1

Debora

Kingdom o

Lesotho HighlanAuth

MACROECONOSTUDY OF

Part 1: Executive Part 2: Main Rep Part 3: Methodol Part 4: Data Sup

Conningarth08 Apr

f Lesotho ds Development ority MIC IMPACT

PHASE IB Summary ort ogy Supplement plement

Economists il 2004

2

3

PART 1 TABLE OF CONTENTS

LIST OF FIGURES LIST OF TABLES GLOSSARY CHAPTER 1: INTRODUCTION 1.1 Overview of the LHWP 1.2 Purpose and Scope 1.3 Organization of final report 1.4 Organization of Main Report CHAPTER 2: OVERVIEW OF THE LESOTHO HIGHLANDS WATER PROJECT AND THE LESOTHO ECONOMY 2.1 Introduction 2.2 A Brief Description of Phase IB 2.3 Broad Overview of Phase II of the Lesotho Highlands Water Project 2.4 Lesotho’s Economic Performance since the Commencement of the LHWP 2.5 Fiscal Developments 2.6 Summary and Conclusions CHAPTER 3: THE METHODOLOGY FOR MEASURING THE IMPACTS OF THE LHWP ON THE LESOTHO ECONOMY 3.1 Background 3.2 Overview of the Doggett Model 3.3 New Analytical Framework for Assessing Economic Impacts of the Project 3.4 Summary and Construction of DSAS 3.5 Application of DSAS model CHAPTER 4: A NEW ANALYTICAL FRAMEWORK FOR ASSESSING THE ECONOMIC IMPACT OF PHASE IB OF THE LHWP 4.1 Introduction 4.2 External factors influencing future economic growth in Lesotho 4.3 The Result of Modelling the Impact of Phase IB on Lesotho Economy 4.4 Comparison of Results with Earlier Studies

Page No. 6 8 10 11 15 17 18 20 20 23 28 38 40 44 45 47 53 54 56 56 74

4

4.5 Microeconomic Studies of Phase IB Impacts on Lesotho’s Economy: Planning Implications CHAPTER 5: THE IMPACT OF PHASE II OF THE LHWP ON THE LESOTHO ECONOMY 5.1 Introduction 5.2 External Factors Influencing Economic Growth in Lesotho at the Onset of Phase II 5.3 The Results of Modelling the Impact of Phase II on the Lesotho Economy CHAPTER 6: THE TREATMENT OF THE VALUATION OF WATER SALES FROM THE LHWP IN THE LESOTHO AND RSA NATIONAL ACCOUNTS 6.1 Current stance on classifying water sales in the national accounts 6.2 Defining the Problem 6.3 Impact of the Alternative Water Valuation Approach on the Lesotho

Economy in respect of Phase IA 6.4 Impact of Phase IB on the Lesotho Economy using the Alternative Water

Valuation Methods 6.5 The way forward CHAPTER 7: SUMMARY, CONCLUSIONS, RECOMMENDATIONS 7.1 Introduction 7.2 Overview of the LHWP and the Lesotho Economy 7.3 Review of Previous Studies Relevant to the LHWP 7.4 The Impact of Phase IB of the LHWP on the Lesotho economy 7.5 Impact of Phase II of LHWP on the Lesotho Economy 7.6 Treatment of the Valuation of water sales of the LHWP in the Lesotho and

RSA National Accounts 7.7 Guidelines/Recommendations for Future Projects

98 102 113 113 127 147 147 150 152 152 154 154 155 156 159 160 161

LIST OF FIGURES CHAPTER 1: Figure 1.1 Total Project Layout Figure 1.2 Lesotho Highlands Water Project, Total Expenditure

Page No. 14 15

5

CHAPTER 2: Figure 2.1 Schematic Design of the Reservoir System Figure 2.2 Economic Growth in Lesotho, Various Periods Figure 2.3 Composition of GNP-Pre-structural (LHWP) change-1980- 1987 Figure 2.4 Composition of GNP-Post-structural (LHWP) change-1999- 2002 Figure 2.5 Gross Domestic Product by Kind of Economic Activity Figure 2.6 Government Budgetary Operations 1990-2001 CHAPTER 3: Figure 3.1 Diagram of Dynamic Sectoral Analysis System (DSAS) CHAPTER 4: Figure 4.1 LHWP – Total Expenditure of Phase IB Figure 4.2 Detail LHWP Phase IB expenditures on a Product Base Figure 4.3 Detail LHWP Phase IB expenditure on Asset Base Figure 4.4 Average number of mineworkers on RSA mines Figure 4.5 Mineworkers Average Earnings (Current and Constant 1995 Prices) Figure 4.6 Projected Total Economic Activity (Constant 1995 Prices) Figure 4.7 Projected Impact on GDP Figure 4.8 Projected Impact on GNP Figure 4.9 Projected impact on key economic sectors [GDP projections, impact percentages Figure 4.10 Current Account Components with Phase IB [Current Prices] Figure 4.11 The project Phase IB, Investment Expenditures Doggett Model vs. DSAS Model [1994 - 2004] 7), percentages

PTER 5:

e 5.1 Phase II Implementation Period [Time Lines] Figure 5.2 Lesotho Highlands Water Project - Total Expenditure of Phase II [1995 prices, Million Maloti] Figure 5.3 Detail LHWP Phase II – Expenditures in terms of Identifiable

25 32 34 35 37 40 51 59 60 62 70 71 79 80 81 89 96 99 117 118

6

Products (2009 – 2020)

Figure 5.4 Detail LHWP Phase II – Expenditure on an Asset Base

[2009 – 2020] Figure 5.5 Projected impact of Phase II on GDP [constant 1995 prices, Million Maloti] Figure 5.6 Projected Impact of Phase II on GNP [constant 1995 prices, Million Maloti]

e 5.7: Projected Impact on Key Economic Sectors [GDP projections, impact percentages]

119 120 131 132 139

LIST OF TABLES

Page No.

7

CHAPTER 1: Table 1.1 CHAPTER 2: Table 2.1 Losses of Arable Land, Grazing Land and Dwellings Associated with Phase IB Table 2.2 Estimated number of Households Directly Affected by loss of Arable Land and/or Dwellings due to Phase IB Table 2.3 LHWP in the National Accounts and Balance of Payments Table 2.4 Selected Macroeconomic Indicators Table 2.5 Employment by Sector and Employer Table 2.6 Composition of Government Receipts and Expenditures CHAPTER 4: Table 4.1 Nature and Magnitude of LHWP – Phase IB Table 4.2 Water Industry Production Structure 2004-2007 (full capacity) Table 4.3 Historic and Future Growth Rates for Exogenous variables Table 4.4 Mineworker’s Earnings Table 4.5 Government Sector Table 4.6 External trade Table 4.7 Projected Impact on Key Macroeconomic Aggregates Projections 1994-2007 Table 4.8 Projected Impact on Per Capita and Per Household GDP and GNP Table 4.9 Projected Key GDP Aggregates Projections Table 4.10 Projected Key External Sector Aggregates Projections Table 4.11 Projected Impact on GDP for Key Economic Sectors Table 4.12 Manufacturing Growth Table 4.13 Projected Impact on Government Account Components Table 4.14 Projected Impact on Balance of Payments Components Table 4.15 Summary: Comparison between Doggett Model and DSAS Multipliers CHAPTER 5:

13 23 24 30 33 38 41 58 64 68 72 72 73 78 83 85 87 90 92 94 97 101

8

Table 5.1 Nature and Magnitude of the LHWP – Phase II [constant 1995 prices, Million Maloti] Table 5.2 Water industry production structure: Phase II, full capacity [constant 1995 prices, Million Maloti] Table 5.3 Historic and future growth rates for exogenous variables Table 5.4 Projected Impact on Key Phase II Macroeconomic Aggregate Projections, 2009 – 2020 [constant 1995, Million Maloti] Table 5.5 Projected Impact on Per Capita and Per Household GDP and

GNP, 2009 - 2020 Table 5.6 Projected Impact on Key Gross Domestic Product Aggregate Projections, 2009 – 2020 [ constant 1995 prices, Million Maloti ] Table 5.7 Projected Impact Key External Sector Aggregates Projections, 2009 – 2020 [constant 1995 prices, Million Maloti] Table 5.8 Projected Impact on GDP projections for Key Economic Sectors (2009 - 2020) Table 5.9 Projections of Government Account Components (2009-2020) (current prices) Table 5.10 Projections of Balance of Payments Components, 2009 - 2020 [current prices] CHAPTER 6: Table 6.1 Water Industry Production Structure: Phase IA Full Capacity [Million Maloti – 1995 Prices] Table 6.2 Growth Rate of the Gross Domestic Product and the Gross National Product, 1994-2002 Table 6.3 Import Leakage Ratios Table 6.4 Impact of Phase 1B on the Lesotho Economy using the Alternative Water Valuation Methods BIBLIOGRAPHY

115 121 126 129 133 135 137 140 143 145 150 151 152 152 166

9

GLOSSARY

ADB African Development Bank AGOA African Growth and Opportunity Act BCR Benefit Cost Ratio BOP Balance of Payments BOS Bureau Of Statistics CBL Central Bank of Lesotho CE Conningarth Economists CE-SAM Lesotho’s Social Accounting Matrix compiled by Conningarth Economists CGE General Equilibrium Model CMA Common Monetary Area DSAS Dynamic Sectoral Analysis System DWAF Department of Water Affairs and Forestry EA Environmental Assessment ECM Error Correction Model FAO Food and Agriculture Organisation FDI Foreign Direct Investment FSL Full Supply Level GDE Gross Domestic Expenditure GDP Gross Domestic Product GNP Gross National Product GoL Government of Lesotho GOS Gross Operating Surplus IMF International Monetary Fund IRR Internal Rate of Return JTC Joint Technical Committee KRBDP Komati River Basin Development Project LFCD Lesotho Fund for Community Development LHDA Lesotho Highlands Development Authority LHWP Lesotho Highlands Water Project Masl Meters above sea level MFA Multi-Fibre Arrangement MOL Minimum Operating Level NPV Net Present Value PDA Project Development Area RFP Request for Proposal RSA Republic of South Africa SACU South African Custom Union SAM Social Accounting Matrix SMME’s Small Medium and Micro Entities SNA System of National Accounts TCTA Trans Caledon Tunnel Authority TOR Terms of Reference CHAPTER 1: INTRODUCTION

10

SUMMARY This chapter deals with the background and history to the Lesotho Highlands Water project, and the present study as well as the purpose and scope of the report. 1. INTRODUCTION 1.1 Overview of the LHWP

The potential for transferring water from the highlands of Lesotho to meet the growing demand for water in the Vaal River System in South Africa was identified more than 50 years ago. The potential for generating hydro-electric power in Lesotho in conjunction with the transfer of water to South Africa was also identified. The recognition of this potential culminated in the establishment of the Lesotho Highlands Water Project. On 24 October 1986, the Kingdom of Lesotho and the Republic of South Africa (RSA) signed a treaty in Maseru which approved the Lesotho Highlands Water Project (LHWP), and paved the way for the implementation of Phase IA of the Project. The main objectives of the Project are: (i) to transfer water from the catchment of the Senqu River System in

Lesotho to the catchment of the Vaal River in South Africa to meet future water requirements of the Vaal Basin (the location of South Africa’s major industrial and population centres), and thereby provide revenue to the GoL through royalty payments to be made by RSA;

(ii) to generate hydro-electric power in Lesotho, in conjunction with the water transfer, by utilizing the difference in elevation between the catchments of the Senqu River and the Vaal Basin;

(iii) to promote the general development of the remote and under developed Senqu region, while ensuring that measures are taken to counteract any adverse effects which the project might have on the local population and their environment;

(iv) to provide the opportunity to undertake ancillary developments such as the provision of water for irrigation and potable water supply.

The Lesotho Highlands Water Project was planned in four phases in accordance with water demand projections for the RSA. Table 1 lists the major activities associated with each of these four phases.

11

TABLE 1.1 MAJOR ACTIVITIES PER LHWP PHASE

PHASE ACTIVITY PHASE IA: Katse - 185m high Katse Dam

- 45km long Transfer Tunnel - 72MW ‘Muela Hydropower Plant - 55m high ‘Muela Dam - 98m high Intake Tower at

Mphorosane - Pelaneng and Hlotse adits - 45km Delivery Tunnel

PHASE IB: Mohale - 145m high Mohale Dam - 947 million m3 Mohale Reservoir - 180m long Matsoku Weir and 5,6m

long diversion tunnel - Mohale Intake - Compensation Outlets - 32km long Mohale-Katse Tunnel

PHASE II: Mashai - Mashai Dam - Pumping Station - Transfer Tunnel - Delivery Tunnel - Hydropower Plant

PHASE III: Tsoelike - Tsoelike Dam - Pumping Station

According to the treaty, only Phase I is binding on the two countries. The governments of South Africa and Lesotho will decide whether and which further phases will be implemented. Phase I comprises two parts: Phase IA and Phase IB. Phase IA consists of a water transfer and hydropower component, whilst Phase IB comprises of a dam and a connecting tunnel to the Katse dam. Lesotho is responsible for managing all construction contracts undertaken in within Lesotho and for operating the Project facilities within its territory.

Construction planning for Phase IA commenced in 1987/881) and major construction activities ended in 1996/97. Construction planning for Phase IB started in 1992/93 and construction and commissioning is expected to be completed during 2004. The total project layout in all its phases is given in Figure 1.1 below.

FIGURE 1.1

1) Refers to a fiscal year. All LHWP and LHDA data are captured and reported in this form. For

modelling and analyses purposes, however, calendar year data have been used.

12

PROJECT LAYOUT

Mohokare

Mohokare

Senqunyane

Khulbelu

Makhaleng

Phuthiatsana

South

SenquMalibam

atso

KatseDam

Tsoelike

Senqu

MuelaPowerStation

Polihali

Mashai

Malatsi

Ntoahae

Tsoelike

Phase 1 TunnelPumped TunnelGravity TunnelReservoirCatchmentWatershedRiverDamTown

Mohale

Ntoahae

Matsoku

TaungSenqu

0 10 20 30 40 km

LESOTHO

Source: LHDA

13

Figure 1.2 reflects the investment profile of Phase IA and IB, plus estimates for Phase II. Expenditure patterns for Phase III have not been included in this report as these are still subject to review. FIGURE 1.2

LESOTHO HIGHLANDS WATER PROJECT TOTAL EXPENDITURE [ MILLION MALOTI]

0

500

1000

1500

1987/88 1990/91 1993/94 1996/97 1999/00 2002/03 2005/06 2008/09 2011/12 2014/15 2017/18 2020/21 Years

Mill

ion

Mal

oti

Phase IA Phase IB Phase II

1.2 Purpose and Scope

This report presents a detailed analysis of Phase IB and anticipated economic impacts of Phase II of the Lesotho Highlands Water Project on the Lesotho economy. This study has been conducted for the Lesotho Highlands Development Authority (LHDA). As defined in the treaty, the Lesotho Highlands Development Authority (LHDA) is entrusted with the responsibility for the implementation, operation and maintenance of the Lesotho Highlands Water Project. The LHDA is also conferred with general functions relating to the management of water resources, electricity generation, relevant training of its employees, monitoring activities and land transactions. Currently the LHDA is implementing Phase IB which, together with the completed Phase IA, form Phase I of the Project. As part of its monitoring

14

responsibilities, the LHDA commissioned an Economic Impact Study that was undertaken by an independent consultant in 19962). The brief was to provide estimates of the actual impacts of Phase IA and Phase IB on the Lesotho economy. Another reason for undertaking the 1996 study was to identify possible causes for the deviations between forecast and actual impacts of LHWP that had occurred during Phase IA so that the necessary precautions could be taken to maximise the impacts of Phase IB on the Lesotho economy. The LHDA commissioned the present study in July 2002. In broad terms, the objectives of the study, as stated in the Terms of Reference3) for the project are: • to measure the macroeconomic impact of actual Phase IB expenditures

and to project the impact of proposed Phase II • to specifically generate estimates for the impact of Phase IB and Phase

II on total GNP and GDP, per capita GNP and GDP as well as sectoral impacts, and

• compare the actual outcome of Phase IB expenditures and impacts with projections of other studies and explain reasons for possible deviations.

• to establish systems to monitor the actual LHWP macroeconomic impact to date, and forecast the economic impact of likely Phase II activities on key indicators in the economy.

The study therefore also includes a comparison of results with those of earlier studies, in particular, the results of a study conducted for LHDA by Mr Ralph Doggett in 1996. The study focused primarily on Phase IA impacts but included impact forecasts of Phase IB. The present study measures the impacts from 1994 to the present comparing them with the results developed in 1996 study. The Doggett study has been followed in methodology by the present study in many ways. The analysis of the economic impacts of Phase IB and Phase II presented in this report is made possible through the use of a detailed computer simulation model of the Lesotho economy4). This is built upon several existing analytical capabilities and using data from the Lesotho national accounts, balance of payments, monetary survey and other sources. The major elements of the computer model are described generally in this report and in more detail in a Methodology Supplement. The analytical discussion in this report focuses on the macroeconomic impacts of Phase IB and projected Phase II of the LHWP, on individual sectors and other stakeholders within the Lesotho economy. To conduct this analysis, several historical and forecast “scenarios” were developed. These scenarios are essentially unique collections of assumptions regarding Phase IB and Phase II expenditure and revenue patterns, government fiscal policy, and other key variables. Among the scenarios is a counter-factual historical scenario,

2) Ralph M. Doggett. “A Macroeconomic Analysis of the Lesotho Highlands Water Project” LHDA.

May 1996. 3) See the Terms of Reference in the Methodology Supplement. 4) The Dynamic Sectoral Analysis System, described in Chapter 3.

15

developed in order to estimate the possible patterns of economic growth in the Lesotho economy, were the LHWP not to have been implemented at all. A comparison of the results from the counter-factual simulation with actual recorded estimates sheds light on the impacts the Project has had on the Lesotho economy to date. The forecast scenarios make use of alternative assumptions regarding Project expenditures and revenues, government fiscal policy and other considerations, out into the future. Specifically, these scenarios are defined by sets of assumptions for alternative futures with and without further development of the Project. Comparisons of results from the model simulations based on these alternative assumptions provide insights into the most likely impacts of the Project on the Lesotho economy.

1.3 Organization of the final report

The full report on the study is organized into four separate documents. These documents and a brief summary of their contents are as follows: • Executive Summary

The Executive Summary provides a brief overview of the study and presents its major findings. The Executive Summary also provides conclusions that have been drawn from the analysis, and recommendations for policy and further study. • Main Report

The main report provides a detailed description of the Lesotho economy, the LHWP and in broad terms the role it has fulfilled in the Lesotho economy since its inception. An analysis of the effect the LHWP has had on the economy, based on the results of a detailed computer model expressly constructed for this purpose, is also presented. The results are presented along with conclusions and recommendations. Of particular note is a finding by the consultant relating to the treatment of the LHWP expenditures and revenues in the Lesotho National Accounts, during the course of the study. This is of utmost importance for further review. The Main Report has a special section to explain the matter and offer suggestions for addressing it. • Methodology Supplement

The Methodology Supplement provides details regarding the computer models used in the analysis and how the simulations were developed. This is also a place to find reviews of previous studies the results of which are compared with the results from this study. This supplement also reproduces the Terms of Reference (TOR) for the study, and provides a crosswalk between the TOR and the Final Report.

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• Data Supplement

While both the Executive Summary and Main Report include charts and tables summarizing economic estimates and other indicators, the Data Supplement provides detailed tables showing historical and forecast data for the Lesotho economy, the expenditure and revenue data for the LHWP with detail for each phase and sub-phase, and detailed estimates of the impacts of the LHWP on the Lesotho economy. These show comparisons between scenarios with and without the implementation of the various phases of the Project under review.

1.4 Organization of the Main Report

Chapter 1: Introduction Chapter 2: Overview of the Lesotho Economy and the Lesotho Highlands

Water Project Chapter 3: Methodology for measuring the Impacts of LHWP on the

Lesotho Economy Chapter 4: The Impacts of Phase IB on the Lesotho Economy Chapter 5: The impacts of Phase II on the Lesotho Economy

Chapter 6: The treatment of LHWP in the Lesotho and RSA National Accounts

Chapter 7: Summary, Conclusions and Recommendations Bibliography

Chapter 2 provides background information on the Lesotho economy and the Project. This chapter is followed by Chapter 3 containing an overview of the methodology used to analyze the impact of the Project on the economy. The next two Chapters 4 and 5 contain the results of the computer model simulations. Chapter 6 is specifically devoted to a comparison between the existing and proposed treatment of the LHWP in the Lesotho and RSA National Accounts. The last chapter is made up of a summary, conclusions and some policy recommendations.

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CHAPTER 2: OVERVIEW OF THE LESOTHO HIGHLANDS WATER PROJECT AND THE LESOTHO ECONOMY SUMMARY Descriptions of Phases IB and II are provided in this chapter. The economic performance since the commencement of LHWP is also reviewed. National account components and the BOP are examined in this regard. Special attention is given to Fiscal developments. 2.1 Introduction

18

Before beginning a detailed discussion of the economic impacts of Phases IB

and II on the Lesotho economy, it is useful to summarize the pertinent aspects of these phases and review the economic conditions of Lesotho leading up to and surrounding the implementation of the LHWP during the past 15 to 20 years. This section takes a look at the LHWP and the economic trends along with the circumstances and policies that have shaped them.

2.2 A Brief Description of Phase IB Currently, the LHDA is busy implementing Phase IB which, together with the

completed Phase IA, makes up Phase I of the LHWP. The main physical features of Phase IB are:

• The 145m high mass rockfill Mohale Dam

• A 32km interconnecting tunnel from Mohale to Katse

• The 180m long Matsoku Weir and a 6km transfer tunnel to Katse

• Associated infrastructure: 3 mountain passes, 72km tarred roads, more

than 100 construction houses, 75km power lines • Associated environmental and social impact mitigation programmes.

Phase IB is under construction to augment Phase IA water to be transferred to South Africa as part of Phase I of the LHWP. The completion of the phase will facilitate the transfer of an additional 11.4 m3/sec of water to RSA by 2003, over and above the 18.2 m3/sec being delivered by Phase IA.

