Lesotho, Kingdom of

Slow and sluggish growth due to the trade war

Growth prospects for the 2025 fiscal year have had to be revised downward due to the global economic downturn and the trade war. The construction sector remains buoyant, with projected growth of 30.4% according to the 2025-2026 budget, and remains the main driver of the economy. It continues to benefit from the second phase of the Lesotho Highlands Water Project (LHWP-II), which includes the extension of the water supply network for South Africa planned for 2029 and a subsequent hydroelectric power generation facility. The completion of maintenance work on the LHWP-I tunnel, which was carried out between October 2024 and the end of May 2025, confirms the return to normal water flow to South Africa, which will boost royalties and, in turn, public spending (50% of GDP) as well as hydroelectric power generation. However, the country will no longer benefit from the momentum of the Health and Horticulture Compact (Compact II) project, conducted in collaboration with the US agency Millennium Challenge Corporation (MCC). This project, which provided for infrastructure works in the areas of irrigation and health, was launched in March 2024 with an investment of USD 300 million spread over five years. It was cancelled in early May 2025, together with USAID programmes in January, which were a major source of support for the fight against HIV.

Export-oriented sectors (45% of GDP in 2024) will continue to suffer. The mining sector, affected by persistently low global diamond prices (22% of exports), is struggling to regain momentum. Meanwhile, the textile industry (40%) faces heightened competition on the US market (textile exports to the United States account for around 10% of GDP), particularly from Asian, Ethiopian, and Kenyan producers, and a slowdown in South African demand. The reinstatement of the US reciprocal tariff of 50%, after a 90-day suspension on 9 April 2025, on 1 August 2025 would exacerbate the difficulties faced by this industry. Conversely, the agricultural sector (18% of GDP and 80% of employment) should see an encouraging recovery this year. After the droughts of 2024, improved rainfall in early 2025 boosted the cereal harvests that began in May. However, the sector's development will be hampered by the cancellation of the Compact II package, which aimed to boost the production of high value-added crops.

Inflation is expected to continue moderating, driven by lower food and fuel prices. Prices for key staple grains remained high in the first half of the year due to high South African white corn prices. However, the recovery in domestic agricultural production will contribute to lower food prices in the second half of the year. Construction material and labour costs will remain high, in line with strong demand in the construction sector. Given the easing of inflationary pressures and the reduction in South Africa's key interest rate at the end of May, the central bank was able to lower its main rate by 25 basis points in early June 2025, bringing it back to 7%, which should support private investment.

Twin accounts fall into deficit

The country recorded a budget surplus for the 2024-2025 fiscal year, supported by higher water royalties paid by the Lesotho Highlands Development Authority (LHDA), despite the maintenance period, and exceptional transfers from the Southern African Customs Union (SACU). However, these transfers are expected to decline significantly in the current fiscal year, although they will remain a major source of revenue (30% of total revenue). This shortfall will be partially offset by an increase in water royalties, which are expected to reach around 11% of GDP (compared with 7% in 2024-2025 and 5% in 2023-2024) according to the 2025-2026 budget. In addition, following the unexpected withdrawal of US aid, the government is seeking to reduce its dependence on development aid by increasing tax revenues by 13%. To achieve this, it plans to broaden the tax base, increase taxes on alcohol and tobacco, VAT, and improve digitisation of the tax system. At the same time, it will raise the minimum income tax threshold and the VAT threshold to support low-income households and small businesses. A 10% increase in total spending is also planned. However, the budget is burdened by the public sector wage bill (18% of GDP) despite ongoing reforms. Public investment will be increased to 24% of GDP (from 15% previously), reflecting a commitment to developing essential infrastructure, particularly in the areas of energy, water and digital connectivity. However, this dynamic should be viewed with caution given past difficulties in budget execution. In addition, the government will have to compensate for the cancellation of the Compact II project, which occurred after the preparation of the 2025-2026 budget, as well as the dismantling of USAID. The public deficit will be financed mainly through domestic borrowing or withdrawals from deposits held with the Central Bank.

The weight of public debt relative to GDP is expected to remain stable, with IMF and the World Bank deeming the risk to be moderate. Nevertheless, nearly 26% of external debt (83% of total debt) is on commercial terms. Despite budget surpluses in the last two fiscal years, the authorities have continued to issue domestic debt instruments to consolidate the domestic bond market. They plan to issue 600 million maloti (approximately USD 33 million) in treasury bills to finance infrastructure projects in FY 2025-2026, compared with 500 million in the previous fiscal year.

The current account balance is expected to return to deficit in 2025, reflecting sluggish global demand affecting export earnings from rough diamonds and textiles, as well as higher imports of capital goods and services related to LHWP II. These factors will outweigh the increase in export revenues from water sales to South Africa and the decline in commodity prices. In addition, the de facto end of the African Growth and Opportunity Act (AGOA), which guaranteed the country duty-free access to the US market, represents a major shock for nearly 18% of total exports and 43% of textile exports. Remittances from expatriate workers will depend on the performance of the regional economy, particularly South Africa. Nevertheless, they will continue to make a positive contribution (23% of GDP). Significant capital inflows will continue to be seen, destined to finance the construction of the LHWP II. Budget surpluses from previous years have boosted foreign exchange reserves, which stood at 5.8 months of imports at the end of December last year.

A more stable regime but reforms still pending

In 2022, King Letsie III dissolved Parliament after a new Electoral Code aimed at limiting political instability failed to be passed in Parliament. The ensuing parliamentary elections held on 7 October 2022 were won by the new Revolution for Prosperity (RFP) party which was created six months earlier. The RFP won 56 seats out of 120, narrowly missing the absolute majority of 61 seats. To become Prime Minister, its leader, Sam Matekane, had to form a coalition with the Movement for Economic Change (MEC) and the Alliance of Democrats (AD), which took his majority to 65 seats. Unlike previous governments, which were often fragile, Matekane benefits from the 2023 electoral law reform which stipulates that a motion of impeachment against the Prime Minister can only be tabled once during the five-year term of Parliament. Matekane survived a motion of no confidence at the end of 2023. However, the country is still struggling to push through the constitutional amendments recommended by the Southern African Development Community (SADC) following the coup attempt and South African military intervention in 2014. These amendments are intended to strengthen parliamentary stability, improve oversight of the government, and reduce the influence of the security forces in political affairs. These reforms are hampered by fragile coalitions, the need to obtain two-thirds of the votes for some of the amendments, and a lack of political will. Added to this are regular outbreaks of violence and poor economic performance, which are prompting some to call for a merger with South Africa or even a return of the king to power. At the same time, the sudden withdrawal of MCC funding risks exacerbating the already high unemployment and food insecurity levels, thereby increasing social tensions.

In a bid to get US tariffs lifted, the country wants to strengthen its ties with the US. In April 2025, the trade minister said a delegation would travel to Washington to negotiate the easing of tariffs and restore development aid. In early April, the government granted an operating license to Starlink, a subsidiary of SpaceX, as part of a broader strategy to “actively remove barriers to US investment,” particularly in the energy and tourism sectors. The country will maintain its close relations with SADC members, particularly South Africa, which remains its main source of imports, export earnings, and remittances from expatriate workers. However, slow progress on constitutional and security reforms could weaken the country's relations with its international development partners.

Last updated: June 2025