation supports three areas central to the reform program: (i) improve private sector competitiveness, through implementing key investment climate reforms; (ii) strengthen the sustainability and efficiency of public spending, through fiscal consolidation and public financial management and public procurement system reforms; and (iii) improve social protection and monitoring systems, through improving the targeting of social safety net programs and strengthening the statistical system. The reforms supported by this operation are expected to have no negative impacts on poverty and inequality. Tentative financing Source: ($m.) Borrower 0 IDA reallocated as a credit 20 Borrower/Recipient IBRD Others (specifiy) Total 2 Tranches (if applicable) ($m.) First Tranche Second Tranche Etc. Total Institutional and Implementation Arrangements The institutional arrangements for implementing the proposed operation fall within the framework of the Joint Budget Support (JBS) structure. The proposed arrangements seek to ensure oversight and buy-in at the political level. A dedicated team of officials from the National Monitoring and Evaluation System (NMES), housed in the MDP, will monitor progress in implementing the overall budget support program. At the ministerial level, dedicated teams of relevant officials responsible for implementation and monitoring of activities2 will track PAF activities and collect data to verify achievement of PAF indicators and report to the JBS secretariat. The secretariat is headed by the MoF’s principal secretary and will report quarterly to the Improvement and Reform Steering Committee (IRSC). Development partners’ representatives are members of the IRSC, ensuring that they are also aware of implementation progress made between the annual joint reviews. The chairperson of the IRSC will, in turn, report, through the minister of finance to the Budget Committee. The MoF’s principal secretary will submit the PAF progress report to the Committee of Principal Secretaries, which is responsible for delivering on these indicators. This will be the forum for initial discussions toward the required remedial actions where problems exist. The MoF’s principal secretary will also pursue these discussions bilaterally with relevant ministries/agencies for implementation of required actions. Briefings to development partners considering budget support will be provided at regular intervals. The PAF will be the basis for the program’s monitoring and evaluation. An annual progress report submitted by the end of January each year will be followed by a joint annual review, based on the PAF, to analyze progress towards agreed targets. The main objective is to come to a joint view on performance, which will serve as the basis for commitments for the next fiscal year. Some DPC indicators differ from those on the PAF, but most of the areas supported by the DPC are monitored through the PAF. Risks and Risk Mitigation The achievement of the development objective is subject to three main risks:  On the institutional side, the main risk stems from the weak capacity of Government institutions to implement the reform program. To reduce this risk, the Bank is working 2 These teams are from within the ministries responsible for implementation of the PAF activities. 3 with other donors to support the Government’s reform program through technical assistance and ongoing operations.  On the political side, the main risk derives from the Government's ability to approve and complete implementation of the reform program, particularly the private sector competitiveness reforms and fiscal consolidation reforms. The new administration is faced with the challenge of managing a complex multi-party coalition government. This arrangement could limit the Government’s ability to build consensus around reforms that are critical for the sustenance of economic growth and its capacity to mobilize enough political support to implement its programs could be impaired. The new Prime Minister has re-affirmed the Government’s commitment to the strategic objectives of the NSDP and his resolve to improve communication between the Government and citizens, and implement key reforms that will help to mitigate the risks associated with weak institutions and poor governance in the country. The Bank prepared a set of policy notes on the major reform areas that was delivered to the new Government. The Bank will continue to foster policy dialogue using its analytical works, investment operations, and coordination with other development partners. 3  On the economic front, the main risk centers on the possibility of further worsening of the global economic environment. Under this scenario, the country’s shock-absorption capacity could face important limitations, particularly in applying effective countercyclical macroeconomic policies and suitable social safety nets. To reduce this risk, the Government has become much more cautious, focusing on fiscal consolidation to build fiscal space and on building international reserves to protect the peg of the maloti with the rand, reforms currently supported under an IMF Extended Credit Facility Program. Poverty and Social Impacts and Environment Aspects Poverty and Social Impact The policy actions supported by this proposed operation have no negative poverty and social impacts. Actions under Component I, Improving Private Sector Competitiveness, are likely to boost private-sector investment and growth on the medium and long run. This is likely to accelerate poverty reduction. Eiefert (2009) shows in cross- country study that a 10 day reduction in the time to start a business is associated with a 0.3 percentage point increase in the investment rate and a 0.36 percent increase in GDP growth rate. Olinto, Saavedra and Ibarra (2013) estimate the growth elasticity of poverty reduction at 4.5 percent for a country with a poverty rate of 60 percent. Therefore, the investment climate reforms supported by the DPC will have an impact on poverty reduction on the medium to the long run. 3 This will include exploring the possibility of mobilizing resources from the Global Partnership for Enhanced Social Accountability (GPESA) to strengthen the capacity of relevant CSOs e.g. NGOs and media etc. 4 Policy actions under Policy Area 2 could help reduce poverty. Fiscal consolidation reforms will generate the fiscal space needed to protect the social safety net program in case of an external shock. The financial management reforms will allow the Government to have a better control and management of its resources. Potential savings in the management of the resources could be used improve and expand services in rural areas where poverty is concentrated. Policy actions under Policy Area III are likely to help reduce inequality. Figure 1 shows that the current social assistance programs in the country do not seem to be well targeted. There are more households who reported social assistance as a main income source receiving social assistance in the top two quintiles of the income distribution than there is in the first quintile. Overall, very few households in Lesotho who reported social assistance as a main source of income receive social assistance benefits. Thus, policies to improve the targeting, effectiveness, and efficiency of Lesotho’s social safety net are likely to reduce inequality and help accelerate poverty reduction in the medium run. Figure 1: The incidence of social assistance benefits by income quintile. Source: CMS/HBS 2010 Consolidating some programs and improving their targeting could help reduce poverty. Redirecting the expenditures on social safety net programs to targeted cash transfer (CCT) programs could reduce Lesotho’s current poverty rate and inequality. As indicated in Figure 2, if all social assistance programs were consolidated into a single CCT program that employs the proxy-means testing method currently employed in the Child Support Program, the incidence of the social assistance would improve dramatically. Depending on the selection criterion chosen, we would have up to approximately two thirds of individuals in the first two quintiles of the income distribution receiving benefits (instead of only 5 to 6 percent who are currently receiving benefits). 5 Figure 2: The incidence of a Hypothetical CCT by quintile of income distribution if targeted via Proxy-Means Testing. Source: CMS/HBS 2010 Environmental Aspects The policy actions supported by the proposed operation are not likely to produce significant impacts on the environment, forests, or other natural resources. The investment climate reforms are not likely to have a significant negative effect on the environment. Although the reforms do promote establishment of new firms in Lesotho, strict environmental regulations are in place to mitigate any potential environment degradation. The policies aimed at improving the effectiveness of public spending are not likely to have a positive or negative effect on the environment. Finally, social protection reforms are not likely to have a negative effect on the environment. Contact point World Bank Contact: Christian Yves Gonzalez Amador Title: Senior Economist Tel: 5369+3165 / 27-12-742-3165 Fax: Email: cgonzalez@worldbank.org Location: Pretoria, South Africa (IBRD) 6 Borrower Contact: Dr. Leketekete Victor Ketso Title: Minister of Finance Tel: (266) 22 323 703 Email: lketso@finance.gov.ls For more information contact: The InfoShop The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 458-4500 Fax: (202) 522-1500 Web: http://www.worldbank.org/infoshop 7