Phase IB is almost complete and the taking over certificate for the construction of Mohale Tunnel was issued on 27 November, 2003. The entire Phase IB is projected to end in 2004. Although the design of the elements of this phase started in 1992, the actual capital expenditure only started in 1995.

Phase IB is expected to yield benefits in terms of infrastructure in the form of roads, housing, power and telecommunication systems, employment opportunities and the development of a skills base through training. The main focus is, however, on the direct benefits in the form of royalties from water and hydropower sales. Major construction works and associated infrastructure of Phase IB are described briefly below.

• Mohale Dam and Reservoir

The Mohale Dam on the Senqunyane river, is a concrete-faced rock-fill

embankment dam. The dam wall is approximately 145m high, 620m long and 10m thick at the crest. The reservoir the dam will create is equally large at 947 million m3 when full..

A huge spillway, with a weir and flip bucket to slow water flow, will be able

to divert about 2 500m3 /sec of water in case of a flood. The early work

19

included the drill-and-blast construction of two 650m long river diversion tunnels: one large unlined while the other tunnel (concrete lined) will maintain the 300 litre/second minimum compensation flow into the Senqunyane River.

To facilitate construction, a 300 000m3 cofferdam, with a pre-cofferdam, were built in mid-1999. Construction progress went on without a hitch and the constructors were confident of completing the project ahead (which they did in October 2001) of the April 2002 date set out in the contract.

• The Mohale-Katse Inter-connecting Tunnel

The Mohale and Katse reservoirs are connected by a concrete lined transfer

tunnel that is 32km long and 4.5m in diameter. The tunnel will allow water to flow in either direction, and keep each dam at optimum operating level. An 8km long section is constructed to an intermediate access adit and service/assembly cavern from the intake gate at Mohale. The second section is about 23.5km long, and is bored from both the Mohale and Katse ends.

• The Matsoku Weir and Tunnel

Though the Matsoku river system was initially planned to be part of Phase IA,

it was implemented after this phase, and is hence part of Phase IB. The system consists of the Matsoku Weir and Tunnel which will divert a maximum of 55m3/sec into the dam, by so doing increasing the yield delivered to RSA by a maximum of 2.2m3/sec.

The Matsoku Tunnel is 5,6km long which was constructed using drill-and

blast techniques to maximise employment for local Basotho labour. The Tunnel is lined with 75mm thick steel-fibre reinforced shotcrete. A slight downhill gradient towards Katse ensures the facility is gravity-fed.

The Matsoku Weir which is 180m long and 20m high is a solid mass of concrete. The weir’s downstream face features a series of large steps, designed to dissipate the energy of water overflowing the weir

• Telecommunications and Control

The main control centre and communications systems were established during Phase IA. Phase IB only made additions to this existing network. Complementary communications links were set up between the main control centre at Muela and the sub-control centres at the Mohale dam and the Mohale-Katse tunnel intake and outlet.

• Access and Feeder Roads

All roads constructed under Phase IB are those that are within Lesotho and consist of paved and gravel roads. The paved roads include the upgrading of an existing 93 km road between Maseru and Ha Cheche, Thaba-Tseka and a new 9 km road from the Maseru - Ha Cheche road to the right abutment of the Mohale dam. Gravel roads consist of three roads from the Maseru - Ha Cheche road to the left abutment of the Mohale dam, to the Mohale-Katse tunnel

20

intake, and to the Mohale-Katse tunnel audit. These make up a total of 60 kms of gravel roads.

• Camps and Buildings

The infrastructure associated with Phase IB includes a permanent camp

adjacent to the Maseru - Ha Cheche road, about 11km from the Mohale dam tunnel. There are also other construction camps and permanent developments and amenities in the vicinity of the various work sites and points that are frequented by project personnel and the public.

• Social and Environmental Aspects of Phase IB

As with Phase IA, the implementation of Phase IB has acknowledged its social

and environmental dimensions. Table 2.1 shows the estimated losses in arable land, grazing land and dwellings for communities residing at or near the project sites.

In total, approximately 1,023 hectares of arable land and 1,491 hectares of

pastureland have been lost as a result of the project. This has translated into 1,352 households and 6 700 individuals losing arable land on the assumption that an average household consists of 5 persons. In addition, a total of 322 dwellings had to be foregone to make space for the construction of the project. This makes up 1,660 individuals losing homes as a result of the project (See Table 2.2)

TABLE 2.1

LOSSES OF ARABLE LAND, GRAZING LAND AND DWELLINGS ASSOCIATED WITH PHASE IB

Arable Land

lost (ha)

Grazing Land

lost (ha) Dwellings Mohale Dam 980 1321 184 Access Roads 10 68 - Rock Dumps - - - Construction camps 18 62 - Matsoku weir 15 40 - Total (Phase IB) 1023 1491 184 Source: MacDonald and Shand “Feasibility Study” April 1986, p8-3.

21

TABLE 2.2 ESTIMATED NUMBER OF HOUSEHOLDS DIRECTLY AFFECTED BY LOSS OF ARABLE LAND AND/OR DWELLINGS DUE TO PHASE IB

Description Number of Households

that lost arable land Number of Households

displaced Mohale Access Roads Mohale Camp Bulk Water Services Matsoku Weir Mohale Dam Mohale Feeder Roads

140 104

0 103 770 235

6 0 4 0

322 0

Total (Phase IB) 1 352 332 Total Persons (Phase IB) 6 760 1 660 Source: LHDA

2.3 Broad Overview of Phase II of the Lesotho Highlands Water Project

Phase II of the LHWP according to the 1986 Feasibility Study, consists of a storage dam of about 170m high at Mashai site (Mashai dam), a pumping station and 19 km long conveyance between Mashai and Katse Reservoirs, an additional conveyance system from Katse Reservoir northwards to the Vaal River System, and another hydropower plant at ‘Muela. The additional conveyance system from Katse to the North will be designed to pass the total firm yield added by Phase II, III and IV, if and when they occur.

Phase II will increase the yield of the LHWP by about 25 m3/s and will increase hydropower by approximately 85 MW (TAMS, 1996). In addition to these direct physical structures of the project, additional power and telecommunication lines will have to be constructed to transport increased power and connect Mashai, ‘Muela and Katse stations, respectively (Macdonald and Shand, 1986).

New roads will have to be built to connect project areas. Like Phase I, Phase II will also have social and environmental costs associated with the loss of arable and grazing lands, and dwellings due to flooding of reservoirs and construction works.

In the following paragraphs, information is based on extracts from Macdonald

and Shand, 1986, where the major physical components of Phase II of the Project are presented in detail, as well as initial estimates of investment costs. In Figure 2.1 a schematic design of the main components of Phase II of the Project is given.

22

FIGURE 2.1: SCHEMATIC DESIGN OF THE RESERVOIR SYSTEM

23

2.3.1 Mashai Dam The Mashai Dam will be constructed on the Senqu River to form a reservoir

with an active storage of 4,370 hm3. The gross storage capacity will be 5,375 hm3, with the full supply level (FSL) at 1911 metres above sea level (masl).

The dam site is located about 21 km downstream of the confluence of the

Malibamatso river with the Senqu river, where a deeply incised meander has been formed, and the Mashai River joins from the east. The dam will be a rockfill embankment with an impermeable central core. It will be about 182m high, with the crest at 1922 masl. Rockfill will be obtained from quarries in selected basalt rock, and from essential excavation for the spillway. About 17 million m3 of rockfill will be required. The impervious and semi-pervious zones will require approximately 3.6 million m3 of material, and this will be obtained from borrow areas in colluvial deposits both upstream and downstream of the site. The filters will require about 550 000 m3 of processed crushed doleritic basalt. The total volume of fill required will be approximately 21 million m3.

River diversion during construction will be accomplished through three 9m

diameter concrete lined tunnels constructed through the right flank ridge. Two of these tunnels will be converted to bottom outlets, with the construction of an upstream gate shaft.

2.3.2 Tsoelike-Mashai Pumping Station Before completion of the Mashai Dam, provision will be made for the

construction of the outfall works for the future Tsoelike-Mashai pumping system. These will comprise a short, 3m diameter concrete lined tunnel, and a control gate shaft located about 2 km upstream of the dam on the right flank. Water from the Mashai Reservoir will be pumped into the Katse Reservoir, from where the water will be conveyed northwards to ‘Muela by a second transfer tunnel (Transfer Tunnel II north), which is to be built in Phase II.

When the Mashai reservoir is at its Full Supply Level (FSL), it will extend to

the toe of the Katse Dam. However, when it is at minimum operating level (MOL), it will be necessary to provide a pumping tunnel from a point on the Senqu river 23km downstream of the Katse dam. The tunnel will be 19.0 km long with a concrete lined 5.10 internal diameter (transfer tunnel II) with a pump station located in a cavern about 400m from the intake. The tunnel will be excavated in basalt throughout. Good tunnelling conditions are expected and only relatively light rock support will be required.

The pump station cavern will be 122m long by 16m wide by 18m high.

Access to the cavern will be provided by an access tunnel 6.35m in diameter and 1,250m long. A pumping capacity of 42 m3/s will be required, and six 15.5 MW pumps each of 8.40 m3/s capacity will be installed, providing a standby capacity of 20%. The pumps will be of a single stage, single flow, horizontal centrifugal type. With the range of water levels in Mashai and

24

Katse Reservoirs, the static head will vary between 120m and 185m. A 12m diameter concrete lined surge will be constructed at the pump station. The pumping intake will be constructed about 4m above the original riverbed level and 8m below the Mashai MOL. Controls will be located in a 5.50m diameter concrete lined gate shaft. The outlet will be located some 175m upstream of Katse Dam. The outlet structure, with its control shaft and short length of tunnel, was constructed in Phase IA, when access was still possible before the filling of the Katse Reservoir.

2.3.3 Katse-‘Muela Transfer Tunnel II North The second transfer tunnel will follow essentially the same alignment as the

transfer tunnel I, constructed in Phase IA. The access adits and ventilation shafts provided for the Phase IA construction will be used. Transfer tunnel II will be concrete lined, with a finished internal diameter of 5.06m. The intake and outlet structures were constructed in Phase IA whilst the sites were still accessible before flooding.

2.3.4 Hydropower development at ‘Muela The Phase II hydropower development at Muela will be similar in concept and

layout to that developed for Phase I. The headrace tunnel will be 6.20m in diameter and 4.7 km long, the intake having been constructed in Phase IA whilst the site was still accessible. The rest of the system will consist of a 14m diameter surge tank, a 5.40m diameter inclined pressure shaft, a 47m long powerhouse cavern, a 35m high and 17m wide, a 17m diameter downstream surge tank and a tailrace tunnel 7.30m in diameter and 1 km long.

The powerhouse cavern will accommodate two Francis turbine/generator

units. The units will be rated for a net head of 166.4m each with a rated discharge of 58.3m3/s and a rated power of 84.7 MW (nominal capacity of 83 MW). The first unit would come into operation in 2010 and the second in 2019, when the additional water from Phase III will become available. The Phase II power will be adjacent to the Phase I system and will have common access.

2.3.5 Delivery Tunnel II South (into RSA) Delivery Tunnel II will be co-constructed, parallel to Delivery Tunnel I, and

will use the access adits provided in Phase IA. This tunnel will be 34.3 km long and lined throughout. Emergency closure and maintenance gates will be located in the intake gate shaft at Muela, which was constructed during Phase IA. Downstream control by means of a slide gate and a sleeve valve will be provided at the outfall to the Ash River to ensure that the tunnel operates under pressure, and to provide control of flow rates over the full range of discharge.

The intake works and gate shaft at ‘Muela, the major part of the

construction/permanent access adits at each of the river crossings, bulk

25

earthworks associated with the Phase I outfall to the Ash river and access roads will all be common to Tunnels I and II, and have been constructed in Phase IA. River crossings and tunnel drainage, ventilation and outfall facilities will be duplicated for Tunnel II.

2.3.6 Transmission lines/telecommunications/access roads and infrastructure

Electricity will be transmitted from the Phase II power station at ‘Muela to the

Maseru load centre. This will require construction of a 60 km double circuit, 132 kV transmission line from ‘Muela to Leribe, to be constructed in 2010. In 2019, a second double circuit will be added, as well as 65 km of single circuit, 132 kV line from Leribe to Maseru. Energy for the Mashai-Katse Pumping Station will be transmitted by a 129 km long double circuit, 132 kV line to be erected from Leribe to the Pump Station.

Additional communication links will be provided between the existing master

control centre at ‘Muela and the new sub control centres at the Mashai dam and the Mashai-Katse station. Access roads and necessary infrastructure will also be built. Phase II principal road constructions will all be in Lesotho and will consist of upgrading an existing gravel road from Ha Cheche to Thaba Tseka, and new construction from Thaba Tseka to Mashai. In total this will make 91.5 km. It will also include the relocation of a section of the existing road from Thaba Tseka to Mokhotlong, which is about 39 km in length.

2.3.7 Social and environmental impacts of Phase II

The Project has significant social and environmental impacts on the highlands of Lesotho, particularly the highlands population, due to the loss of arable land, grazing land and dwellings resulting from flooding by the reservoirs, and as a result of construction works. It is estimated that Phase II will result in a loss of 1,765 ha of arable land, 9,045 ha of grazing land and 383 dwellings. This translates into 1,765 households loosing arable land and a total of 8,825 persons affected.

2.4 Lesotho’s Economic Performance since the Commencement of the LHWP In order to analyse the impact of any project on the economy of a country, it is

necessary to examine the project itself as well as the economy within which it will take place. In the case of examining the Lesotho economy, we are fortunate that the LHWP has already influenced the economy to a great extent. Therefore, in examining the economy, it is possible to get a sense of the so-called direct effects of Phases IA and IB.

Special attention has been paid to addressing economic aspects of the LHWP

in the collection and reporting of economic data in specifically Lesotho’s national accounts and balance of payments. These estimates provide general measure of the magnitudes of the LHWP’s direct impact on the economy. Table 2.3 summarizes the LHWP share of investment, imports and other indicators in the Lesotho economic statistics for 1990, 1995 and 2000.

26

27

TABLE 2.3 REPORTING OF LHWP IN THE NATIONAL ACCOUNTS AND BALANCE OF PAYMENTS 1990, 1995 AND 2000

(CURRENT PRICES, MILLION MALOTI)

Aggregate/ Component 1990 1995 2000

National Accounts

Gross National Income 2,642.72 4,794.65 7,761.10

Net Factor Payment 1,050.65 1,410.94 1,522.30

Gross Domestic Product 1,592.07 3,383.71 6,238.80

Final Consumption Expenditure 2,652.92 5,162.35 8,659.12

Gross Fixed Capital Formation 635.20 1,423.97 1,883.87

of which LHWP IB - 31.84 478.74

Exports 267.61 720.38 1,775.60

Imports (1,949.38) (4,066.09) (5,511.90)

of which LHWP IB - (69.8) (449.97 )

Balance of Payments

Current Account Balance (488.38) (1,512.70) (1,317.72)

Goods & Services (1,681.77) (3,345.71) (3,736.30)

- Exports: goods and services 267.61 720.38 1,775.60

of which LHWP IB NA NA NA

- Imports: goods and services (1,949.38) (4,066.09) (5,511.90)

of which LHWP IB5) - (69.8) (449.97 )

Income 978.44 1,139.82 1,563.56

- Labour Income 1,000.44 1,213.03 1,553.82

- Other (22.00) (73.21) 9.74

Transfers 214.95 693.19 855.02

- Receipts 320.63 766.12 943.00

- Payments (105.68) (72.93) (87.98)

Capital and Financial Account 389.90 1,426.50 790.36

Capital Account 110.60 158.32 150.70

Financial Account 279.30 1,268.18 639.66

Special Financing-LHWP 183.43 913.64 624.90

Overall Balance of Payments (98.48) (86.20) (527.37)

5) Estimates by Conningarth Economists.

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The implementation of the structural adjustment program by the International

Monetary Fund (IMF) in the 1988/89 fiscal year and the coincidental launching of the LHWP in 1987/886) brought significant changes in the structure of the economy of Lesotho. Coming from a history of low level of economic growth, and internal and external economic imbalances that characterised the greater part of the 1980s, a policy change was needed to improve the macroeconomic situation and to establish a framework that would encourage and receive the development of a sound private sector. Specific targets for the adjustment policies included increasing domestic output, reducing the government budget and balance of payments deficits as well as achieving price and monetary stability.

The structural rigidities in Lesotho and its peculiar geographical position are

still considered major impediments to economic growth and development. However, significant improvements, though erratic, are observed in the performance of the economy during the period under review in this study. Figure 2.2, which is based on data from Central Bank of Lesotho (CBL) Annual Reports and the CBL 2000 Data Base, indicates that the economy grew at a relatively slow rate of 3.0 percent per annum in the pre-LHWP period. However, the economy began to accelerate almost immediately following the commencement of the LHWP and the effects of structural adjustment programs of 1988/89.

FIGURE 2.2

ECONOMIC GROWTH IN LESOTHO, VARIOUS PERIODS 6) Please note that in this chapter, in many instances, figures reported are in terms of fiscal years. This is because financial analyses and statements by the Project are done in terms of financial years. Where necessary, financial years were converted to calendar years.

29

(AVERAGE ANNUAL PERCENTAGE GROWTH)

-2%

0%

2%

4%

6%

8%

10%

Pre-LHWP(1980 - 1988)

LHWP - Phase1A (1988 -

1997)

LHWP - Phase1B (1997 -

2002)

Total Manufacturing Construction

Source: BOS and CBL.

Beginning 1986-87, several developments – two of which involved foreign

direct investments (FDI) – contributed to structural changes in Lesotho’s economy. Firstly, the construction associated with the Project beginning in 1987 impacted on Lesotho’s economy in many ways during the past 15 to 18 years. Secondly, the garment industry that developed during this period emerged as a leading wage employer, with considerable growth potential.

As a share of Gross National Product (GNP), annual FDI in Lesotho to finance

these two developments have been as high as 6-7 percent in the late 1980s, and settled close to 3-4 percent by the late 1990s. These statistics are based on data from the Lesotho Bureau of Statistics (BOS), CBL and IMF. During 1988-93, FDI flowing into the LHWP was 3.6 times larger than FDI into the garment industry. In addition, in the decade following 1988, annual inflows in the form of grants and loans to finance the LHWP averaged as much as 16 percent of GNP. Since 1999, these have dropped to less than 3 percent of GNP.

The 1990s began with a much higher growth rate of 6.2 percent in 1990,

reaching a peak of 10 percent in 1996 . Notable improvements were observed in the inflation rate, mainly determined by the RSA rate, falling from 17 percent to 6.1 percent in 2000. However, in 2001/02 the inflationary position deteriorated. A budget surplus is also one of the major highlights of this period, caused mainly by LHWP-related tax revenues. Because of the

30

increased need for loan financing, the country’s debt burden increased steadily from 1998 as reflected in budget deficits (See Table 2.4)7).

TABLE 2.4 SELECTED MACROECONOMIC INDICATORS

(PERCENTAGES)

1990 1992 1994 1996 1998 2000 2001

GDP growth 6.2 4.8 3.4 10.0 -4.6 3.3 3.5

GNP growth 4.8 6.8 1.1 4.4 -9.0 -3.2 2.7

GNP per capita growth 2.8 4.3 -1.1 2.3 -11.0 -5.0 0.1

CPI inflation 11.5 17.0 7.2 9.1 7.8 6.1 6.9

Gross savings ratio Percent of GDP 20.2 29.3 24.8 17.4 11.2 16.9 24.2

Budget deficit/surplus % of GDP -0.5 2.5 4.6 4.9 -3.9 -5.1 3.7

Current account % of GDP -11.6 -23.0 -22.2 -36.3 -36.8 -25.7 -19.3

Total debt to GNP 38.7 48.5 47.2 53.1 66.1 82.2

Debt service ratio∗ 3.5 3.5 4.1 7.2 8.4 4.5

∗ Net of LHWP debt

Source: Central Bank of Lesotho Annual Reports 2000 and 2001.

Changes in sectoral composition accompanied the above structural changes in Lesotho. As noted, there has been a dramatic expansion in domestic production, as evident from the change in the ratio of GDP and GNP. Two factors underpin this transformation: firstly, the share of net factor income in GNP has declined drastically, and secondly, there were significant structural changes within the domestic sector.

Almost half of the pre-LHWP economy was comprised of net factor incomes

from RSA, primary and secondary sectors jointly accounting for only about one quarter of the GNP. The remaining quarter of the GNP was generated in the tertiary sector, (mostly by wholesale and retail trade) as shown in Figure 2.3 below.

7) t for water transfer, but for ‘Muela – i.e. technically not for Phase IB. No

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FIGURE 2.3 COMPOSITION OF GNP - PRE-STRUCTURAL (LHWP) CHANGE - 1980 - 1987

Primary Sector12%

Secondary Sector13%

Tertiary Sector24%

Indirect taxes7%

Net Factor Income44%

Source: World Bank “Lesotho Growth Options Study” January 2003.

The post-LHWP economy (since 1998/99) is remarkably different: Factor income from RSA has more than halved and the tertiary and secondary sectors each account for roughly a third of GNP (See Figure 2.4).

32

FIGURE 2.4 COMPOSITION OF GNP - POST-STRUCTURAL (LHWP) CHANGE 1999 – 2002

Primary Sector12%

Secondary Sec32%

Tertiary Sector29%

Indirect taxes8%

Net Factor Income19%

Source: World Bank “Lesotho Growth Options Study” January 2003. As in many other developing countries, the agricultural sector has traditionally

played a pivotal role in the economy of Lesotho. The late 1980s were characterised by a fall in the growth of real GDP, largely attributed to a decline in agricultural value added due to productivity problems and price declines.

In the early 1990s things changed, because of favourable weather conditions

which resulted in higher crop and livestock production and, hence, an increase in value added of the agricultural sector. Unlike other sectors, performance of the primary sector was independent of external structural shocks. It was largely due to cycles of drought and good weather, resource degradation and institutional factors that constrain optimal use of land and commercialization.

Within secondary activity, the key drivers of growth – local construction,

utilities and manufacturing - all expanded considerably in response to structural changes. Prior to the LHWP, electricity and water accounted for less than 1 percent, manufacturing for 10 percent and construction for 10 percent of GDP. The crux of the structural transformation of these sectors lay in the two external shocks of the late 1980s: the LHWP and FDI in the garments industry.

Financed by foreign capital flows, the LHWP construction sub-sector grew at

11.6 percent per annum and accounted for 6 percent of GDP during the LHWP construction peak period. In recent years, as the project is winding down, this

33

sub-sector is contracting. According to statistics published by BOS, CBL and The World Bank (2002) its share in 2001/02, was only 2 percent of GDP. Due to inter-sectoral linkages, the LHWP has had positive spillovers into utilities and construction. During the high-LHWP period, growth in electricity and water escalated to 23 percent and in construction to 5 percent per annum. In 2000/01, electricity and water accounted for 5 percent, and local non-LHWP construction for 18 percent of GDP – these were the only visible signs of spillovers from the Project into the domestic economy.

Largely due to the FDI-driven, export-oriented investments in garments and

textiles in the late 1980’s, manufacturing has grown steadily at 8 to 10 percent per annum. Since 2001, the establishment of AGOA has provided further impetus to garment exports. As a result, by 2001/02, the textile industry share of manufacturing in GDP increased to 15 percent and that of the overall secondary sector to 40 percent, up from 23 percent in the pre-LHWP period. If one excludes LHWP-construction, the secondary sector accounted for 38 percent of GDP.

The share of the tertiary or service sectors in GDP shrank by 10 percent

between the pre- and post-LHWP construction periods. With the exception of trade and education, almost all other sub-sectors contracted. In the pre-LHWP period, wholesale and retail trade and education each accounted for 6 percent of GDP, owner-occupied real estate 12 percent, and public administration 8 percent. By 2001/01, the share of wholesale and retail trade and education were the only ones that rose to 8 percent of GDP. In general, growth trends in services move in concert with overall growth in Lesotho. (See Figure 2.5).

34

FIGURE 2.5 GROSS DOMESTIC PRODUCT BY KIND OF ECONOMIC ACTIVITY (1995 PRICES, MILLION MALOTI)

0%

20%

40%

60%

80%

100%

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Primary sector secondary sector tertiary sector

Though labour market statistics are quite scanty, a few conclusions can be

drawn on the basis of periodic surveys that have been conducted by the Bureau of Statistics office. Population growth has been estimated at 2.6 percent per annum, and labour force growth at 2.8 percent in the 1990s. Given a GDP growth rate of 6.0 percent per annum during the LHWP era, one can conclude that the per capita income has improved. Since 1999, however, GDP growth has decelerated to less than 2 percent per annum. Gross National Income has not performed as well either, putting pressure on the poverty reduction initiatives of the Government of Lesotho (GoL). These phenomena, together with the prevalence of HIV/AIDS, have resulted in poverty alleviation being one of the main focuses of government since the end of the 1990s.

Employment statistics show that the unskilled and low-skilled labour force

grew at a higher rate than the capacity of the economy to create employment, despite the recent growth in the export-manufacturing sector. Since 1990, employment growth rates have lagged behind the rate of growth of GDP causing the employment-GDP elasticity to fall below unity.

Within the formal sector, government and other service providers are the

largest employers, taking up 60 percent of the labour force in 1994. The manufacturing sector and the LHWP accounted for 31 percent and 8.4 percent respectively. However, because of fiscal restraints, the growth in the number

35

of government employees fell 0.02 percent and 0.2 percent respectively in 1993 and 2001. Table 2.5 shows employment by sector and employer in 1991 and 1999.

TABLE 2.5 EMPLOYMENT BY SECTOR AND EMPLOYER (PERCENTAGES)

By sector 1991 1999

Primary 53.1 58.41)

Secondary 14.7 13.2

Of which:

Manufacturing 29.9 44.5

Construction 65.9 50.8

Tertiary 32.2 28.4

TOTAL 100.0 100.0

By employer

Government and parastatals - 13.1

Private - 35.6

Subsistence farming - 51.3

TOTAL 100.0 1)A large part still classified as underemployed.

Source: BOS AND CBL

On the basis of these statistics, the bulk of the workforce still resides in the

primary sector, followed by the tertiary sector and the secondary sector. Within the secondary sector, the construction sub-sector has been closely linked to LHWP-related activities, and its share of employment reached a peak of 57.7 percent in 1992 (BOS, 2000), after which it grew by 14 percent and 12.8 percent in 1993 and 1994. Since 1998, the construction industry has contracted and, along with it, the overall number of people employed.

Since beginning October 1999, the Economics Section of the LHDA has been

engaged in micro-economic impact analyses of Phase IB. Preliminary figures to December 2003 indicate that during Phase IB, 9,000 jobs (which translates into 16,000 person years), with an estimated income of M701 million, have been created. Contracts and sub-contracts worth approximately M149 million have been awarded to Basotho companies.

36

2.5 Fiscal Developments As a member of the Common Monetary Area (CMA) Lesotho's key fiscal

variables – exchange rates and interest rates – have always been related to South Africa’s macroeconomic policies with the exception of fiscal policy that the Government of Lesotho determines.

There has been a significant improvement in GoL’s finances since the

commencement of the Project in 1987/88, coupled with the structural adjustment programmes. The latter is reflected in the efforts of the government to curb excessive recurrent expenditures, to improve administration efficiency and better coverage of the tax base. Since 1992, total receipts have been in excess of total expenditures, although the margin narrowed from 1994 onwards. Figure 2.6 shows a summary of the position of government finances during the 1990s.

37

FIGURE 2.6 GOVERNMENT BUDGETARY OPERATIONS 1990-2001

(CURRENT PRICES, MILLION MALOTI)

- 1 0 0 0

- 5 0 0

0

5 0 0

1 0 0 0

1 5 0 0

2 0 0 0

2 5 0 0

3 0 0 0

3 5 0 0

1 9 9 0 1 9 9 1 1 9 9 2 1 9 9 3 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1 9 9 9 2 0 0 0 2 0 0 1

G o v e r n m e n t R e v e n u eG o v e r n m e n t E x p e n d i tu r e sS u r p lu s / d e f ic i t

Source: Central Bank of Lesotho

Government receipts are composed mainly of customs revenue and a range of

taxes. Of these, customs revenue is the largest source of revenue. Prior to 1990 it constituted more than half of total government receipts. In the early 1990s, the increase in customs revenues was made possible mainly by the growth of imports related to the LHWP. Official statistics show that the share of customs revenue in total receipts was 42.5 percent in 1990 while that of tax revenue was 30.2 percent. Towards the mid 1990s customs revenue growth declined somewhat because of the slowdown in the growth of imports related to the Project, i.e. from a growth of 13 percent in 1994, to 8 percent in 1995. This followed a range of tax reform measures undertaken during the 1990s. It is notable that water royalties, albeit a small amount, emerged in 1996 towards the completion of the first phase of LHWP. Table 2.6 shows a summary of the composition of government receipts and expenditures between 1990 and 2001.

38

TABLE 2.6 COMPOSITION OF GOVERNMENT RECEIPTS AND EXPENDITURES 1990 - 2000 [CONSTANT 1995 PRICES, PERCENTAGES] 1990 1992 1994 1996 1998 2000

Total Receipts (TR) [Million Maloti] 785 1113 1537 2140 2324 2599

Customs receipts (% of TR) 42.3 46.4 53.2

45.9

46.0 43.9

Other taxes (% of TR) 30.2 28.7 26.6

25.1

28.2 29.2

Non tax revenue (% of TR) 3.0 11.9 10.9

20.0

18.8 17.7

Of which -Water royalties and (% of TR) - - - - 1.3 4.2 -Other (% of TR) 3.0 11.9 10.9 20.0 17.5 13.5 Grants (% of TR) 24.5 12.9 9.2 9.0 5.8 5.0

Growth of total receipts 25.7 19.4 14.6 20.3 (2.3) 8.1 Total receipts of GDP 28.2 36.8 47.4 57.5 60.6 64.2

Total Expenditures (TE) [Million Maloti] 836 1059 1387 1974 2414 2827

Recurrent expenditure (% of TE) 52.8 66.0 68.9 59.0 75.6 81.6Capital expenditure (% of TE) 47.2 34.0 31.1 41.0 24.4 18.4

Growth to total expenditures 11.9 11.7 14.7 18.9 6.4 4.9Total expenditures to GDP 30.0 34.9 42.8 53.0 62.9 69.8

Surplus/Deficit to GDP -1.8 1.8 4.6 4.5 -2.4 -5.6

Source: CBL Annual Report, data reported in fiscal years.

Converted to the calendar years for analysis purposes

2.6 Summary and Conclusions The basic aim of Chapter 2 has been to provide a brief description of the

Lesotho Highlands Water Project along with a macroeconomic overview of the economy of Lesotho, concentrating on the period since 1990 when the expenditures related to the Project started to increase. The analysis has been based primarily on the CBL’s annual reports, statistical bulletins published by the BOS, as well as World Bank, LHDA and IMF reports and databases.

During the last half of the 1980s and the largest part of the 1990s, major

structural changes in the Lesotho economy have occurred, accompanied by changes in development policies. Firstly, the inception of the LHWP in 1987/88 infused significant changes to the supply and demand structures of the economy, raising the level of foreign capital inflows as well as imports. These have had significant implications for the productive sectors of the economy, as well as the balance of payments. Secondly, the adjustment programs starting in

39

1988/89 introduced a more favourable environment for private investments. As a consequence of increased tax revenues, the government was able to reduce its deficit before borrowing. Thirdly, the decline in the income of citizens working in the RSA over this period put further pressure on the economy to adjust accordingly.

Having gone through a period of slow growth in the first half of 1980’s, since

the inception of the Project in 1986/87, the economy’s performance level has risen considerably. On the fiscal front, a combination of fiscal restraints, tax reforms and increased imports and, hence, SACU receipts, have jointly benefited the fiscal stance directly. Through revenue raising and expenditure cutting policies, government has managed to secure a surplus position in its budget for a number of years. Increased LHWP capital expenditures, which also led to an improved fiscal position, have encouraged foreign direct investment, especially in manufacturing, which, to some extent, have counteracted the fall in labour income and the decline in private consumption expenditures. On the supply side, these changes have jointly increased the relative share of domestic output in GNP through the increased value added of the manufacturing, electricity and construction sub-sectors in particular.

Changes in the current account of the balance of payments over these periods

have been predominantly influenced by LHWP-related activities, whilst other changes have also made a contribution, i.e. the decline in foreign labour income. The worsening in the current account deficit has been caused by the acceleration in imports (caused by LHWP imports), as well as the decline in labour income earned abroad. It is notable, however, that the decline in labour income has been partly offset by the rise in LHWP-related SACU receipts and transfers. On the other hand, the capital and financial accounts have benefited from increased foreign investment due to government policy, especially with respect to the manufacturing sector and LHWP activities. Overall, the balance of payments remains in deficit. The monetary sector is linked to the system by the growth of net foreign assets in the balance of payments, of which transfers and grants are a part. A large part of grants are related to the funding of LHWP. The growth of credit has remained stable.

The country’s exports of goods and non-factor services in real terms have been

growing at greater than 12 percent since the late 1980s. Nearly three quarters of the merchandise exports are miscellaneous goods, which include textiles. The primary destination for textile exports is the United States, and these exports currently enter the market with preferential access as Lesotho’s part of the AGOA. However, Lesotho’s exports will be subjected to competition from some of the most efficient producers in the world when the MFA expires. Nevertheless, Lesotho has succeeded in transforming its economy, lessening its dependence on the primary sector, and widening the base of the manufacturing sector through exports.

Lesotho’s dependence on imports continues to be high. Foreign Direct

Investment (FDI) flows have been critical to Lesotho’s manufactured exports.

40

The analysis has revealed, to some extent, the mechanism by which, and the extent to which, LHWP expenditures directly and indirectly work their way through the economy to affect major macroeconomic variables. It appears that the LHWP expenditures produced significant responses from all major sectors of the economy and hence have implications for the growth of output, employment and price stability in future.

Its major, lasting effect seems to have been on the construction, electricity and

water sectors. Together with the improvement in the exports of manufactured goods, the LHWP has succeeded in cushioning the rather serious decline in the remittances of Lesotho migrant workers based in the RSA. The extent to which it really contributed to the diversification of Lesotho’s economy is partly shown in this study.

The Lesotho economy presently finds itself confronted with daunting developmental challenges of employment creation, the need for FDI, and fiscal balance among others.

Phase IB (including supporting infrastructure - which started in 1994) has now

been under construction for close to 6 years. As such, the government of Lesotho, the donors and lending agencies, and the LHDA are now interested in measuring the actual impact of this second phase on the Lesotho economy.

The LHDA consequently commissioned this Macroeconomic Impact Study of

the Phase IB actual expenditures on the economy of Lesotho. The results of this study will be used to identify missed opportunities and constraints for maximising the benefits of the LHWP. In addition, the study will make recommendations for optimising the economic impact of future phases of the Project.

Before turning to the detailed analysis of macroeconomic and sectoral impacts

of the LHWP on the Lesotho economy, the next section provides a brief description of the approach used to develop the detailed estimates, using computer simulation models of the Lesotho economy.

CHAPTER 3: THE METHODOLOGY FOR MEASURING THE IMPACTS OF THE LHWP ON THE LESOTHO ECONOMY SUMMARY In this section, the economic modelling system used to develop estimates of the

41

impacts of Phase IB and Phase II on the Lesotho economy is briefly described. A more detailed discussion of the various models and methods used is provided in a Methodology Supplement to this Main Report. Also included in the Supplement are descriptions of previous studies (including the Doggett study) and discussions surrounding the results of those studies. The paragraphs that follow provide a brief description of the methods used in this study. The discussion presented here is necessarily technical in nature. Some readers may wish to skip this chapter and go on to the analysis and discussion of the economic impacts which begins in Chapter 4.

3.1 Background According to the Terms of Reference (TOR), the consultants were required to

use the current macroeconometric modelling structure of the Central Bank of Lesotho (CBL). In addition, a sub-model based on the 2000 Social Accounting Matrix (SAM) compiled by Conningarth Economists (CE) for Lesotho had to be linked into the CBL macroeconomic model1). In the process of doing this, the behavioural equations of the CBL model were analysed and evaluated to determine their suitability for inclusion in the updated model. Through a process of data collection, plus the establishment of a suitable database that was used for regression analysis, the most appropriate regression equations and coefficients were selected to replace the behavioural equations in the current CBL model where necessary.

A more detailed rendition of the theoretical under-pinnings of the new

Dynamic Sectoral Analysis System (DSAS) model, as well as its technical ramifications can be found in the Methodology Supplement to this Main Report. The new modelling system is essentially a modification of the modelling system used to evaluate the economic impacts of Phase IA, (i.e., the Doggett model) which is briefly described below.

3.2 Overview of the Doggett Model

Beginning in 1994, Mr Ralph Doggett developed a macroeconomic forecasting model for the Central Bank of Lesotho. In a subsequent project with the LHDA, this Accelerator-Multiplier Interaction general equilibrium model developed for CBL was expanded to include sectoral detail. The expanded CBL model was used for estimating the impact of Phase IA on the Lesotho economy. Mr Doggett, who is part of the Conningarth Economists team, assisted in developing the updated DSAS model. In doing so, he played an important role in formulating the underlying assumptions and in developing the methodology for linking the CBL model with a sectoral structure that enabled the Consultant to quantify the impact of Phase IB on certain sectors and public finance. Consequently, as the author of the original modelling

1) A background discussion of the model is given in the Methodology Supplement. A discussion of

the various scenario assumptions and outcomes may be found in Chapters 4 and 5 of this report.

42

system, Doggett was able to provide first hand information on its composition and main capabilities.

As mentioned above, the analysis that was undertaken to assess the economic impacts of Phase IA of the Project began with a macroeconomic model of the Lesotho economy, which was developed for the Central Bank of Lesotho in 1994. A number of modifications were made to this model in order to more fully address specific aspects of the Project and its potential impact on the economy of Lesotho during the construction period.

To perform the analysis of Phase IA, the original CBL model was updated using more data available than in 1996. Furthermore, and more significantly, it was modified to include additional detail, much of which was obtained from a Social Accounting Matrix (SAM) that was developed by Dr. Carvallo.

The Carvallo SAM provided data on inter-industry flows, as well as flows

from industries to consumers, government, investors, imports and exports. This information was incorporated into the updated version of the CBL model and organized into 24 different activity sectors and 6 categories of final demand. The 24 activities provided more detailed data for agriculture, mining, manufacturing and service industries. This newly augmented CBL model was adapted in order to provide estimates of total output and value added for each of the activity sectors.

The expanded CBL model addressed some 600 variables and included 104

behavioural equations in 6 major model components, all linked together and solved in a dynamic simultaneous equation model. A short description of the components, or “blocks” of the model follows below. Included in these blocks were details specific to the Lesotho Highlands Water Project.

Real National Accounts Block

A Real National Accounts block provided estimates of real GDP at factor cost (supply) as well as its major demand side determinants, namely household consumption, consumption by non-profit organizations, government consumption, private fixed investment, government fixed investment, changes in stocks, imports and exports. Included in this block, and as well as in other blocks, were details specific to the Lesotho Highlands Water Project.

An important aspect of the Real National Accounts block was the embedded

interindustry component, which was drawn from the Carvalo SAM. Using sector-specific behavioural equations for private consumption, exports and imports, combined with various sharing algorithms, estimates were made of sector level final demand, outputs and value added. The value added component had been used to estimate real GDP at factor cost. Estimates of net factor income from abroad and terms of trade adjustment provided the detail for estimating aggregate real Gross National Product (GNP).

43

• Price Block

A second block of the model provided projections of prices. This Price Block included 9 deflator equations, three exogenous deflator projections and 1 deflator identity. The price projections were used to translate the Real National Accounts estimates into nominal values in a third Nominal National Accounts Block.

• Monetary Survey Block Another block addressed the Monetary Survey aggregates, in which the key

endogenous variable was money supply. Five variables were addressed in this block. In a Government Receipts and Expenditures Block, some 14 variables had been addressed using 4 behavioural equations, the most important of which is the equation dealing with customs duties receipts.

• Balance of Payments block Finally, a Balance of Payments Block provided estimates of Current and

Capital Account flows of about 24 variables. This block had 8 behavioural equations. Most of the key information for this model element was drawn from the Real National Accounts Block, plus a number of exogenous assumptions regarding the Project.

3.2.1 Application of the Doggett Model The model was applied by first developing a baseline forecast simulation that

took into account planned expenditures for the LHWP and other assumptions regarding the Lesotho government’s fiscal and monetary policy and major trends in the Republic of South Africa. Results from the baseline forecast simulation were compared with results from alternative forecast simulations in which the assumptions regarding LHWP expenditures were changed. A detailed description of the model and its use in the LHWP Phase IA economic impact analysis can be found in the Doggett study2)

3.3 A New Analytical Framework for Assessing the Economic Impacts of the

Project (The DSAS model) It is not the intention to go into detail regarding the technical/theoretical

specification of the elaborate Dynamic Sectoral Analysis System. This aspect is adequately covered in the Methodology Supplement. The material in the Methodology Supplement is presented in such a way that the reader will be able to follow the step-by-step solution of the model to ultimately produce

2) Ralph M. Doggett “A Macroeconomic Analysis of the Lesotho Highlands Water Project” LHDA.

May 1996.

44

estimated values of targeted macroeconomic aggregates. This section provides a brief overview of the DSAS model.

After a thorough investigation by the Consultant in collaboration with CBL, it was identified that a new modelling framework for the analysis of Phase IB would have to be constructed. The most important reasons for this requirement are as follows.

The original CBL model that was used for the analysis of Phase IA had not

been used since 1996. Since then, more current data has become available, which would enable the model to be updated and improved. However, to do so would require more time and effort than is available within the scope of the current study.

Furthermore, the CBL model that had been used in the earlier study was

modified to the extent that it had become too cumbersome for CBL staff to update and to manipulate for their own needs. As a result, the CBL had decided to develop a new macroeconometric model that would cater for its present own specific planning needs. Since the LHDA also required a macroeconomic model, it was decided that the CBL model would be used as a core macro-driver of the new modelling system.

Consequently, the analytical framework envisioned for the current study is

such that the current configuration of the CBL model is maintained, while its strengths are exploited for two main purposes. These are:

• Estimating macroeconomic impacts of the Project, and

• Providing controlling estimates for estimating more detailed impacts of

the Project on sectoral level

3.3.1 The Current CBL Macroeconometric Model The current CBL model was developed as part of the Research Network for

Development Policy Analysis co-sponsored by the United Nations and the University of Pretoria. The primary authors of the model are Messrs. R Matsenyetse and G. Kamary3). The model is described as an Engle-Granger two-step procedure of error correction model, or ECM, which uses a notion of co-integration to mimic long run equilibrium to which an economic system theoretically converges.

The model is designed to evaluate the presence of disequilibrium in one period

in order to capture corrective behaviour in following periods. The model attempts to accomplish this task by incorporating behavioural equations based

3) For a detailed discussion of the main attributes of the CBL model, see the Methodology

Supplement.

45

on first and higher order differences in its dependent and independent variables. Hence to estimate values for key demand and income variables, a two-stage approach is used.

The CBL’s model is a relatively small and simple one designed to capture both

long-term and short-term effects in the interactions between demand, supply, the external sector and fiscal and monetary policy. The emphasis of the model is on the monetary survey and the balance of payments, as these are, after all, the province of the Central Bank. The model also provides detail for the public sector to capture interactions between government receipts and expenditures and the monetary sector and the balance of payments, as these are, also of prime interest to the Central Bank.

The model is essentially an accounting framework in which relatively few

equations are used to generate projections for key variables upon which estimates for the rest of the model variables hinge. The projections rely largely on the demand equations. Each of the estimated components of the CBL-model proved to comply with both economic and statistical a priori conditions.

This model, therefore, has been established as a robust mechanism to explain

the Lesotho economy. As such, it can be incorporated into an updated and expanded model. (The CBL model is described in more technical detail in the Methodology Supplement).

3.3.2 Linking the Current CBL-model with the 2000 SAM for Lesotho 3.3.2.1 The Current Social Accounting Matrix for Lesotho Dr Carvalo developed the Social Accounting Matrix from which

elements were used to construct the model employed in the Phase IA economic impact analysis, and the Phase IB forecasts. Dr. Carvalo’s SAM was based on data for 1987.

Conningarth Economists (CE) developed the current Lesotho SAM for

the World Bank, based on data for 2000. This SAM model includes details for 57 commodities distributed amongst 53 activities (i.e. sectors spanning agriculture, mining, manufacturing, construction, utilities and services), 10 categories of factor payments for labour, 6 for capital, 10 categories of household consumption, and 17 categories of government consumption and capital expenditure.

46

Using this SAM, one can trace the flows of expenditures on commodities between and amongst industries and consumers, government, investors, and the rest of the world. The SAM framework is arranged as a large table, upon which sales of commodities, such as maize or bricks, are shown across rows; while the input requirements of a sector, such as “improved field crops” or “brick production” are shown as columns. Included along the rows are estimates of sales of a commodity (or sales of all commodities by a particular activity) to consumers, investors, government and the rest of the world. Commodity-specific imports are identified separately, in columns which show how much of Lesotho’s total domestic demand is supplied by imports and how much is produced domestically. (A detailed exposition of the main features of the Lesotho SAM for the year 2000 is contained in the Methodology Supplement).

The Conningarth Economists’ Social Accounting Matrix (CE-SAM)

constitutes a ready framework for analysis of the impacts of Phase IB on the Lesotho economy. Elements of the CE-SAM can be used in one of several alternative methods, in conjunction with the existing CBL macroeconomic model.

3.3.2.2 A proposed new analytical framework

Figure 3.1 presents a highly simplified diagram of the analytical framework used for the analysis of the LHWP impacts. The diagram shows a system in which, for a given model simulation, a unique set of scenario assumptions are used as inputs to both the existing CBL model and the component built upon elements of the existing SAM. The unique scenario assumptions include all of those necessary to project macroeconomic variables in the CBL model, plus LHWP expenditure assumptions and any other variables needed to generate estimates of output and value added in the SAM component. The latter includes assumptions regarding the imports share of domestic demand at the sector level, or shifting patterns in the distribution of private consumption expenditures across sectors/activities. This approach preserves the integrity of the CBL model while exploiting the richness of detail included in the CE-SAM.

47

Figure 3.1: Simplified Diagram of the Dynamic Sectoral Analysis System (DSAS)

NOTE

= Macroeconometric Model (1-5, 7-15)

Exogenous assumptions regarding demographics, policy,environment and LHWP receipts and expenditures

2-5 Real National Accounts: GNP (Market Prices) and its components (Demand) Demand

Labour 1. Gross National Product at Factor Cost by sector (Supply)

components

6. Embedded Sectoral Component (SAM)

16 Lesotho Government Receipts and Expenditures

12,14 Prices, wages, employment and income

13,15 Lesotho Balance of Payments

8, 9, 10,11. Lesotho Monetary Survey: MoneySupply, Credit, and Other Monetary Aggregates

Tvin

= Sectoral System (6)

he numbers in the blocks refer to numbers assigned to the equations in the arious sections in the mathematical representation in the modelling framework Model Supplement.

48

The CBL model provides initial projections of aggregate demand variables, which are then linked to the CE-SAM component. The CE-SAM component is then used to estimate sectoral-level implications of the macro-level demand variables. The CE-SAM component provides estimates of value added for each of a number of activities, complementing the supply side aggregates generated by the CBL model.

The CBL model is then run again, using results of the CE-SAM component as

inputs, in order to ensure consistency between the demand and supply estimates generated by the two systems. Differences between the two are then compared, and if the differences exceed some pre-specified criteria for convergence, the outputs of the CBL component will be used to generate new estimates in the CE-SAM component. This iterative process will continue until the convergence criteria are met, or until the total number of iterations has exceeded some present maximum.

3.3.3 Theoretical and Technical Specification of the New Dynamic Sectoral

Analysis System (DSAS) As indicated above, a linkage between the CBL macroeconomic demand

variables and the detail of final demand in the CE-SAM forms the basis of the new modelling system. It is preferred that the inter-sectoral detail included in the SAM be maintained. Equations have been developed to estimate the total output of each sector as a function of its sales to all other sectors (intermediate demand) and to each category of total final demand in the macro model, with appropriate adjustments for imports. Solving the system requires an iterative solution procedure within the SAM component itself, before going on to estimating value added/GDP at factor cost for the next iteration of the CBL model (See Figure 3.1).

3.3.4 Evaluation of DSAS’s Estimation Accuracy over the Historical Period,

1980-2000

Macro-econometric models are usually used for either forecasting purposes or for impact analyses. In this study, the impact of Phase IB must be determined, as well as forecasting the impact of a possible Phase II of the Project on the Lesotho economy. The sectorally linked macro-econometric model that has been constructed for this purpose had to be statistically tested to determine its suitability to realistically simulate the actual impact of Phase IB and Phase II. For this purpose an in-sample evaluation exercise was carried out.

In short, the in-sample evaluation exercise involves the comparison of the estimated endogenous variables, as determined through the model by actual exogenous aggregates, with the actual observed data provided by the Central Bank of Lesotho. From these results it can be determined whether the model can be used to simulate the impact of Phase IB over the historical period in question.

49

For this purpose, in-sample evaluations were made on a macro level as well as on a sectoral level for the period 1980 – 20004).

From this in-sample evaluation it can be concluded that the new modelling system is technically sound and fundamentally capable of simulating the impacts of Phase IB and Phase II on the Lesotho economy.

3.4 Summary on construction of DSAS

In summary, the sectoral system links with the current macroeconomic model in the following ways:

• The final demand components of the current macroeconomic model are the

initial drivers of the sectoral model that determine production per sector. • The production and value added (GDP) calculated by the sectoral system is

linked back to the macroeconomic model and is crucial in determining the actual total Gross Domestic Product in the macro model.

• The sectoral labour component computed by the sectoral system is also

linked back to the current CBL macroeconomic model to eventually determine the actual total number of people to find employment in the Lesotho economy.

• The incorporation of the sectoral system into the macroeconomic model

was successful. The entire modelling system, containing both the CBL macroeconomic model as well as the sectoral system, can now formally be dubbed the “Dynamic Sectoral Analysis System (DSAS)”.

• As was set out at the beginning, the main outcome of the research effort is

to leave the CBL’s macroeconomic model basically intact and in good operational condition and suitable for their own needs and objectives. The DSAS on the other hand is able to function on its own without “contaminating” the CBL macroeconometric model but still uses the latter as its main driving agent.

The main benefits of this system are that, for the first time, information on gross domestic product (GDP), production and labour can be provided by both the macroeconomic model and the sectoral system in a coordinated and interactive way. Thus, the sectoral system enhances the entire modelling system and is able to provide much more data than the aggregated annual data that is characteristic of macroeconomic models in general.

3.5 Application of DSAS model

4) For a detailed presentation of the evaluation of the DSAS’s estimation accuracy over the historical

period 1980-2000, see the Methodology Supplement.

50

In order to quantify the impact of phase IB on the economy, information is required on the performance of the main aggregates “with IB” and “without IB”. The difference between the two sets of data then represents the impact of implementing Phase IB.

Two main types of variables are distinguished in this system, namely exogenous and endogenous variables. In layman’s terms, it can be explained in the following way. Firstly, values have to be assigned to all exogenous variables i.e. they are predetermined. When these values are fed into the modelling system, it enables the model to calculate the values of the endogenous variables, or in other words, the model is solved. From a technical viewpoint, endogenous variables are generally indicated on the left hand side of the mathematical equations and the predetermined variables, exogenous and lagged endogenous variables, appear on the right hand side. Endogenous variables are, therefore, determined within the system, given a certain set of exogenous variables. Exogenous variables, on the other hand, are determined outside the system. They, therefore, have an effect on the value of endogenous variables, without being affected by the endogenous variables in return.

In the modelling system, labels are used to denote the various variables. An

alphabetic list of these labels is presented in the Methodology Supplement. A shortened version of the exogenous variables list, is reported at the end of this section.

For purposes of this study, it should be mentioned that there are two main

types of exogenous variables, namely: • Assumptions pertaining to the LHWP. (Discussed in detail in Chapter 2

(Technical details) and Chapter 5 (Investment profiles) • Assumptions of other outside factors affecting the Lesotho economy, e.g. the oil

price.

Forecasting exogenous variables is an important exercise in scenario development. However, it isn’t an exact science. There are various methods that can be employed to arrive at plausible forecasts. These include:

• Prior knowledge

Sometimes information regarding the future development of a certain variable is known beforehand. This information can then be incorporated in the forecast. Examples in this regard are the prior knowledge regarding LHWP spending, and expected government tax policies.

• Historical growth rates

51

The historical growth rate of a particular economic variable, can be extrapolated into the future to portray a plausible pattern of change. • Trend values

A trend line (regression over time) can also be fitted to an historical time series and then extrapolated to provide future values.

• Expert opinion

Sometimes an expert in a particular field can be consulted to provide insights on likely future developments.

• Other forecasts

Forecasts already made by other credible institutions are sometimes used if it conforms to the strict conditions set by the researcher. Some assumptions pertaining to the LHWP spending are based on the actual engineering costs, as well as actual measured expenditures. With regard to other exogenous variables, use was made of a variety of methods as explained above.

The next two chapters of the report present the findings from applications of the modelling system described above. The discussion describes the use of unique specifications of exogenous variables to characterize the Phase IA and Phase II scenarios and the subsequent results.

CHAPTER 4: THE IMPACT OF PHASE IB OF THE LHWP ON THE LESOTHO ECONOMY

SUMMARY Chapter 4 provides a perspective of the impact of Phase IB on the economy of Lesotho. The two groups of external factors, influencing the economy of Lesotho, are discussed in detail. Firstly assumptions pertaining to LHWP expenditures and then assumptions pertaining to other external factors influencing the Lesotho economy. A detailed table of historic and forecast growth rates for the latter

52

exogenous variables is reported.

Projected impacts on macroeconomic demand aggregates, economic sectors, government accounts and balance of payments are discussed in detail. A comparison is also made between these results and those of an earlier study. At the end of the chapter, study outcomes are presented and discussed for future phases.

4.1 Introduction This chapter analyses the impact of Phase IB of the LHWP on the economy of

Lesotho. The DSAS model, as described in Chapter 3, has been used as the basis for undertaking this analysis. DSAS had to be activated by means of a number of exogenous variables which have been explained in general terms in the previous section. This chapter begins by describing these external factors in more detail. These include Phase IB expenditures and other economic variables that have a major external impact on the future development of the Lesotho economy.

This is followed by a description of the impact of Phase IB on the economy.

Thereafter, a comparison is made of the results achieved in this study with other earlier studies undertaken by the LHDA.

Finally, the section concludes with a description of the lessons to be learned

for future phases of the LHWP. 4.2 External Factors Influencing Future Economic Growth in Lesotho

As stated previously, there are two distinct groups of external factors (exogenous variables) that will influence the economy of Lesotho. These two groups are:

a. Expenditure (and to a lesser extent revenues) directly associated with the construction of Phase IB of the LHWP.

b. Other external factors that have a definite impact on the economy of Lesotho, and that cannot be controlled by the stakeholders in Lesotho. Factors which are regarded as external to the economy for instance, are world demand, as well as fiscal policy.

4.2.1 The Nature and Magnitude of Phase IB Expenditure

All aspects relating to the nature and magnitude of the construction and operation of Phase IB are discussed in terms of the following:

1. Construction Phase – Capital expenditure of Phase IB

53

2. Operational Phase – Water Revenue – Electricity Generation

For the purpose of the quantitative exercise, it is necessary to isolate the Phase IB expenditure from the rest of the LHWPs expenditures. The expenditure on Phase IB started in 1992/931). The data has been sourced from the Annual Reports of the LHDA. In this section of the report, capital expenditure information on Phase IB is given according to each asset type i.e. Mohale Dam, Mohale Tunnel, etc, as obtained from the LHDA. Later it will be shown how the Phase IB expenditure were further disaggregated and reclassified to conform to the needs of DSAS.

The total costs of Phase IB are classified into investment costs and operating costs. The construction of the major works of Phase IB, the Mohale dam and the Mohale-Katse tunnel, make up to 76 percent of the total costs of the project. The second largest share of the investment costs is taken up by infrastructure, followed by engineering and environment.

The profile of the expenditure and revenue from 1994 to 2007 resulting from the construction of Phase IB is provided in Table 4.1. The expenditure reflects the total capital expenditure related to Phase IB, while the revenue portion of the table provides the magnitude of the two final products of Phase IB, namely water revenue and electricity generation.

1) Fiscal year.

55

TABLE 4.1 NATURE AND MAGNITUDE OF LHWP – PHASE IB, 1994-2006 [CONSTANT 1995 PRICES, MILLION MALOTI]

LHWP Phase IB components

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

EXPENDITURES Total capital expenditure Percentage contribution REVENUE Water revenue - Water sales - Royalties Electricity generation

3 0.11%

0 0

0

32 1.25%

0 0

0

64 2.52%

0 0

0

179 6.99%

0 0

0

271 10.58%

0 0

0

309 12.09%

0 0

0

324 12.69%

0 0

0

313 12.25%

0 0

0

377 14.76%

0 0

0

315.45

Source: LHDA database & TCTA. 4.2.1.1 Construction Phase - Capital expenditure of Phase IB

56

Figure 4.1 depicts a diagrammatic view of the costs of Phase IB spread over the period 1994 to 2006. The figure illustrates the course of expenditure over the construction period.

FIGURE 4.1

LESOTHO HIGHLANDS WATER PROJECT TOTAL EXPENDITURE [1995 PRICES, MILLION MALOTI]

0

50

100

150

200

250

300

350

400

450

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Years

1995

pri

ces,

Mill

ion

Mal

oti

Phase IB

Expenditure on Phase IB was relatively small in the first three years, reflecting mainly the engineering work associated with the design of the project. Thereafter, expenditures steadily increased, reaching a peak in 2003. The outlays on the Mohale Tunnel are projected to increase to a peak in 2004, after which construction will come to an end in 2005. The years 2005 and 2006 will feature mainly administrative and environmental expenditures.

Figure 4.2 depicts the components of capital expenditure on Phase IB in terms of its identifiable products such as the Mohale Dam, the Mohale tunnel and other.

57

FIGURE 4.2 DETAIL LHWP PHASE IB EXPENDITURES ON A PRODUCT BASE 1992-2006

Environment12.99%

Administration12.18%

Ancillary Developments1.46%

Infrastructure19.31%

Matsoku Diversion5.67%

Mohale Tunnel31.11%

Mohale Dam17.29%

From Figure 4.2 it is apparent that the bulk of the expenditure on Phase IB will be on the Mohale Tunnel which is given as 31 percent of the total. In addition, infrastructure and the Mohale Dam are large contributories to the expenditures of Phase IB at 19.31 percent and 17.29 percent of the total capital expenditure respectively. The annual capital expenditure of Phase IB is provided in Appendix 4.1.

The costs, as presented in Figure 4.2 and in Appendix 4.1 are not functionally suitable for use in the DSAS model. Consequently, various adjustments were made to these data categories in order to make them suitable for incorporation into the appropriate components of the DSAS econometric model. The main task involved breakdown of the monetary values of the various asset categories into their main cost components in terms of each component’s construction and engineering contents.

The information required for this disaggregation exercise was provided by the LHDA. Construction and engineering activities have totally different cost input structures that require a different range of labour, commodity and services inputs. As such, each of the capital expenditure components

58

(asset types) identified in Figure 4.2 were further sub-divided into the following categories of asset structures and cost elements:

* Building construction * Civil construction

- Concrete structures - Roads - Earth works

* Machinery and other equipment - Mechanical machinery and metal

products - Electrical machinery

* Professional fees

The results of this exercise are depicted in Figure 4.3 and detail is provided in Appendix 4.2 at the end of the chapter. The figure is a reflection of the composition of the asset base as distinguished in Phase IB according to National Accounts classifications i.e. building construction, roads, electrical machinery, etc.

59

FIGURE 4.3 DETAIL LHWP PHASE IB

Each of the components depicted in Figure 4.3 above had to be even

further disaggregated between various commodities, services and other value added components. Based on field surveys conducted over the duration of the study, it was possible to further break down the cost and activity categories into the following components:

2)

EXPENDITURES ON AN ASSET BASE 1992-2006

Electrical Machinery0.00%

Plastic Products0.00%

Research & Development13.52%

Mechanical Machinery & Metal Products

6.94% Earth Works

7.64%

Roads2.94%

Concrete Structures19.20%

Relocation Costs0.20%

Building Construction49.57%

• Economic sectors (Intermediate demand of each

asset category) • Salaries and wages • Gross operating surplus • Direct imports

Once this level of disaggregation and sub-division of the capital

expenditure of Phase IB had been attained, the results were suitable for introduction into the DSAS model as part of the exogenous compartment specifically designed for that purpose. The sectoral results as derived

2) Developed in cooperation with the Development Bank of Southern Africa.

60

from the asset base of Phase IB are provided in detail on the electronic database.

In more technical terms, the sectoral values - as derived from the process of re-classification and disaggregation described above - are then introduced into the modelling system in the following way:

• An exogenous addition to the investment function in the

macro model (which is part of the Dynamic Sectoral Analysis System).

• Exogenous increases in the demand for goods and services produced by a particular sector, emanating from Phase IB construction activities.

• An exogenous enlargement of the direct labour needs of the construction sector.

Information obtained from previous studies was used as an input in calculating the total impact on employment3). In calculating the direct labour requirements, a labour-investment ratio was utilized which is based on the actual capital expenditures of LHWP. This ratio was applied to investment figures to obtain the imputed direct effect during the construction phase and was incorporated into the model to capture the total employment impact. An exogenous enlargement of the value added of the construction sector, which results from direct salaries and wages, as well as the Gross Operating Surplus (GOS) generated by the construction of Phase IB.

4.2.1.2 Operational phase

It is important to realize that the impact of the construction phase of Phase IB is only temporary in nature. In contrast, the operational phase of the LHWP brings permanent benefits to the Lesotho economy and, therefore, need to be quantified.

The long-term benefits flowing from Phase IB consist of additional water sales to the RSA, as well as increased electricity generation by existing

3) LHDA Economics Section “The Economics of Phase IB” April 1998: According to this study, total

jobs created by Phase IB was 3,000 during the construction phase. It was estimated that almost 90% of all jobs and some 16,500 person-years of employment would go to Basotho. This information was used as an input in calculating the total impact of employment.

61

plant and direct labour requirements of the electricity sector4). It is assumed that water sales will start in 2004, as will incremental electricity generation.

There were doubts in some quarters as to whether the operational impact

of Phase IB should be modelled at all, as a result of the uncertainty as to when water transfers will actually begin. It was ultimately decided to include the operational impact for the reason that it is required when a “base case” forecast of the Lesotho economy is made for the period 2007 to 2020, when the impact of a possible Phase II is modelled.

The operational impact of Phase IB is discussed under the following

headings:

• Water revenue • Electricity generation

• Water sales/revenue

Table 4.2 reflects the water sector’s production structure. TABLE 4.2

WATER INDUSTRY PRODUCTION STRUCTURE, 2004 – 2007 [FULL CAPACITY] [CONSTANT 1995 PRICES, MILLION MALOTI]

2004 2005 2006 2007 Structure Intermediate inputs Salaries & wages Gross operating surplus Government revenue (water royalties)

0.46 0.58 52.00 7.61

1.09 1.37 124.21 18.19

1.67 2.11 190.82 27.94

1.67 2.77 190.82 27.94

0.8% 0.9% 85.7% 12.6%

TOTAL WATER SALES 60.65 144.86 222.55 222.55 100% Source: Trans-Caledon Tunnel Authority (TCTA)

Cognisance has to be taken of the fact that, for purposes of exogenous inputs into DSAS, only intermediate inputs, salaries and wages and water royalties were introduced into the model. As far as the Gross Operating Surplus (GOS) is concerned, none of the revenues generated in this regard

4) ) Ditto

62

ever reach Lesotho and, as such, have no impact on economic growth in the country.

The intermediate inputs reflected in Table 4.2 consist mainly of operational and maintenance cost (e.g. spares, administration etc.) Salaries and wages include annual and head office allocated salaries and wages. The GOS is calculated as shown below, with total water sales and royalties information provided by TCTA.

According to a document produced by the World Bank, Phase IB will deliver 322.2 million cubic metres of water per annum at full capacity at a tariff of 69c per cubic meters of water per annum at full capacity at a tariff of 69c per cubic meter. This amounts to total water sales of M222.50 million per annum. Thus, the gross turnover of the water sector in the Lesotho economy should comprise M222.50 million (in 1995 prices), per year, when Phase IB is operating at full capacity.

To put a value to each of the economic aggregates shown in Table 4.2, the

following approach was adopted:

• Intermediate inputs and salaries and wages constitute approximately 1.7 % of total water sales, based on the Social Accounting Matrix (2000) for Lesotho compiled by Conningarth Economists.

• Water royalties attached to Phase IB will amount to M27,94 million (constant prices) according to estimates by the LHDA. For the purpose of this study, royalties are regarded as part of taxes paid to the government (indirect taxes).

• GOS is then calculated as follows: GOS = Total water sales revenue, minus Intermediate costs, minus Salaries and wages, minus Water royalties

The operational impact of Phase IB of the LHWP (i.e. the water royalties) is incorporated into the DSAS model by adding it to exports of commodities (i.e. water).

The explanation supplied above will be amplified in Chapter 6, where the issue of determining the GOS of water sales will be discussed as well as the magnitude of its impact on the economy of Lesotho.

63

However, after having estimated the incremental value added in its totality through the sectoral system, an adjustment has to be made in respect of that portion of the salaries and wages, as well as the GOS that will flow out of the Lesotho economy to the rest of the world. This is mainly due to the fact that one can expect that a large number of foreign workers as well as foreign companies will probably be involved in the construction of Phase II of the LHWP. Thus, the negative impact on the current account of the balance of payments, which also takes into account these labour and capital debits, will be increased when these factor payments are taken into consideration.

Various analyses were conducted to establish as close as possible the real magnitude of these outflows. The following ratios were ultimately employed for this exercise.

- Labour debits

• Approximately 59 % of value added directly created by Phase II construction activities consist of salaries and wages.

• Of this amount, it is assumed that 44 % will flow out of the Lesotho economy. This situation is summarized below.

Origin of labourers Person

Years

Average

Annual

Remuneration

Weighted

Annual

Remuneration

Percentage

Remuneration

Basotho Nationals

Foreigners

88 %

12 %

R 24 000

R 140 000

R 21 119

R 16 806

56 %

44 %

100 % R164 000 R37 925 100 %

- Capital debits

• Gross Operating Surplus (GOS) amounts to approximately 39 % of the total value added by the construction of Phase IB.

64

• Of this amount, 75 % will probably flow out of Lesotho. This is based on historical experience as documented by the LHDA.

The necessary adjustments will be made to the balance of payments to reflect the production factor remuneration outflows referred to above.

• The generation of hydropower (Electricity generation)

As mentioned previously, another benefit from Phase IB is the generation of additional electricity through hydropower. It is envisaged that an additional M7.84 million worth of electricity per annum will be generated in terms of value added in the electricity sector of Lesotho.

This amount is added exogenously to the value added of the electricity sector as defined in DSAS. This has the simultaneous effect of reducing imports of electricity from ESKOM.

4.2.2 Other External (Exogenous) Factors affecting economic growth in Lesotho As indicated in Chapter 3, Section 3.5, an important element of the new modelling

system is its exogenous variables. These economic variables are not determined “inside” the model, but have to be estimated independently of the model. The exogenous variables serve to initiate or “kick” the model into action, which then ultimately determines the values of the endogenous variables.

Table 4.3 summarises the historic growth rates and projected future growth rates which were used in forecasting exogenous economic variables, for purposes of inclusion in DSAS. These rates were calculated using the point-to-point growth rate method.

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TABLE 4.3 HISTORIC AND FUTURE AVERAGE ANNUAL GROWTH RATES FOR EXOGENOUS VARIABLES1

Description 1980 - 2000 2000 - 2007 2007 - 2020

Current transfers debit (current prices) 26.41% 16.77% 2.66% Employment in the public sector (numbers) 4.66% 5.97% 5.83% Gov exp on personnel emoluments (current prices) 15.53% 7.98% 7.47% Gov subsidies and transfers (current prices) 21.66% 4.30% 4.30% Investment income debit (current prices) 20.66% 1.61% -0.72% Labour income credit (current prices) 11.77% 0.71% 0.15% Labour income debit (current prices) 13.02% -0.26% -2.17% Labour Productivity (constant 95 prices) 0.02% 0.08% 0.08% Loti to US dollar (current prices) 12.29% -4.53% -4.86% Mineworkers avg earnings (current prices) 14.42% 5.17% 4.74% Mineworkers employment (average number) -3.06% -3.10% -3.44% Net Foreign Assets (current prices) 21.88% 4.41% 4.41% Other gov transfers: credit (current prices) NA 2.69% 2.01% Other non tax revenue (current prices) NA 4.66% 6.02% Parastatals investment (constant 95 prices) 9.26% 3.17% 2.28% Private Sector Credit (constant 95 prices) 6.72% -2.68% -4.48% Ratio: Import Price Index to CPI (constant 95 prices) -0.32% -0.64% -0.64% Real savings (constant 95 prices) 2.22% -1.15% -1.17% Reserve money (constant 95 prices) 15.45% 5.10% 4.70% SA real long term interest rate index 0.85% 0.46% 0.46% SA real prime lending rate 2.14% 0.91% 0.98% SA real treasury bill rate -1.64% -1.06% -1.09% Total Interest Payment of Gov (current prices) 22.84% 6.33% 6.14% Total of Private Investment (constant 95 prices) 11.45% 8.52% 7.44% Transfer balance on cap&fin acc (current prices) 10.52% 10.63% 9.03% World demand (constant 95 prices) 5.90% 3.55% 4.10% World price index (constant 95 prices) 2.17% 0.57% 0.56%

1: point to point growth rates What follows is a detailed discussion of three of the more important categories of

exogenous variables: mine workers earnings, the government-sector and the external sector.

4.2.2.1 Migrant Labour Income

Mineworkers earnings is a very important source of income for the Lesotho economy. This is reflected both in the balance of payments and the Gross National Product (GNP). The importance of mineworkers’ income to the Lesotho economy can be discerned from the fact that it constituted approximately 20 percent of GNP (in current prices) in 2000. In years preceding the development of LHWP, mineworker earnings were an even more important factor shaping the Lesotho economy, as discussed in Chapter 2 and shown graphically below.

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For the DSAS simulations, aggregate mineworker earnings in current prices are determined by two elements, namely the average number of workers and average remuneration per worker. For forecasting purposes it is necessary that separate views be taken on the development of these two variables.

• Mineworkers employed on RSA mines

Figure 4.4 reflects a considerable decrease in the number of mineworkers

employed on RSA mines in the recent past. The numbers declined from 126 264 in 1989 to about 65 000 in 2000. The reasons for this phenomenon are manifold. Since the early nineties, South African mines have rationalized on a large scale mainly because of cost pressures as opposed to a relatively static gold price. This also forced gold mines to become more capital intensive into mining a higher-grade ore.

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FIGURE 4.4 AVERAGE NUMBER OF MINEWORKERS IN RSA MINES

60,000

70,000

80,000

90,000

100,000

110,000

120,000

130,000

1975 1980 1985 1990 1995 2000

Year

Ave

rage

num

ber

It is foreseen that this trend will continue in future if international demand

conditions prevail. Against this background, the workers employed might be as low as 33 000 in 2020.

• Mineworkers average earnings

In current as well as in constant terms, mineworkers’ average earnings have increased significantly in the recent past. This is depicted in Figure 4.5. In 1990, average earnings were approximately 15 000 Maloti in constant (1995) terms. This figure increased to approximately 18 000 Maloti in 2000. This increase is partly due to the fact that Basotho have progressed to higher skilled jobs both in the technical and administrative fields - the increase in capital intensity in the production process, has stimulated the demand for higher skilled workers.

It is foreseen that this trend will continue in the long-term, given the expected pressures on the Rand gold price and the necessity of gold mines to remain profitable.

FIGURE 4.5

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MINEWORKERS AVERAGE EARNINGS (CURRENT & CONSTANT PRICES)

2,000

7,000

12,000

17,000

22,000

27,000

32,000

1980 1985 1990 1995 2000

Year

Mill

ion

Mal

oti

Current PricesConstant Prices

The net impact of the opposite movements of these two variables is that, in constant prices, the expected decline of the overall remuneration package would not be as severe as what one would normally expect. In fact, in constant prices a slight growth can be expected.

From Table 4.4 one can see how this phenomenon has played itself out

over the past 20 years and what can be expected over the medium to long-term.

TABLE 4.4

MINEWORKERS' EARNINGS

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Average annual growth Period

current prices constant prices

1980 -2000 14.42% 1.96% 2000 - 2007 5.17% 1.79%

4.2.2.2 Government Sector The main characteristics of the government’s activities are its revenue and

expenditure actions. For modelling purposes, government revenue is determined endogenously in the DSAS, whilst government expenditure (i.e. recurrent and capital expenditure) is regarded as an exogenous variable. In other words, its most probable future development has to be determined without the help of the model. To demonstrate the principles involved here, details are given in Table 4.5 of the government expenditures with and without Phase IB.

TABLE 4.5

GOVERNMENT SECTOR

With IB Without IB Average annual growth

Period Recurrent Capital Recurrent Capital Expenditure Expenditure Expenditure Expenditure

1994 -2000 5.31% -0.57% 4.58% -1.26% 1994 - 2007 3.93% 0.89% 3.60% 0.57%

The basic point of departure here is the assumption that, with Phase IB,

additional tax revenues will flow to the state because of the project’s activities. This fact will provide government with more leeway to increase spending. The opposite would, obviously, also hold true. For purpose of this exercise, the further assumption is made that, irrespective of what the influences are on government’s income and expenditure patterns, due to Phase IB it will be obliged to keep its deficit/surplus amount as a percentage of GDP unchanged.

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There are, of course, many other ways to attempt a forecast of government spending over the long-term. For, example, spending on social services can be linked to population, economic services can be linked to the GDP, etc. However, in the end, the magnitude of government spending will be determined by the availability of funds. The latter, in turn, is determined by the growth in the economy - which is determined endogenously in the model.

4.2.2.3 External Sector

Lesotho is part of the global economy. Being a small economy, it is naturally not able to have much influence on the world demand and prices for its products. Therefore, both these variables have to be determined exogenously. Projections were based on the view of a local financial institution, as well as the views of international bodies like the OECD and the IMF. Historic and projected growth rates of Lesotho’s external trade are influenced bythe behaviour of World Demand and World Prices. These rates are reflected in Table 4.6. Assumptions are given below.

TABLE 4.6 EXTERNAL TRADE

Average annual growth

Period World World Demand Price Index

1980 -2000 5.90% -2.17% 2000 - 2007 3.56% 0.57%

4.2.2.4 Summary

As stated previously, the annual data set generated from this portion of the study is added into the macroeconomic model via the sectoral system, and via certain macroeconomic variables. It should be noted that, for analytical purposes, all figures pertaining to LHWP expenditures were converted to calendar years.

The DSAS model is activated by the construction and operational impacts of Phase IB at the following levels:

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• The direct value added of construction activities

• The demand for the products of the various sectors of the economy of

Lesotho through direct investment in Project deliverables

• Induced private investment in Lesotho

• Exports from Lesotho, in terms of the royalties from water deliveries

• The value added of the water sector, based on royalties income

• The value added of the electricity sector

• Factor payments flowing out of the Lesotho economy that impact on the capital account of the Balance of Payments

• Incorporating the total labour effect: the direct labour effect during

construction and operational phase assigned to the construction and electricity sectors.

4.3 THE RESULTS OF MODELLING THE IMPACT OF PHASE IB ON THE

LESOTHO ECONOMY

4.3.1 Introduction

In this section the impact of Phase IB of the LHWP on the Lesotho economy will be quantified and discussed in detail. The results of this analysis are presented in two alternative scenarios:

• The growth of the economy with the inclusion of Phase IB ( Base Case scenario), and

• The growth of the economy without the inclusion of Phase IB

The impact of Phase IB is therefore determined as the difference between these two alternative growth scenarios.

The outcomes of these scenarios are reflected in Tables 4.7 to Tables 4.14. When interpreting figures reflected in these tables, it is important to note that the officially published historical figures will not necessarily coincide with the

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model’s simulated figures. It is standard practice to use model-derived figures of national accounts aggregates as proxies for actually realized figures when determining the impact of a project on an economy. This practise minimises the risk of compounding the effect of model-level mistakes.

As stated above, the impact of Phase IB is calculated as the difference between the “with Phase IB” scenario and the “without Phase IB” scenario. The impact measurements are presented in different ways. In some cases, impact measures are presented for a specific year – either as absolute value figures or as percentages. In other instances, impact measures are presented for the total period.

In order to gain a more realistic perspective of the long-term impact of Phase IB, average annual growth rates are used. In doing so, two different growth rates are determined:

• A point-to-point growth rate, and

• A growth rate based on the annuity principle

Capital expenditure on Phase IB, as well as it’s impact on the economy, is “bulge” shaped. Capital expenditure starts at practically zero, then gradually increases over time to a maximum, after which it gradually decreases to virtually nothing see Figure 4.1, Section 4.2.

It is difficult to calculate a realistic growth rate for this economic phenomenon due to the fact that expenditure (and its economic impact) returns to zero. Therefore, a simple point-to-point calculation will underestimate the real value that is gained from capital expenditure during the period between the point where it started and ended. By annualising growth over the duration of the period during which the capital expenditure took place, average annual growth rates provide a more realistic perspective of the real welfare gains. This growth rate, based on annuity principals, is statistically more sound since it takes into account all observations over the period under consideration.

4.3.2 Results

The impact of Phase IB on the Lesotho economy will be discussed within the

context of the following economic aggregates:

- Macroeconomic aggregates - Impact on key economic sectors - Government accounts

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- Balance of payments 4.3.2.1 Macroeconomic Aggregates The macroeconomic aggregates have been further sub-divided into the

following elements:

- Total economic activity - Gross domestic expenditures - The external sector - Inflation and employment

4.3.2.1.1 Total Economic Activity

The total economic impact of Phase IB is measured in terms of its impact on Gross Domestic Product (GDP) and Gross National Product (GNP). Table 4.7 on the following page reflects absolute values and percentages for these two measures for the “with Phase IB” and “without Phase IB” scenarios, and the difference between these two, which determines the actual impact.

Table 4.7 reflects data for a series of critical years (i.e. 1996, 1998, 2002, 2005, and 2007). Point-to-point and annuity growth rates have been calculated for the total period, 1994-2007.

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TABLE 4.7 PROJECTED IMPACT ON KEY MACROECONOMIC AGGREGATES TOTAL ECONOMIC ACTIVITY, 1994 – 2007 [ CONSTANT 1995 MILLION MALOTI ]

1994-2007 AGGREGATE 1996 1998 2002 2005 2007 Total Over

Period Annuity Growth Point-to-Point

Growth Gross Domestic Product

-With Phase 1B [BASE] 3,523 3,860 4,251 4,549 4,603 56,358 3.90% 3.08% -Without Phase 1B 3,500 3,659 3,871 4,369 4,491 53,654 3.19% 2.89% -Impact [With- Without] 23 201 380 179 112 2,705 0.71% 0.19% -Impact as % of Base 0.6% 5.2% 8.9% 3.9% 2.4% 4.8%

Gross National Product

-With Phase 1B [BASE] 4,851 4,893 5,067 5,498 5,574 70,747 2.12% 1.85% -Without Phase 1B 4,849 4,786 4,854 5,356 5,462 69,073 1.77% 1.69% -Impact [With- Without] 2 107 214 143 112 1,673 0.36% 0.16% -Impact as % of Base 0.0% 2.2% 4.2% 2.6% 2.0% 2.4%

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In the case of the “with Phase IB” scenario (i.e. the base case scenario), both indicators of total economic activity (i.e. GDP and GNP) grow at relatively high rates: GDP annuity growth of 3.9%, and GNP annuity growth of 2.12%.

It should be noted that GNP is expected to grow at a considerably lower rate than GDP. The main reason for this is the decline in remittances from Lesotho miners working in South Africa. Another possible explanation is that there will be a significant outflow of capital (e.g. interest on foreign debt and repayment of foreign loans). The decline in the net factor income and its effect on GDP and GNP can be seen in Figure 4.6

FIGURE 4.6 PROJECTED TOTAL ECONOMIC ACTIVITY [CONSTANT 1995 PRICES, MILLION MALOTI]

-

1,000

2,000

3,000

4,000

5,000

6,000

1994 1996 1998 2000 2003 2005 2007Years

Con

stan

t 199

5 Pr

ices

, Mill

ions

Mal

oti

Gross National Income Net Factor Income Gross Domestic Product

Figure 4.7 on the following page illustrates the absolute GDP effects for the period under review for the “with Phase IB” and

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“without Phase IB” scenarios, whilst figure 4.8 illustrates the effects on GNP.

FIGURE 4.7 PROJECTED IMPACT ON GDP [CONSTANT 1995 PRICES, MILLION MALOTI]

3000

3200

3400

3600

3800

4000

4200

4400

4600

4800

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007Years

Con

stan

t 199

5 Pr

ices

, Mill

ions

Mal

oti

With Phase IB Without Phase IB

77

FIGURE 4.8 PROJECTED IMPACT ON GNP [CONSTANT 1995 PRICES, MILLION MALOTI]

4000

4200

4400

4600

4800

5000

5200

5400

5600

5800

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007Years

Con

stan

t 199

5 Pr

ices

, Mill

ions

Mal

oti

With Phase IB Without Phase IB

In the case of the “without Phase IB” scenario, GDP grew at a slower rate (i.e. by

0.71 percentage points per annum using annuity principle, and by 0.19% using point-to-point growth rates). Figure 4.7 clearly illustrates the extent to which the investment activities pertaining to Phase IB have impacted on GDP between the years 1998 and 2004. To some extent, the same tendency was experienced with GNP. However, the discrepancy over the total period is much less, and amounts to 0.16% per annum.

From Table 4.7 it is also interesting to note the impact that Phase IB has on specific years. The greatest impact occurs in 2002, where the percentage impact is as high as 8.9% for GDP and 4.2% for GNP. As reflected in Table 4.8 on the following page, the impact of Phase IB has elevated GDP per capita by approximately 4.79% over the period 1994 – 2007. However, due to the leakage effects described above, per capita GNP only increased by approximately 3.70% over the same period.

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TABLE 4.8 PROJECTED IMPACT ON PER CAPITA AND PER HOUSEHOLD GDP AND GNP AVERAGE: 1994-2007, 2003 PRICES [MILLION MALOTI]

GDP GNP

2003 prices - Million Maloti 2003 prices – Million Maloti

BASE Impact of IB1 Impact of IB1 BASE Impact of IB1 Impact of IB1

UNIT As percentage as percentage

WITH IB Without IB (With - Without) of base WITH IB Without IB (With - Without) of base

Per Capita 3,593 3,421 172 4.79% 4,646 4,474 172 3.70%

Per Household 17,967 17,106 860 4.79% 23,230 22,370 860 3.70%

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4.3.2.1.2 Gross Domestic Expenditure

The impact of Phase IB on Gross Domestic Expenditure (GDE) is measured in terms of: i) Final consumption expenditure by households and general

government; and ii) Gross fixed capital formation by private businesses, government

and parastatals.

Consumption Expenditure by Households

The impact on final consumption expenditure by households is relatively small 0.22%, and the annual growth rate over the period is only - see Table 4.9. The explanation for this is that there is only a small trickle-down effect on households due to the LHWPs high capital-intensive nature. Households are mainly impacted by the consumption expenditure that flows from the remuneration of the Basotho workers working on construction sites. Furthermore, a significant proportion of salaries paid is made to highly skilled workers, most of which flows out of the country as highly skilled workers are mostly foreigners.

To a certain extent, household expenditure is also affected by the additional expenditure by government, due to additional government revenue that is attributable from Phase IB.

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TABLE 4.9: PROJECTED IMPACT ON KEY GROSS DOMESTIC PRODUCT AGGREGATES PROJECTIONS, 1994 – 2007 [ CONSTANT 1995 PRICES, MILLION MALOTI ]

Annuity Growth Rates Point-to-Point

AGGREGATE 1996 1998 2002 2005 2007 TOTAL 1994-2007 1994-2007

OVER Annual Annual PERIOD Growth Rate Growth Rate

Final Consumption Expenditure - Households -With Phase IB [BASE] 4,054 4,750 4,317 4,735 4,826 61,461 1.99% 1.75% -Without Phase IB 4,041 4,713 4,221 4,634 4,758 60,584 1.77% 1.64% -Impact [With- Without] 13 37 95 100 68 877 0.22% 0.11% -Impact as % 0.3% 0.8% 2.2% 2.1% 1.4% 1.4% - General government -With Phase IB [BASE] 599 749 770 836 880 10,279 4.77% 3.93% -Without Phase IB 599 731 724 814 859 9,978 4.34% 3.74% -Impact [With – Without] 0 18 46 22 21 301 0.43% 0.19% -Impact as % of base 0.0% 2.3% 6.0% 2.7% 2.4% 2.9% Gross Fixed Capital Formation - Private -With Phase IB [BASE] 186 204 219 231 225 2,976 5.12% 3.15% -Without Phase IB 184 191 193 216 218 2,777 4.13% 2.89% -Impact [With – Without] 2 13 26 16 7 199 0.99% 0.26% -Impact as % of base 1.0% 6.2% 11.9% 6.7% 3.3% 6.7% - Government -With Phase IB [BASE] 1,011 897 958 1,021 1,066 13,578 1.35% 0.89% -Without Phase IB 1,011 875 901 994 1,040 12,217 0.97% 0.70% -Impact [With – Without] 0 21 57 27 25 361 0.38% 0.19% -Impact as % of base 0.0% 2.3% 6.0% 2.7% 2.4% 2.7% - Other (Parastatals) -With Phase IB [BASE] 780 512 650 712 747 9,694 -1.87% -0.34% -Without Phase IB 780 512 650 712 747 9,694 -1.87% -0.34% -Impact [With – Without] 0 0 0 0 0 0 0.00% 0.00% -Impact as % of base 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Government Expenditure

Table 4.9 indicates that Phase IB has already made a significant impact on government expenditure. It seems that the additional revenue from the introduction of Phase IB has provided Government with leeway to make additional expenditure of 0.43 percentage points per annum over the period on government’s current expenditures. The net effect of this is that government could raise its level of current expenditure by 2.9% over the period.

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From Table 4.9, it is evident that the impact of Phase IB on gross fixed capital formation is higher than that on recurrent expenditure by the government. This is due to the fact that the treaty prescribes that the royalty income should be invested in projects for development purposes. This aspect has been taken into account when the assumptions have been made as far as the “without Phase IB” scenario is concerned.

Gross Fixed Capital Formation (excluding government)

• Private Sector

The impact on private sector investment is significantly positive. In 2002, approximately 11.9% of private sector investment can be attributed to Phase IB. This investment includes direct involvement with the project in terms of sub-contracts as well as other indirect investment that was required in the private sector to accommodate the general rise in economic activity caused by the construction of Phase IB.

• Parastatals (excluding LHWP)

The gross fixed capital formation of parastatals is treated as exogenous to the system. For purposes of this analysis, it was assumed that parastatals would not be significantly impacted by Phase IB and, therefore, would not have to make any new gross fixed capital formation.

However, in the case of current activity, parastatals are included as part of the sectoral system, e.g. the Lesotho Post Office is part of the communication sector. As such, parastatals’ current activity is included in the model as an endogenous variable.

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4.3.2.1.3 The External Sector

Table 4.10 indicates the impact that Phase IB has on exports and imports.

TABLE 4.10 PROJECTED IMPACT ON KEY EXTERNAL SECTOR AGGREGATES PROJECTIONS, 1994-2007 [CONSTANT 1995 PRICES, MILLION MALOTI]

Annuity Growth Rates Point-to-Point

AGGREGATE 1996 1998 2002 2005 2007 TOTAL 1994-2007 1994-2007

OVER Annual Annual PERIOD Growth Rate Growth Rate

Exports - Goods and Services1

-With Phase IB [Base] 1048 852 1461 1687 1633 17344 6.89% 5.90% -Without Phase IB 1048 852 1461 1669 1605 17262 6.83% 5.76% -Impact [With – Without] 0 0 0 18 28 82 0.07% 0.14% -Impact as % of base 0.0% 0.0% 0.0% 1.1% 1.7% 0.5% Imports - Goods and Services -With Phase IB [Base] 3860 4039 4136 4358 4426 56511 1.78% 1.62% -Without Phase IB 3839 3777 3731 4234 4349 53696 1.02% 1.49% -Impact[With – Without] 21 262 405 124 77 2815 0.76% 0.13% -Impact as % of base 0.5% 6.5% 9.8% 2.9% 1.7% 5.0%

Exports

The impact of Phase IB on exports of goods and services is limited to the income of water sales to the RSA, which is by definition royalties received. Other exports are mostly determined by exogenous variables, i.e. world demand and world inflation, which are not impacted by Phase IB.

Interestingly, exports have not been impacted to the extent that one would have expected. The main reason for this is that Phase IB water exports will only start to have a significant impact from 2005 onwards. Furthermore, concerns have been expressed by the consultants regarding the way in which the value of water exports have been determined, i.e. the royalty approach. This issue is discussed in detail in Chapter 6 of this report.

Imports

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The impact of Phase IB on imports is significant. In 2002, the impact on imports (i.e. the difference between the “with Phase IB” and “without Phase IB” scenarios) is as much as 9.8%, imports increase by 5.0 % as a result of Phase IB on average over the total period. Lesotho is a very “open” economy and depends heavily specifically on the RSA for manufactured goods. This includes both capital and consumption goods.

4.3.2.1.4 Inflation and Employment

Inflation

Although prices are determined internally in DSAS (i.e. endogenously), the impact of Phase IB on the inflation of Lesotho is very small (or even zero). Lesotho is a very open economy and is influenced to a large extent by price changes in the South African economy. On a micro level, there is possibly some pressure on wages and on the prices of certain products that are produced in Lesotho. However, this effect is so small that it does not effect the DSAS model.

Employment

It is expected that Phase IB will create new employment equivalent to 29,030 person-years over the period 1994 to 2007. Included in this figure is 14,500 person-years derived from direct job opportunities created by Phase IB – this figure has been obtained from the latest micro-economic impact analysis conducted by LHDA.

The balance of the 14,530 person years comprises of indirect and induced job opportunities. Indirect job opportunities refer to employment opportunities created mainly in those sectors that link backwards from the construction activities of Phase IB due to the supply of intermediate inputs (e.g. locally manufactured bricks, metal products, etc). Induced employment opportunities refer to the employment opportunities created as a result of salaries and profits that are ploughed into the economy in the form of private consumer spending.

In combination, the job opportunities that stem from the introduction of LHWP, plus the jobs created in the textile sector as a result of the AGOA treaty in the recent past have contributed significantly to the alleviation of poverty in Lesotho.

4.3.2.2 Impact on Economic Sectors

Figure 4.9 and Table 4.11 reflect the impact of Phase IB (i.e. the difference between the “with Phase IB” and the “without Phase IB”

86

scenarios) on the primary, secondary and tertiary sectors of the Lesotho economy.

FIGURE 4.9 PROJECTED IMPACT ON KEY ECONOMIC SECTORS [GDP PROJECTIONS, IMPACT PERCENTAGES]

- Community social & personal services

13%

- Financial & business services

4%

- Transport and communication

2%

- Trade & accommodation

8%

- Agriculture2%

- Mining and quarrying0%

- Manufacturing4%

- Electricity and water6%

- Construction61%

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TABLE 4.11 PROJECTED IMPACT ON GDP FOR KEY ECONOMIC SECTORS, 1994 - 2007 [ CONSTANT 1995 PRODUCERS' PRICES ]

1994-2007 ECONOMIC SECTOR Total Over Period Annuity Growth Point-to-Point Growth

Primary sector - Agriculture -With Phase 1B [BASE] 9,056 2.05% 1.89% -Without Phase 1B 9,016 1.98% 1.80% -Impact as % of Base 0.4% 0.07% 0.09% - Mining and quarrying -With Phase 1B [BASE] 40 1.42% 1.09% -Without Phase 1B 40 1.45% 1.07% -Impact as % of Base 0.0% -0.03% 0.02% Secondary sector - Manufacturing -With Phase 1B [BASE] 7,941 10.09% 7.69% -Without Phase 1B 7,854 9.92% 7.57% -Impact as % of Base 1.1% 0.17% 0.13% - Electricity and water -With Phase 1B [BASE] 3,313 6.45% 5.35% -Without Phase 1B 3,149 5.73% 4.19% -Impact as % of Base 4.9% 0.72% 1.16% - Construction -With Phase 1B [BASE] 8,766 2.77% 0.44% -Without Phase 1B 7,157 -0.23% 0.37% -Impact as % of Base 18.4% 3.00% 0.07% Tertiary sector - Trade & accommodation -With Phase 1B [BASE] 4,848 2.11% 2.37% -Without Phase 1B 4,644 1.47% 2.16% -Impact as % of Base 4.2% 0.64% 0.21% - Transport and communication -With Phase 1B [BASE] 1,970 3.09% 2.95% -Without Phase 1B 1,909 2.63% 2.79% -Impact as % of Base 3.1% 0.47% 0.16% - Financial & business services -With Phase 1B [BASE] 5,898 3.70% 3.06% -Without Phase 1B 5,799 3.45% 2.95% -Impact as % of Base 1.7% 0.25% 0.10% - Community social & personal services -With Phase 1B [BASE] 8,425 4.31% 3.95% -Without Phase 1B 8,081 3.71% 3.76% -Impact as % of Base 4.1% 0.60% 0.18% Total GDP (Producers' Prices) -With Phase 1B [BASE] 50,257 4.15% 3.25% -Without Phase 1B 47,639 3.38% 2.84% -Impact as % of Base 5.2% 0.77% 0.42% Net Taxes on Products -With Phase 1B [BASE] 6,100 1.98% 1.75% -Without Phase 1B 6,015 1.77% 1.64% -Impact as % of Base 1.4% 0.21% 0.11% Total GDP (Market Prices) -With Phase 1B [BASE] 56,356 3.90% 3.08% -Without Phase 1B 53,654 3.19% 2.89% -Impact as % of Base 4.8% 0.71% 0.19%

4.3.2.2.4 Sectoral Results

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- Primary Sector

The primary sector has not been significantly affected by Phase IB. As shown in Table 4.11, the “with Phase IB” scenario indicates that both the agriculture and mining and quarrying sectors display moderate growth rates i.e. more or less in line with their long-term growth potential. The reason for this is not so much that the demand for agricultural products has not increased, but because this sector can’t really respond to increased demand because it consists mostly of subsistence farming that is not commercially driven. Consequently, most of the additional food required as a result of the impact of Phase IB had to be imported.

- Manufacturing Industry

Manufacturing grew at a significant rate, mainly due to the fast growing textile industry, which is driven by the AGOA treaty. The largest contributions to growth come from Textiles and Clothing, Furniture and Printing and Chemical Products respectively (see Table 4.12). The latter two industry sub-sectors only make up 1.3% of manufacturing output. Lesotho’s manufacturing industry is still dominated by the Food and Beverages sub-sector. The manufacturing sector shows no clear relationship with Phase IB activities in view of the small estimated impact of Phase IB (see Table 4.12). Lesotho’s manufacturing sector is still in an early phase of development and products that are used in significant volumes in the construction of Phase IB (i.e. cement, steel, fuel, etc.) had to be imported. As has already been explained, the reason for the manufacturing industry’s good performance over the period analysed can be attributed to the textile industry, which has no meaningful link with the demand for goods and services created by Phase IB.

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TABLE 4.12 MANUFACTURING GROWTH (1996-2000)

1996 = 100

Industry 1996 1997 1998 1999 2000 Weights Growth Rates 1996 - 2000

Food & Beverages 100 106.6 103.4 105.7 107.6 46.4 7.6% Textiles & Clothing 100 102.8 85.7 96.7 119.8 19.2 20.0% Leather & Footwear 100 120.0 91.3 76.9 100.1 15.0 - Furniture & Printing 100 105.1 179.3 169.3 136.1 0.5 36.1% Chemical production 100 103.5 101.2 100.8 140.0 0.8 40.0% Non-metal overall products 100 98.5 89.1 79.0 95.7 1.1 -4.3% Leather industries 100 151.0 107.7 129.0 109.3 16.9 9.3% Total Manufacturing 100 112.4 97.6 102.1 110.6 100 10.6%

Source: Bureau of Statistics.

- Electricity, Gas and Water

Electricity and water grew at an extremely high rate, albeit off a low starting base. This is to be expected, given that both Phases 1A and IB came into operation during this period. As a result, both additional water delivery and electricity capacity came into effect over this period. As shown in Table 4.11, Phase IB’s contribution to the electricity, gas and water sector’s GDP-growth rate over the period amounts to 0.72% per annum on an annuity growth, and 1.16% on a point-to-point basis. The reason for the low annuity growth rate is that the delivery of water to South Africa will only start flowing towards the end of the period, and Phase IB only adds a relatively small amount to hydro-electricity generating capacity during the period. It is important to note that the impact on electricity, gas and water will be substantially higher if the method of valuing water sales is changed to the approach explained in Section 6.

- Construction

Construction experienced a high level of activity over the period. However, it should be noted that the construction of Phase 1A was already at an advanced stage by 1994 (the start of this analysis period) which meant that Phase IB did not contribute significantly to growth rate as such. The point-to-point growth rate of 0.44% illustrates this point (see Table 4.12).

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It is important to note that, had it not been for the construction of Phase IB, the construction sector would have in fact declined (see the annualised growth rate of –0.23% in Table 4.11). The reason for this decline is to be found in the fact that due Phase 1A, construction activities was at a very high level. Without Phase IB expenditure, it is to be expected that construction activities will decline. Even with Phase 1B expenditure an initial decline would have been expected, since phase 1B is a substantially smaller project than Phase 1A.

- Tertiary Sector

The tertiary sector comprises approximately 40% of Lesotho’s GDP, of which the community, social and personal services sub-sectors contribute 42% to the tertiary sector. All of the tertiary sectors grew at more or less their historical rates throughout the period. The Trade and Accommodation industry received a substantial boost from the construction activities associated with Phase IB. This is mostly based on a significantly higher level of indirect wholesale and retail trade stemming from demand for materials and consumer products stimulated by the project.

4.3.2.3 Government Accounts

In Table 4.13, totals for important government income and expenditure aggregates for the period 1994-2007 are reported for the “with Phase IB” and “without Phase IB” scenarios. As in previous sections, impacts are obtained by subtracting the outcomes of the “without Phase IB” scenario from the “with Phase IB” scenario.

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TABLE 4.13 PROJECTED IMPACT ON GOVERNMENT ACCOUNT COMPONENTS, 1994 - 2007 [ CURRENT PRICES ]

1994- 2007

GOVERNMENT ACCOUNT COMPONENT

1996 1998 2002 2005 2007 TOTAL OVER PERIOD

TOTAL REVENUE AND GRANTS -With Phase 1B [BASE] 1,835 2,276 3,355 4,073 4,562 40,833 -Without Phase 1B 1,835 2,188 3,134 3,953 4,448 39,239 -Impact [With- Without] - 88 221 120 114 1,594 -Impact as % of Base 0.0% 3.9% 6.6% 2.9% 2.5% 3.9% Tax revenue * Customs -With Phase 1B [BASE] 850 1,069 1,546 1,875 2,095 18,911 -Without Phase 1B 848 1,003 1,393 1,824 2,063 17,932 -Impact [With- Without] 2 66 153 51 33 978 -Impact as % of Base 0.2% 6.2% 9.9% 2.7% 1.6% 5.2% * Non Customs -With Phase 1B [BASE] 467 614 883 1,129 1,272 11,041 -Without Phase 1B 467 611 854 1,106 1,255 10,847 -Impact [With- Without] - 3 29 23 16 195 -Impact as % of Base 0.0% 0.5% 3.3% 2.0% 1.3% 1.8% Non Tax Revenue 1 -With Phase 1B [BASE] 428 489 754 890 996 8,890 -Without Phase 1B 428 489 753 853 934 8,713 -Impact [With- Without] - 0 1 37 62 177 -Impact as % of Base 0.0% 0.1% 0.1% 4.1% 6.2% 2.0% Grants -With Phase 1B [BASE] 96 104 172 179 199 1,991 -Without Phase 1B 92 85 134 170 196 1,747 -Impact [With- Without] 4 19 38 9 3 244 -Impact as % of Base 3.9% 18.1% 22.2% 5.2% 1.5% 12.3% TOTAL EXPENDITURE -With Phase 1B [BASE] 1,669 2,041 3,000 3,713 4,278 37,404 -Without Phase 1B 1,669 1,975 2,810 3,605 4,170 36,001 -Impact [With- Without] - 66 191 107 108 1,402 -Impact as % of Base 0.0% 3.2% 6.4% 2.9% 2.5% 3.7%

SURPLUS [Million Maloti] 164 235 355 360 284 3,429

SURPLUS [ % of GDP ] 4.59% 4.98% 4.83% 3.98% 2.82% 3.87%

4.3.2.3.1 Income

The inclusion of Phase IB in Lesotho’s economy has a relatively large impact on the income side of the government accounts. Two items in particular, viz. customs and income tax, show significant increases.

Additional revenue of M1,594 million has been collected by government as a result of Phase IB over the period from 1994 to 2007. This additional revenue is derived from:

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Source Additional Revenue Percentage Tax Revenue: Customs 978 61.4 Tax Revenue: Non-Customs 195 12.2 Non-Tax Revenue (incl. Royalties)

171 11.1

Grants 244 15.3 TOTAL 1 760 100

It is important to note that the main source of additional revenue is from Customs. This income stems from SACU receipts, which are based on the significant increase in imports associated with construction of Phase IB. Royalties is an ongoing item, which is projected to be worth M61 million in 2007, expressed in current terms. The positive impact of Phase IB, on government’s income led the deficit before lending to decrease by M192 million in total over the period in question.

4.3.2.3.2 Expenditure

As far as government expenditure is concerned, it was accepted that this had to be adjusted downwards in the “without Phase IB” scenario in order to keep the deficit on the current account expressed as a percentage of GDP at the same level on a yearly basis as in the “with Phase IB” scenario. The impact of this is that government expenditure in total is M1,402 million less in the “without Phase IB” scenario than in the “with Phase IB” scenario.

4.3.2.3.3 Surplus on the Government Account

As a result of keeping the deficit on the current account, expressed as a percentage of GDP, at the same level in both the “with Phase IB” and “without Phase IB” scenarios, the absolute surplus on the government account is negligible. This is because the expenditure has been reduced by the more or less the same amount as revenue decreased in the “without Phase IB” scenario.

4.3.2.4 Balance of Payments

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The impact of Phase IB on the Balance of Payments is reflected in Figure 4.10 and Table 4.14 below. FIGURE 4.10 CURRENT ACCOUNT COMPONENTS WITH PHASE IB [CURRENT PRICES]

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

1996 1998 2002 2005 2007Years

Mill

ions

Mal

oti

-25.0%

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

Perc

enta

ges

Exports: goods and services Imports: goods and services Current account as % of GNP

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TABLE 4.14 PROJECTED IMPACT ON BALANCE OF PAYMENTS COMPONENTS, 1994-2007 [ CURRENT PRICES ]

1994- 2007 BALANCE OF PAYMENTS COMPONENTS 1996 1998 2002 2005 2007 TOTAL OVER

PERIOD

I. CURRENT ACCOUNT -With Phase 1B [BASE] -678 -1,629 -1,755 -1,718 -2,100 -20,214 -Without Phase 1B -636 -1,261 -918 -1,487 -2,029 -15,135 -Impact [With- Without] -42 -368 -837 -231 -72 -5,079 -Impact as % of Base 6.3% 22.6% 47.7% 13.4% 3.4% 25.1% a) GOODS & SERVICES - Exports: goods and services 1 -With Phase 1B [BASE] 1,072 1,047 2,526 3,401 3,648 28,625 -Without Phase 1B 1,072 1,047 2,526 3,328 3,525 28,284 -Impact [With- Without] 0 0 0 73 123 341 -Impact as % of Base 0.0% 0.0% 0.0% 2.1% 3.4% 1.2% - Imports: goods and services -With Phase 1B [BASE] -3,948 -4,965 -7,151 -8,692 -9,718 -87,617 -Without Phase 1B -3,926 -4,643 -6,450 -8,444 -9,549 -83,016 -Impact [With- Without] -22 -322 -700 -248 -170 -4,602 -Impact as % of Base 0.5% 6.5% 9.8% 2.9% 1.7% 5.3% b) INCOME & TRANSFERS -With Phase 1B [BASE] 2,198 2,288 2,869 3,610 4,032 38,949 -Without Phase 1B 2,219 2,334 3,006 3,629 3,995 39,597 -Impact [With- Without] -21 -46 -137 -19 37 -648 -Impact as % of Base -0.9% -2.0% -4.8% -0.5% 0.9% -1.7%

II. CAPITAL AND FINANCIAL ACCOUNT -With Phase 1B [BASE] 1,700 1,596 865 903 758 15,664 -Without Phase 1B 1,606 1,122 279 528 758 10,355 -Impact [With- Without] 94 474 585 376 0 5,309 -Impact as % of Base 5.5% 29.7% 67.7% 41.6% 0.0% 33.9% III. OVERALL BALANCE OF PAYMENTS -With Phase 1B [BASE] 1,008 70 -818 -743 -1270 -3443 -Without Phase 1B 956 -35 -566 -887 -1199 -3672 -Impact [With- Without] 51 106 -252 145 -72 229 -Impact as % of Base 5.1% 150.4% 30.7% -19.5% 5.6% -6.7%

Current account as % of GNP -With Phase 1B [BASE] -13.7% -27.1% -20.0% -15.7% -17.2% -18.4% -Without Phase 1B -12.8% -21.4% -10.9% -13.9% -16.9% -14.1% -Impact [With- Without] -0.9% -5.6% -9.1% -1.7% -0.2% -4.2% Capital and Financial as % of GNP -With Phase 1B [BASE] 34.3% 26.5% 9.9% 8.2% 6.2% 14.2% -Without Phase 1B 32.4% 19.1% 3.3% 4.9% 6.3% 9.7% -Impact [With- Without] 1.9% 7.5% 6.5% 3.3% -0.1% 4.6% Balance of Payments account as % of GNP -With Phase 1B [BASE] 20.3% 1.2% -9.3% -6.8% -10.4% -3.1% -Without Phase 1B 19.3% -0.6% -6.7% -8.3% -10.0% -3.4% -Impact [With- Without] 1.0% 1.8% -2.6% 1.5% -0.4% 0.3%

Errors and Omissions included

4.3.2.4.1 Current Account

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Interestingly, the deficit on the current account of the balance of payments

as a percentage of GDP increases (worsens) as a result of Phase IB activities. This is brought about by a relatively small increase in exports as a result of the inclusion of Phase IB water sales (note should be taken of the fact that water sales are only included for 3 years). Imports, on the other hand, increase significantly due to the high import content of capital expenditures and the outflow of capital and labour remuneration. However, the negative impact on the trade account of the balance of payments in the “with Phase IB” scenario is not offset by increases in components in the income account – i.e. SACU-non-duty receipts, royalties, etc.

4.3.2.4.2 Capital and Financial Account

With regard to the capital and financial account, the construction of Phase IB has had a huge positive impact as a result of capital inflows from the RSA to fund Phase IB. To a large extent, this is a “book entry” to reconcile the investment that has taken place in Lesotho. The financial burden of this investment is taken care of by the TCTA, which is situated outside of Lesotho in the RSA.

4.3.2.4.3 Overall Balance of Payments

The net impact on the overall balance of payments is an improvement as a result of the construction of Phase IB.

4.4 Comparison of Results with Earlier Studies

This section compares the actual impact of Phase IB of the Lesotho Highlands

Water Project, as measured by the current research project, with projections made in a previous study by Ralph M. Doggett5).

It is extremely difficult to make scientific comparisons between these two studies,

due to the fact that there are a wide range of possible reasons why impacts could differ.

Firstly, the levels of economic aggregates (baseline) against which the impacts are

measured are different. Specifically, this has to do with the estimated values of the exogenous variables that Doggett used in his model as compared to what was actually realized. In addition, the Doggett model used a postulated economic structure for the Lesotho economy, whilst the current study had the advantage of using actual data representing the current structure of the Lesotho economy (including a 2000 SAM).

5) Ralph M. Doggett “A Macroeconomic Analysis of the Lesotho Highlands Water Project:. LHDA. May

1996.

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Secondly, the magnitude of the investment expenditure itself, as well as the time

scheduling of the total expenditure and its constituent parts, will not be the same. Thus, the planned and actual expenditures associated with Phase IB of the LHWP are not the same – either in total, or on an annual basis (this is well illustrated in Figure 4.11).

FIGURE 4.11 THE PROJECT PHASE IB, INVESTMENT EXPENDITURES DOGGETT MODEL VS. DSAS MODEL

[1994 - 2004] 6) PERCENTAGES

0%

5%

10%

15%

20%

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004YEARS

PER

CE

NT

AG

ES

%

Dogget model Current model [DSAS]

1998

2002

A

B

The third reason has much to do with the underlying structures of the economic

models themselves, each of which endeavoured to simulate the structure of the economy as accurately as possible. Since the Doggett and DSAS models differ fundamentally, it is highly unlikely that similar impact results will be obtained. It is, therefore, difficult, if not impossible, to make a meaningful comparison between the results generated by these two models. Nevertheless, comparisons have been made of two criteria: percentage differences and, the multipliers used in each model, which is a standardized way of measuring the impact on the various macroeconomic variables.

6) Each point on the graph represent the percentage of the total cost of the project spent in that particular

year. Represents the construction phase only.

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4.4.1 Comparing the Time Paths of Projected and Actual Investment Expenditures As indicated previously, it is reasonable to assume that the forecasted/planned

capital expenditure figures over time will differ from actual expenditure figures. This almost always happens with large capital intensive projects such as the LHWP.

From Figure 4.11, one can see quite clearly that what Doggett had foreseen as far

as the timeline of Phase IB expenditures is concerned, differs quite markedly from what has, in reality, transpired. Two things are clear:

• The actual expenditure pattern of Phase IB, although it resembles the planned

version, shifted forward by ± 2 years, and • Capital expenditure actually reached its peak two years later than what

Doggett had projected (See A and B, Figure 4.11).

Because of these fundamental differences in the two data levels over time, it is suggested that not too much should be read into the comparative figures given in Table 4.15. In order to facilitate a reasonably meaningful evaluation, totals are given the respective peak periods of Phase IB for the respective studies. In the case of the Doggett study the peak period was between 1998 and 2002 and in the case of DSAS 1998 to 2004. In addition, totals given for the peak periods of the construction phase in Table 4.15. In the case of the Doggett study the peak period was between 1998 and 2002 and in the case of DSAS, 1998 to 2004.

4.4.2 Evaluation of the Results It must be kept in mind that these impacts only reflect the construction phase of

Phase IB, as Doggett only dealt with this part of the project. The results of this analysis are provided in Table 4.15.

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TABLE 4.15 SUMMARY: COMPARISON BETWEEN DOGGETT MODEL AND DSAS MULTIPLIERS, CONSTRUCTION PHASE

Total over construction phase

Deviation over entire period Multipliers Economic aggregates/ Percentage Sectoral analysis deviation Value

from base Macro level Gross Domestic Product Doggett model (planned) 5.46% 1051 0.59 DSAS (actual) 7.56% 1456 0.67 Difference 2.11% 406 0.08 Household consumption expenditure Doggett model 3.08% 630 0.19 DSAS 3.78% 772 0.35 Difference 0.69% 142 0.16 Imports Doggett model 10.64% 2034 0.86 DSAS 8.66% 1656 0.76 Difference -1.98% -378 -0.10

Sectoral level Building and construction Doggett model 34.29% 2431 0.39 DSAS 38.12% 2702 1.24 Difference 3.83% 271 0.85 Other Sectors/ Rest of Economy Doggett model 1.67% 418 0.13 DSAS 2.10% 524 0.24 Difference 0.43% 106 0.11

Note: Peak period of construction phase: Doggett: 1998-2002 (planned figures used) DSAS: 1998-2004 (actual figures) All figures were expressed in 1995 constant prices

In view of the above reservations, the figures in Table 4.15 should be treated with

some caution. 4.4.2.1 Construction phase

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When viewing the period as a whole, the following aspects stand out (See Table 4.15).

• Taking the construction period as a whole, the actual impact of Phase

IB on GDP was higher than the planned impact. • Planned household consumption expenditure was only slightly lower

than the actual household expenditure. • The Doggett model foresaw a slightly larger impact on imports than

what actually happened. This should again be attributed to the fact that Doggett foresaw that capital expenditures would reach a peak in 2000, whilst, in actual terms, investment in Phase IB since 1999 moved on a more even plane, and only reached its peak in 2003.The relatively slow growth in consumer spending also made a contribution.

4.4.2.2 Sectoral Impact In actual terms, the impact on the construction industry was higher than

foreseen by Doggett. Again, this can be attributed to the fact that, in reality, investment showed much less volatility than was predicted. In the case of other economic sectors, the actual impact and predicted impact of Phase IB were moderately higher over the construction phase.

4.4.2.3 Multipliers To interpret the possible variances in the multipliers produced by each

model the following method was followed. In the case of the Doggett model, the total investment costs of Phase IB, as foreseen by him in 1996, were divided by the total change in the value of major economic aggregates attributed to this investment action over that particular time period. In the present study and model, the same method was followed, with the exception that the impact on the various economic aggregates (i.e. GDP, imports, sectoral outputs, etc) were divided by the total actual construction costs of phase IB.

In calculating multipliers, one should eliminate differences in the level of

exogenous economic variables over time. Differences in multipliers produced by the two models should then be attributed to structural changes in the economy.

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The overall impression of the results in Table 4.15 is that, due to structural changes in the Lesotho economy, the actual impact of Phase IB investments was indeed larger than what Doggett had foreseen in 1996 (except in the case of the impact on GDP). Specifically, building and construction received a much larger “kick” from phase IB than was originally foreseen. From a developmental perspective, this is positive as it signifies that, for various reasons highlighted upon in other sections of this report, the LHDA has succeeded in enlarging the economic impact on Lesotho citizens through a broad range of policy initiatives (see next section).

4.5 Microeconomic Studies of Phase IB Impacts on Lesotho’s Economy: Planning Implications The project has produced a wealth of information pertaining to the actual impact

of Phase IB expenditures on the Lesotho economy on a macro level, as compared to initial expectations. This can be found mainly in two sources, viz. comparisons of the actual quantified economic impacts of Phase IB as calculated by the newly prepared DSAS model, and comparisons with the forecasts of the 1996 study by Ralph Doggett. However, a lot of information was also gathered on a micro-level, mainly based on previous, although somewhat outdated studies. The LHDA, as part of its injunction, has commissioned ongoing research directed at developments at a micro-level with the aim of devising measures to improve the Lesotho economy’s capability to utilize opportunities associated with Phase IB of the Project (and possible future phases).

In this section, an attempt is made to summarise the main features of the

comparative studies conducted and reported on in detail in the Methodology Supplement, and then to attempt to identify possible foregone opportunities and constraints to the maximization of the Phase IB budget. In conclusion, an attempt is made to provide broad guidelines for estimating and optimising the economic impact of Phase II of the Project.

4.5.1 Microeconomic Impact Assessment

4.5.1.1 Research Outcomes

101

Due to the nature of the projects, their impacts on the economy can be

divided between transitional benefits and permanent benefits. Both can be measured on macro- and micro levels. Probably the most important recommendations that flowed from the TRC study were directives to the appropriate authorities to enhance conditions “on the ground” that would make Lesotho more “receptive” to the potential benefits that the project will bring. Studies by the World Bank and other consultants in this regard also support this perspective.

Transitional Benefits (Phase IB)

The LHDA has, based on the TRC and its own research, made a specific effort to increase the Lesotho citizens’ share of direct work opportunities. For example, nearly 85 percent of people directly employed were Basotho, and 36 percent from the Project Development Area. This is a substantial improvement on Phase IA.

LHDA sponsored training programmes, that were far more attuned to project’s needs. As a result, they were successful in enhancing employability of local citizens (up to 35 percent of total project labour requirements).

On an indirect level, the principal contractor was obliged to increase the share of direct building contracts and consultancy services going to Lesotho companies.

All in all, from a pool-of-skills and relevant experience perspective, Lesotho is in a much better position now to reap the benefits of any large capital construction project such as Phase IB.

Permanent Benefits In contrast with the transitional benefits (which are temporary) permanent

benefits are viewed as being more important in the sense that they will affect the lives of individuals and communities over a long period of time.

As is the case with transitional benefits, a lot of preparatory work is required to ensure the unlocking of these benefits. In the methodology supplement, detail is given of planning exercises by the LHDA and government departments to either maximise benefits or limit costs to

102

communities/sectors brought about by the investment in permanent infrastructure. Only a few will be focussed on here.

• Compared with Phase IA, better preplanning was undertaken to

resettle affected committees and to train them to enhance self-sustaining development.

• All of the affected committees have already benefited from upgraded water supply, sanitation, electricity, access roads, etc. A cost-benefit study launched by the LHDA in 1998 provided guidelines to ensure that a net benefit accrued to the affected communities. The same was done for the environmental impact.

• Other aspects on a policy and institutional level that may need reform so that the actual development impact on Lesotho citizens will improve further, are dealt with in Chapter 6.

As indicated above, a major part of the microeconomic impact assessment is based on the research work done by the LHDA since 1999. The latest report in this regard was published in Octoberl 20037).

Detail is given in the methodology supplement of the outcome of a

comparative assessment of the impact of Phase IB as compared with Phase IA. Where appropriate, the recommendations in the TRC study (1996) are also taken into account as requested by the client.

In summary, good progress has been made in all of the major policy areas

identified by various studies aimed at enhancing the developmental impact of Phase IB. Specifically, the relative direct employment impact of the construction of Phase IB exceeds that of Phase IA in terms of Lesotho’s share of total employment.

There is also no doubt that the creation of permanent supporting socio-

economic infrastructure (i.e. water, electricity, access roads, telecommunications, schools, clinics etc.) has already produced major uplifting effects on the Lesotho economy. The other benefits can be summarised as follows:

• increased commerce in project development areas • much improved telecommunications, domestically and internationally • improved living standards of affected communities as a result of

better health services delivery, education and training • tourism has increased

7) Lesotho Highlands Development Authority “The Impacts of the Project: Analysis of Microeconomic

Impacts” October 2003.

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4.5.1.2 Recommendations for future projects

Even though one can look back with some measure of satisfaction

regarding the improvement in Phase IB’s socio-economic impact vis-à-vis Phase IA, future successes will still require a sustained and coordinated effort from government. A number of areas are highlighted here:

• The TRC report recommended that the Project Treaty be amended to

affect a more enabling environment for local participation. Even though many of these areas have been successfully covered in Phase IB without a re-negotiated Treaty, it is nevertheless recommended that, for future large projects, the Treaty be reviewed beforehand (for further reasons why the study points towards a re-negotiated treaty, see Section 4.5.2).

• The Lesotho Fund for Community Development (LFCD) could

become increasingly important as a vehicle for channelling financial benefits of the Project back to the nation in order to strengthen its long-term growth and development potential. The success of this fund’s activities will also contribute to the ability of Lesotho to gain a larger share in future projects. Liaison between the LFCD’s plans and programmes and that of the Lesotho Government’s Poverty Reduction Strategy should be pursued (see also recommendation (ii(b) in Chapter 7).

• The systems and structures that were put in place during Phase I of

the LHWP to enlarge the pool of skills (especially semi-skilled and skilled labour) should be retained in order to further enhance the response capability of the Lesotho’s manpower resources in respect of future large capital projects.

• Measures should be taken to enhance the capacity of local

entrepreneurs to supply goods and services on a much larger scale than has been the case until now (excluding construction contractors, sub-contractors, consultants etc.). The macro results, point towards improvements in this important area. However, these were not conclusive.

• The tourism potential of the large dams and the natural environment

surrounding them should be more vigorously exploited. In this regard, the creation of the new Tourist Development Corporation is a step in the right direction. Furthermore, the participation of local SMMEs in the tourist industry is also of vital importance.

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4.5.2 Assumptions and Guidelines on a Macro Level that will have a bearing on

Future Projects In this section, specific attention will be given to various aspects of the LHWP

that can have a direct bearing on future developments pertaining to the project. In the course of studying and analysing various phases of the LHWP, the consultants have identified a number of issues that are of the utmost importance to the economy of Lesotho, but that, possibly, have not yet received the necessary attention. Some of these issues are discussed in more detail below:

• The water sales emanating from the LHWP, and how these are accounted for

in the national accounts of Lesotho (See Chapter 6)

• The Consultants’ opinion regarding the future management structure of the LHWP, based on their findings in respect of the handling of the exports of water in terms of its full economic value in the balance of payments

• Ideas on the impact on the GoL accounts with an increased flow of income

emanating from Phase I of the Project, and possible future phases.

• More detailed project orientated information requirements for the improvement of impact modelling

• Comparison with previous studies

• Revision of cost and planning of Phase II (and other subsequent phases)

4.5.2.1 Lesotho should take more direct Financial and Management Control

of the Project Based on the Bilateral Treaty that governs the execution of the LHWP,

Lesotho undertook a major share of the construction of the dam through the Lesotho Highlands Development Authority (LHDA). However, as far as the operational aspect is concerned, including financial ownership, risk management, financial and profit management), the Republic of South Africa appears to have the main responsibility through its agent the Trans-Caledon Tunnel Authority (TCTA) – possibly because it provided the bulk of the financing.

There was great merit in having such an arrangement for Phase I to secure

the huge initial financial risk of the project. However, this has now been

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accomplished and the question now is whether, for the sake of maximizing the developmental impact on Lesotho, any future phases of the LHWP should be structured on the same basis. If, for example, Lesotho takes full responsibility of Phases II, III and IV, one would expect that they would be able to secure a larger portion of “soft” loans, which would considerably decrease the interest payments over the lifetime of the projects. The result would be that Lesotho would be able to secure a part of the profit margin at an earlier stage. This would of course also be in the form of higher taxes paid to the Lesotho government.

In view of the scarcity of water in Southern Africa, the relative price of

water will definitely increase over time. Lesotho can only benefit from that opportunity if it secures a larger share of the financial ownership and management of the project. The price of water could be adjusted at shorter intervals, keeping track of the ever-increasing real value of water in Southern Africa and, also, having regard to the fact that water is Lesotho’s only major primary resource, which has limited availability.

4.5.2.2 Utilization of Funds Generated by the Project The possible economic benefits emanating from future phases of the

LHWP (i.e. Phase II) will largely be determined by the way in which the government utilizes additional tax and royalty incomes generated. These funds can be utilized in the following ways:

• To increase recurrent government expenditure and/or

• Be used to finance government infrastructure, and/or

• To reduce taxes.

Obviously, the type of recurrent government expenditure, as well as the

kind of new infrastructure created, will determine the ultimate impact on the population’s well-being.

These benefits will trickle down to the populace via an increase in GNP,

which is linked directly and indirectly to economic variables such as household consumption expenditure, investment, etc. However, a note of caution is appropriate at this point. As shown in Table 4.13, a tendency has been identified in terms of which the GoL’s surplus before grants declines when approaching the year 2007. It is therefore incumbent on the authorities not to base long-term expenditure commitments on expected inflows of water royalties.

106

4.5.2.3 More Detailed Information Requirements More thorough and realistic macroeconomic impact study will require a

set of detailed and appropriate information. This is especially true with regard to the construction and operational phases of the project. For pure financial analysis purposes, this kind of detailed information is not necessary. However, for the purposes of analysing the macroeconomic impact of the project, it is of cardinal importance.

The following are examples of the information required:

Construction Phase

• Import content of capital goods acquired • A clear distinction between various skill levels with regard to labour

employed/demanded • Information on the numbers of workers sourced locally and

internationally • Value of contracts awarded to Lesotho citizens as well as to foreigners

in respect of all of the aspects of the project, i.e. the main contract, sub-contracts, consultancy work, goods and services bought, etc.

The LHDA has, over the years, set in motion systems to obtain this kind of

information from the contractors and other role players. However, as indicated by the LHDA in its latest reports, more research is needed to ensure that such information will indeed be obtained in future.

Operational Phase

• Comprehensive accounting of water transfers and deliveries is

required in the form of appropriate income and expenditure accounts. Costs should be itemised at least for the following items:

Consumables Labour remuneration Depreciation Interest on debt Indirect taxes Direct taxes

107

• The sales of water should be broken down into quantity, and price per unit

• Information on local and foreign workers needed for the

operational phase, etc.

4.5.2.4 Comparison with Previous Economic Impact Studies It is always very difficult to compare the results of two independent

studies with regard to the impact of a particular capital intensive project on the economy in a particular year. Obviously, there are a myriad of factors that differ between the two situations that are practically impossible to isolate in order to ultimately prepare the economic aggregates for comparison purposes (i.e. to compare apples with apples). Furthermore, the criteria used to evaluate the macroeconomic impact of a project are not that clearly defined as is the case with standard economic and financial evaluation methods such as the Cost Benefit Analysis (CBA) criteria, viz. the Internal Rate of Return (IRR), Net Present Value (NPV) and the Benefit Cost Ratio (BCR), all of which are very well defined and internationally standardized.

Comparing macro model outcomes also brings into question the time

factor. For example, the Doggett study measured the projected impact of the project for a specific year. When the actual outcome is measured years thereafter, so many assumptions could have become invalid that to make a comparison for that particular year is impossible. The question of leads and lags also come into play. Probably a more acceptable way of doing this is to calculate the total impact over the life span (or investment period) of the project, or to calculate an annual average over the construction period (this is indeed the approach followed in this current study.

In order to meaningfully compare the results of projected and realized

outcomes at different stages of the project, it is necessary that clear and definite instructions be given to the researchers at the first evaluation (planning phase) of the project. The following aspects should be stipulated:

•

•

•

Evaluation criteria (e.g. GDP, Labour etc)

Specific evaluation period (specific year or total period)

Methodology of calculating growth rates, for instance point-to-point, regression analysis through the various points and amortisation of all points, etc.

108

4.5.2.5 Revision of the Cost of Phase II All phases of the Lesotho Highlands Water Project were planned

simultaneously. Except for this initial planning that was done in 1985, no further development work has been done on Phase II of the project. The validity of the data (although adjusted for inflation) could be questioned as a result of the time that has elapsed. A more pragmatic evaluation of Phase II will require that all aspects pertaining to the project (including the engineering aspects) be fundamentally reviewed before a more reliable forecasting exercise can be undertaken.

109

ANNEXURE 4a: DETAIL LHWP PHASE IB EXPENDITURES ON AN PROJECT BASE , 1992-2006

[CONSTANT 1995 PRICES, MILLION MALOTI]

1992 199

3 199

4 199

5 199

6 1997 1998 1999 2000 2001 2002 2003

Mohale Dam -

-

-

-

-

-

4.3

79.4

88.1 89.1

86.7 90.

Mohale Tunnel -

-

-

-

-

-

49.1

128.1

122.8 122.0

144.6 120.

Matsoku Diversion -

-

-

-

-

-

19.9

12.8

39.1 32.2

17.3 23.

Infrastructure -

0.7

2.8

31.8

57.6

158.1

167.2

47.5

21.8

(3.3)

5.0 4.

Ancillary Developments

-

-

-

-

0.6

5.3

17.1

9.3

1.0 0.4

3.5

Environment -

-

0.0

0.0

5.0

9.6

8.1

4.8

10.3 40.4

73.3 103.

Administration -

-

-

-

1.3

5.6

4.8

27.2

41.4 32.4

47.1 52.

Total -

0.7

2.8

31.8

64.5

178.7

270.6

309.2

324.5 313.2

377.5

395.0

*Note: Expenditures will occur within Lesotho

110

ANNEXURE 4b: DETAILED LHWP PHASE IB EXPENDITURES ON AN ASSET BASE , 1992-2006

[CONSTANT 1995 PRICES, MILLION MALOTI]

1992 1993 1994 1995199

6 1997 1998 1999 2000 2001

Building Construction - -

-

8.4

33.3

104.3

187.6

186.3

161.

186.1 2

Concrete Structures - -

0.0

4.6

20.3

49.3

0.0

7.9

42.0

77.4

Roads - 0.7

2.8

1.6

16.1

32.8

14.4

3.3

2.8

(5.0)

Earth Works - -

0.0

1.0

4.7

13.9

21.9

27.0

24.5

Mechanical Machinery & Metal Products -

-

0.0

1.0

4.7

21.5

13.9

21.9

23.6

20.9

Electrical Machinery - -

-

-

-

-

-

-

-

-

Plastic Products - -

-

-

-

-

-

-

-

-

Research & Development - 6.3

5.2

28.8

43.4

34.8

-

-

-

1.3

Relocation Costs - -

-

-

-

0.1

0.0

0.1

0.0

0.2

Total - 0.7

2.8

12.1

64.7

179.3

271.3

311.0

327.0

315.4

*Note: Expenditures will occur within Lesotho

111

SUMMARY Chapter 5 also discusses external factors, influencing the Lesotho economy. The nature and magnitude of Phase II expenditures, as well as other external factors which influence the Lesotho economy. Detailed discussions of the projected impact on macroeconomic demand variables, economic sectors, government accounts and balance of payments components are given.

CHAPTER 5: THE IMPACT OF PHASE II OF THE LHWP ON THE LESOTHO ECONOMY

5.1 Introduction

An important aspect of this analysis is the estimation of the impact of Phase II of the LHWP on the Lesotho economy. The main objective of this portion of the study is to use information presently available on the nature and magnitude of Phase II of the Project, as well as other relevant data, to appropriately adjust and populate the relevant exogenous variables of the DSAS model for the purpose of quantifying the impact of Phase II. In addition, cognisance has to be taken of the guidelines that have been developed in the process of executing the analysis of Phase IB impact, presented in Chapter 4.

5.2 External Factors Influencing Economic Growth in Lesotho at the Onset of Phase II

The total cost of implementing Phase II can be grouped into construction costs and operational costs. The construction costs are all capital expenditures related to Phase II. The operational costs include both water sales revenue and electricity generation. Each of these aspects is discussed below.

As discussed in the previous chapter dealing with Phase IB, there are two distinct

groups of external factors that will influence economic growth in Lesotho when Phase II commences. The first group includes the expenditure directly associated with the construction of Phase II of the Project. The second group consists of all the other external factors that have an impact on the economy of Lesotho, but that cannot be controlled by stakeholders in Lesotho.

5.2.1 The Nature and Magnitude of Phase II Expenditures

112

Construction costs

• civil, mechanical and electrical construction associated with each major component of the project

The estimated construction costs include:

• access roads to construction sites and the provision of infrastructure at construction sites

• those aspects of the proposed environmental programme that are necessitated

by the effect the project will have on the environment and the people living in the project area

• engineering during the planning, design and construction stages; and

• administration during the planning, design and construction stages.

Operating costs

The estimated operating costs include:

• operation and maintenance costs including post-construction administration expenses

• the costs of replacing mechanical and electrical equipment

Table 5.1 provides a profile of the expenditure and revenue resulting from Phase II for the period from 2009 to 2020. The expenditure includes the total capital expenditure related to Phase II, whilst the revenue portion of the table provides the magnitude of the two final products of Phase II, which are water sales revenues and electricity generation.

113

TABLE 5.1 NATURE AND MAGNITUDE OF THE LHWP – PHASE II [Constant 1995 Prices, Million Maloti] LHWP PHASE II 2009-2020

COMPONENTS 2009 2010 2011 2012 2013 2014 2015

2016

2017 2018

2019 2020 TOTAL

Expenditures

Total Capital Expenditure

136 659 773 849 810

349

67

312

239 5,250 770

99

191

% Contribution 2.6% 12.5

%14.7

%16.2

%1.3%

4.5%

15.4%

14.7%

6.6%

1.9%

5.9% 3.6% 100%

Revenue Water Revenue

- Water Sales

-

-

-

-

-

-

168

402

617

617

617

617 3,036

- Royalties

-

-

-

-

-

-

21.1

50

78

78

78

78 381

Electricity Generation

-

-

-

14

53

-

-

-

34

53

53

53 258

Source: Macdonald and Shand “Feasibility Study” April 1986 p10-5.

114

Assumptions underlying capital and operating costs

Costs are expressed in mid 1985 prices and include an allowance for physical contingencies. They do not include taxes and duties, price contingencies or finance charges on capital required for the purchase of the construction plant. The exchange rate used is M1 = US$ 0.5, which was the prevailing rate at the time of the study.

Different price escalation rates, according to the origin of the cost item6), have been used for the purpose of financial analysis. Escalation rates are based on the changes in prices and quantities for each sector of the Lesotho economy, based on detailed information obtained from the Bureau of Statistics of Lesotho.

The Assumed Phase II Implementation Period

It was recommended that the major planning study for all phases subsequent to Phase I be done commencing in 1994 (Macdonald and Shand, 1986). Notwithstanding this, according to the overall construction programme, Phase II was scheduled to take 16 years in total, including design and tender, construction, and reservoir filling (See Figure 5.1).

Phase II’s implementation was not fully studied in detail in the project’s feasibility study.

According to this Figure, major construction works for the water transfer component are scheduled to take eight and a half years, and the hydropower component, four years (Water delivery to the RSA would start approximately 3 years before the hydro-electrical power plant starts production).

6) That is, whether the cost item was sourced within or outside the customs union (SACU).

115

FIGURE 5.1 PHASE II IMPLEMENTATION PERIOD [Time Lines]

1995

1994 1996

1995 1997 1998

1999 2000

2001 2002

2003 2004 2005

2006

2007

2008

2009

Phase II Planning Study Access Rods & Infrastructure

- Construction Main works Design & Tender

- Mashai Dam - Pumping Station

- Delivery Tunnel

- Hydropower Plant

- Design & tender

Main Works Construction

- Transfer Tunnel

Mashai Reservoir Filling

Legend

Design & Tender

Filling

Construction

Reservoir First Water Delivery

Source: Macdonald and Shand “Feasibility Study” April 1986 p12-13 Fig. 12.1.

For purposes of this study, it is assumed that Phase II construction works would start in 2009 instead of the original date of 1995. The paragraphs below describe the broad methodology for including Phase II income and expenditure aggregates into the DSAS modelling system.

It is important to note that the disaggregation and re-classification of capital expenditures in respect of Phase II of the Project follows exactly the same routine as for Phase IB. However, because Phase II differs from Phase IB in many respects, it was deemed necessary to repeat some of the aspects in detail in respect of Phase II.

116

For a detailed explanation of this disaggregation of the re-classification process, please refer to Section 4.7.

It is apparent that the expenditures associated with Phase II will peak between 2010 and 2015. By the end of the project in 2016, capital expenditure will have decreased significantly.

The composition of the expenditure related to Phase II is depicted in Figure 5.3. The composition is provided in terms of identifiable products, for instance the Mashai Dam, the Mashai-Katse Pumping System, a

5.2.1.1 Construction Phase

Figure 5.2 presents the costs of Phase II, spread over the 2009 to 2020

period.

FIGURE 5.2

Lesotho Highlands Water Project Total Expenditure Phase II [1995 Prices, Million Maloti]

0

100

200

300

400

500

600

700

800

900

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Years

1995

pri

ces,

Mill

ion

Mal

oti

Phase II

117

transfer tunnel, etc. Detail pertaining to these identifiable products is provided in Appendix 5.1 at the end of this chapter.

FIGURE 5.3

DETAIL LHWP PHASE II EXPENDITURES IN TERMS OF IDENTIFIABLE PRODUCTS

2009-2020

Delivery tunnel II North11.03%

Delivery tunnel II South4.40%

Hydropower Plant II10.17%

Transfer tunnel II22.96%

Mashai -Katse Pumping System20.96%

Mashai Dam - Construction30.49%

From Figure 5.3, it is clear that the construction of the Mashai Dam will be the largest expenditure associated with Phase II. Other large investments include the Mashai-Katse Pumping System, and a transfer tunnel.

The results of the disaggregation of the asset types are provided in Figure 5.4. Asset types refer to, for instance, building construction, roads, earth works and other associated assets.

118

FIGURE 5.4

DETAIL LHWP PHASE II EXPENDITURE ON AN ASSET BASE

2009 – 2020

Building Construction43.27%

Relocation Costs0.00%

Concrete Structures37.45%

Roads0.00%

Earth Works10.41%

Mechanical Machinery & Metal Products

8.88%Research & Development

0.00%

Plastic Products0.00%

Electrical Machinery0.00%

A further step involved a further breakdown of these sectors into their main cost components:

• Economic sectors (Intermediate demand of each asset category) • Salaries and wages • Gross operating surplus • Direct imports

The methodology of this exercise is described in detail in Chapter 4. The results of this exercise are provided in Appendix 5.2 at the end of this chapter.

119

5.2.1.2 Operational Phase

The operational benefits flowing from Phase II consist of additional water sales to the RSA, as well as increased electricity generation through a new hydropower plant. It is assumed that water sales will start in 2015, with enlarged electricity generation occurring a number of years thereafter.

Table 5.2 provides an exposition of the water sector’s production structure.

[CONSTANT 1995 PRICES, MILLION MALOTI]

TABLE 5.2 WATER INDUSTRY PRODUCTION STRUCTURE:

PHASE II, 2009-2020 [FULL CAPACITY]

2015 2016 2017 2018 2019 2020 Total Structure

Intermediate inputs

1.3

3.0

4.6

4.6

4.6

4.6

22.8 0.8%

Salaries and wages

1.6

3.8

5.9

5.9

5.9

5.9

28.8 0.9%Gross operating surplus

144.2

344.3

529.0

529.0

529.0

529.0

2,604.6 85.7%

Government revenue (water royalties)

21.1

50.4

77.5

77.5

77.5

77.5

381.4

12.6%

Total water sales

168.1

401.6

617.0

617.0

617.0

617.0

3,037.6 100.0%Source: Trans-Caledon Tunnel Authority (TCTA)

According to an estimate made in the feasibility study1, Phase II will deliver 1 893.57 million cubic meters of water per annum at full capacity, at a tariff of 69c per cubic meter. This amounts to total water sales of M 616.97 million per annum. Thus, the gross turnover of the water sector in the Lesotho economy will comprise M 616.97 million (in constant prices) per year when Phase II is operating at full capacity.

1 Macdonald and Shand, “Feasibility Study”, Lesotho Highlands Water Project, April 1986

120

As mentioned previously, another benefit from Phase II is the generation of additional electricity through hydropower. It is envisaged that an additional M53 million (constant prices) will be generated by the electricity sector of Lesotho, after implementation of Phase II of the LHWP.

This amount is added exogenously to the electricity sector as defined in

DSAS. In addition, imports of electricity from ESKOM will be reduced as exports are channelled into the ESKOM grid, depending on the situation at that time – the impact on the economy will be the same. The direct labour effect on the electricity sector, during the operational phase was incorporated with the same approach as for Phase IB.

121

APPENDIX 5.1 Detail LHWP Phase II Expenditures on an Project Base , 2009-2020

[Constant 1995 Prices, Million Maloti]

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

TOTAL

% Contributi

on Mashai Dam – Construction

15

267

324

328

319

334

-

-

14

-

-

-

1,601 30%

Mashai –Katse Pumping System

-

0

24

97

11

13

71

44

99

312

239

191

1,100 21%

Transfer tunnel II 69

181

190 23%

188

223

186

155

13

-

-

-

-

1,205

Hydropower Plant II 5

89

108 - 10%

109

106

111

5

-

-

-

-

534

Delivery tunnel II South 13

- -

35

36

36

43

36

30

2

-

-

231 4%

Delivery tunnel II North 33 90 74

-

-

87

91

107

89

6

-

-

579 11%

Total 135

659

773

849

810

770

349

66

99

312

239

191

5,250

122

APPENDIX 5.2 Detail LHWP Phase II Expenditures on an Asset Base , 2009 - 2020

[Constant 1995 Prices, Million Maloti]

200

9 201

0 201

1 201

2 201

3 201

4 201

5 201

6 201

7 201

8 201

9

Building Construction 16

57

293

339

385

327

343

56

26

181

138

Concrete Structures 100

261

258

279

298

250

31

97

75

226

31

Roads -

-

-

-

-

-

-

-

-

-

-

Earth Works 15

85

91

95

95

92

31

4

4

14

11

Mechanical Machinery & Metal Products

15

79

71

75

79

75

31

4

4

14

11

Electrical Machinery -

-

-

-

-

-

-

-

-

-

-

Plastic Products -

-

-

-

-

-

-

-

-

-

-

Research & Development -

-

-

-

-

-

-

-

-

-

-

Relocation Costs -

-

-

-

-

-

-

-

-

-

-

Total 146

711

763

837

800

760

344

65

97

306

234

*Note: Expenditures will occur within Lesotho

123

5.2.2 Other External (Exogenous) Factors affecting economic growth in Lesotho

Table 5.3 summarises the historic growth rates, as well as projected future growth rates, which have been used in forecasting exogenous economic variables for purposes of DSAS. The periods for which growth rates are reported coincide with Phase II expenditures of the LHWP. The point-to-point method was applied to calculating these growth rates.

124

TABLE 5.3 HISTORIC AND FUTURE GROWTH RATES FOR EXOGENOUS

VARIABLES1

Description 1980 - 2000 2000 - 2007 2007 - 2020

Current transfers debit (current prices) 26.4% 14.30% 2.06%Employment in the public sector 4.7% 5.82%(numbers) 5.95% Gov exp on personnel emoluments (current prices) 15.5% 7.88% 7.46%Gov subsidies and transfers (current prices) 21.7% 4.30% 4.30%Gov exp on other g&s (current prices) 17.4% 7.80% 7.61%Government Investment (constant 95 prices) - With Phase II 1.1% 2.2% 2.1% - Without Phase II 1.1% 2.2% 1.3%Government Recurrent Exp (constant 95 prices) - With Phase II 3.7% 2.7% 2.1% - Without Phase II 3.7% 2.7% 1.3%Investment income debit (current prices) 20.7% 1.26% -0.86%Labour income credit (current prices) 11.8% 0.60% 0.13%Labour income debit (current prices) 13.0% -0.50% -2.32%Labour Productivity (constant 95 prices) 0.0% 0.08% 0.08%Loti to US dollar (current prices) 12.3% -6.87% -2.97%Mineworkers avg earnings (current prices) 14.4% 5.08% 4.74%Mineworkers employment (average number) -3.1% -3.13% -3.47%Net Foreign Assets (current prices) 21.9% 4.41% 4.41%Other gov transfers: credit (current prices) NA 2.54% 2.01%Other non tax revenue (current prices) NA 4.97% 6.00%Parastatals investment (constant 95 prices) 9.3% 2.99% 2.27%Private Sector Credit (constant 95 prices) 6.7% -2.86% -4.66%Ratio: Import Price Index to CPI (constant 95 prices) -0.3% -0.64% -0.64%Real savings (constant 95 prices) 2.2% -1.16% -1.17%Reserve money (constant 95 prices) 15.4% 5.01% 4.70%SA long term interest rate index 0.8% 0.46% 0.46%SA prime lending rate (constant 95 prices) 2.1% 0.93% 0.98%SA treasury bill rate (constant 95 prices) -1.6% -1.06% -1.09%Total Interest Payment of Gov (current prices) 22.8% 6.26% 6.16%Total of Private Investment (constant 95 prices) 11.4% 8.35% 7.39%Transfer balance on cap&fin acc (current prices) 10.5% 10.38% 8.94%World demand (constant 95 prices) 5.9% 3.68% 4.10%World price index (constant 95 prices) 2.17% 0.57% 0.56%

1 : Point to point growth rates

125

The significance of certain exogenous variables was highlighted in Chapter 4. As

such, it is not repeated here. However, it is important to note that government recurrent expenditure and investment determined for both “with” and “without” Phase II. In the “without” Phase II scenario, the current account of the government accounts expressed as a percentage of GDP, was kept at the same level as for the “with” Phase II scenario.

• The growth of the economy with the inclusion of Phase II (the so called Base Case scenario), and

The impact of Phase II is therefore determined as the difference between these two alternative growth scenarios. The outcomes of these scenarios are reflected in Tables 5.4 to 5.11.

5.3 The Results of Modelling the Impact of Phase II on the Lesotho Economy

5.3.1 Introduction

In this section, the impact of Phase II of the LHWP on the Lesotho economy will be quantified and discussed. As in the case of analysing the impact of Phase IB, the results of the Phase II analysis are presented in two alternative scenarios:

• The growth of the economy without the inclusion of Phase II

5.3.2 Results

As in the case of analysing the impact of Phase IB, the impact of Phase II on the Lesotho economy will be discussed within the context of the following economic aggregates:

- Macroeconomic aggregates - Impact on key economic sectors - Government accounts - Balance of payments

5.3.2.1 Macroeconomic Aggregates The macroeconomic aggregates have been further sub-divided into the

following elements:

126

- Total economic activity - Gross domestic expenditures - The external sector - Inflation and employment

5.3.2.1.1 Total Economic Activity The total economic impact of Phase II is measured in terms of its impact on gross domestic product (GDP) and gross national product (GNP). Table 5.4 reflects absolute values and percentages for these two measures for the “with Phase II” and “without Phase II” scenarios, and the difference between these two, which determines the actual impact.

Table 5.4 reflects data for a series of critical years (i.e. 2009, 2013, 2015, 2017, and 2020). Point-to-point and annuity growth rates have been calculated for the period between 2009 to 2020.

127

TABLE 5.4 PROJECTED IMPACT ON KEY MACROECONOMIC AGGREGATES TOTAL ECONOMIC ACTIVITY, 2009 – 2020 [CONSTANT 1995, MILLION MALOTI]

2009-20AGGREGATE 2009 2013 2015 2017 2020 Total

Over Period

Annuity Growth P

Gross Domestic Product

-With Phase II [BASE]

4,796 5,388 5,671 6,012 5,472 60,708 2.32%

-Without Phase II 4,760 4,964 5,107 5,253 5,466 56,220 1.18% -Impact [With-Without]

36 424 365 418 546 4,488 1.14%

-Impact as % of Base

0.8% 7.9% 6.7% 7.4% 9.1% 7.4%

Gross National Product

-With Phase II [BASE]

5,741 6,024 6,071 6,255 6,529 67,624 1.16%

-Without Phase II 5,721 5,767 5,778 5,858 6,023 64,170 0.33% -Impact [With-Without]

21 257 293 397 506 3,454 0.83%

-Impact as % of Base

0.4% 4.3% 6.3% 5.1%4.8% 7.7%

128

In the case of the “with Phase II” scenario (i.e. the base case scenario), GDP will grow at a moderate rate of 2.32%, measured on an annuity basis.

The other more localised indicator of total activity, GNP, is expected to grow at an even lower rate of 1.16%. as was explained in Chapter 4. The main reason for this is the decline in remittances from Lesotho miners working in South Africa.

Figure 5.5 illustrates the absolute GDP effects for the period under

review for the “with Phase II” and “without Phase II” scenarios, whilst figure 5.6 illustrates the effects on GNP.

FIGURE 5.5

PROJECTED IMPACT OF PHASE II ON GDP[CONSTANT 1995 PRICES, MILLION MALOTI]

4000

4500

5000

5500

6000

6500

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020Years

Con

stan

t 199

5 Pr

ices

, Mill

ions

Mal

oti

With Phase II Without Phase II

129

FIGURE 5.6

PROJECTED IMPACT OF PHASE II ON GNP [CONSTANT 1995 PRICES, MILLION MALOTI]

5000

5200

5400

5600

5800

6000

6200

6400

6600

6800

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Years

Con

stan

t 199

5 Pr

ices

, Mill

ions

Mal

oti

With Phase II Without Phase II

In the case of the “without Phase II” scenario, GDP will grow at a slower rate (i.e. by 1.14 percentage points per annum using annuity principals, and by 0.81% using point-to-point growth rates).

Figure 5.5 clearly illustrates the extent to which the investment activities pertaining to Phase II will impact GDP between the years 2009 and 2020. To some extent, the same tendency should be experienced with GNP. However, the discrepancy over the total period is much less, and amounts to 0.83% per annum.

As reflected in Table 5.5, the impact of Phase II will elevate GDP per capita by approximately 6.35% over the period 2009 to 2020. However, due to the leakage effects described above, per capita GNP only increased by approximately 4.65% over the same period.

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TABLE 5.5 PROJECTED IMPACT ON PER CAPITA AND PER HOUSEHOLD GDP AND GNP, AVERAGE: 2009 – 2020

[2003 PRICES MILLION MALOTI] GDP GNP

2003 prices - Million Maloti 2003 prices – Million Maloti

UNIT BASE Impact of II Impact of II as

percentage

BASE Impact of II

Impact of II as

percentage (With –

Without) Without II

(With - Without)

WITH II Without II of base WITH II of base

Per Capita 4,421.54

4,118.85 4.65%

302.696.85%

4,956.18 4,725.83 230.35

Per Household

22,107.70 20,594.26 1,513.45

6.85% 24,780.89 23,629.13 1,151.76

4.65%

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5.3.2.1.2 Gross Domestic Expenditure

The impact of Phase II on Gross Domestic Expenditure (GDE) is measured in terms of: i) Final consumption expenditure by households and general

government; and ii) Gross fixed capital formation by private businesses,

government and parastatals.

Consumption Expenditure by Households

As in the case of the impact of Phase IB, the impact on final consumption expenditure by households will be relatively small, and the annual growth rate over the period may be only 0.22% - (See Table 5.6). The explanation for this is that there is only a small trickle-down effect on households due to the LHWPs high capital-intensive nature. Households will be mainly impacted by the consumption expenditure that flow from the remuneration of the Basotho workers who will work on construction sites. Furthermore, a significant proportion of salaries will be paid to highly skilled workers, most of which will flow out of the country as highly skilled workers are mostly foreigners.

To a certain extent, household expenditure will also be affected by the additional expenditure by government, due to additional government revenue that will be attributable to Phase II.

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TABLE 5.6

PROJECTED IMPACT ON KEY GROSS DOMESTIC EXPENDITURE AGGREGATES, 2009 - 2020

[ CONSTANT 1995 PRICES, MILLION MALOTI ]

2009 - 2020

AGGREGATE

2009 2013 2015 2017 2020 TOTAL

OVER PERIOD

Annual Growth Point-to-Point Growth

Final Consumption Expenditure - Households -With Phase II [BASE] 4,984 5,216 5,271 5,465 5,769 63,583 1.20% 1.38% -Without Phase II 4,959 5,175 5,098 5,239 5,414 61,900 0.62% 0.75% -Impact [With-Without] 25 41 173 227 355 1,683 0.57% 0.63% -Impact as % of Base 0.5% 0.8% 3.3% 4.1% 6.2% 2.6% - General government -With Phase II [BASE] 923 1,011 1,054 1,098 1,164 12,521 2.20% 2.13% -Without Phase II 909 912 983 1,005 1,044 11,464 0.89% 1.26% -Impact [With-Without] 14 99 72 93 120 1,057 1.31% 0.86% -Impact as % of Base 1.5% 9.8% 6.8% 8.5% 10.3% 8.4% Gross Fixed Capital Formation - Private -With Phase II [BASE] 229 250 245 243 242 2,914 1.09% 0.52% -Without Phase II 227 225 222 219 213 2,665 -0.39% -0.57% -Impact [With-Without] 2 25 23 23 29 249 1.48% 1.09% -Impact as % of Base 0.7% 9.9% 9.2% 9.6% 12.0% 8.5% - Government -With Phase II [BASE] 1,112 1,209 1,261 1,315 1,400 15,013 2.12% 2.12% -Without Phase II 1,095 1,091 1,204 13,7461,175 1,256 0.81% 1.25% -Impact [With-Without] 17 118 86 111 144 1,267 1.31% 0.86% -Impact as % of Base 1.5% 9.8% 6.8% 8.5% 10.3% 8.4% - Other (Parastatals) -With Phase II [BASE] 782 897 1,001857 938 10,667 2.29% 2.27% -Without Phase II 782 857 897 938 1,001 10,667 2.29% 2.27% -Impact [With-Without] 0 0 0 0 0 0 0.00% 0.00% -Impact as % of Base 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Government Expenditure

Table 5.6 indicates that the additional revenue from the implementation of Phase II will provide Government with significant leeway to make additional expenditure of 1.31 percentage points per annum over the period on current expenditures. The net effect is that government could raise its level of current expenditure by 8.4% over the period. As far as government’s Gross Fixed Capital Formation (GFCF) is concerned, it can be expected that this will also be markedly positively impacted by Phase II. A significant portion of this additional revenue

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will probably be allocated to investment, i.e. the Treaty states that royalties should be used for this purpose. Gross Fixed Capital Formation (excluding government)

•

•

Private Sector

The impact on private sector investment will be significantly positive and the impact on private GFCF will be higher than 1.5% per annum. This investment includes direct involvement with the project in terms of sub-contracts as well as other indirect investment that will be required in the private sector to accommodate the general rise in economic activity caused by the construction of Phase II.

Parastatals (excluding LHWP)

The gross fixed capital formation of parastatals is treated as exogenous to the system. For purposes of this analysis, it is assumed that parastatals will not be significantly impacted by Phase II and, therefore, will not have to make any new gross fixed capital formation.

However, in the case of current activity, parastatals are included as part of the sectoral system, e.g. the Lesotho Post Office is part of the communication sector. As such, parastatals’ current activities are included in the model as endogenous variables.

In summary, every component of GDE will grow faster than the projected GNP growth rate, suggesting that Lesotho will still require additional resources from abroad to maintain the projected GDP growth rate.

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5.3.2.1.3 The External Sector

Table 5.7 indicates the impact that Phase II has on exports and imports.

TABLE 5.7: PROJECTED IMPACT ON KEY EXTERNAL SECTOR AGGREGATES, 2009 - 2020 [CONSTANT 1995 PRICES, MILLION MALOTI]

2009 - 2020 AGGREGATE 2009 2013 2015 2017 2020 TOTAL

OVER PERIOD

Annuity Growth

Point to Point Growth

Exports - Goods and Services1 -With Phase II [BASE] 1,652 1,743 1,772 1,825 1,827 21,131 1.16% 0.92%

-Without Phase II 1,652 1,750 0.83% 1,743 1,748 1,749 20,750 0.52% -Impact [With-Without] 0 77 381 0.40%0 21 77 0.33% -Impact as % of Base 0.0% 0.0% 1.2% 4.2% 4.2% 1.8%Imports - Goods and Services -With Phase I [BASE]I 4,693 5,426 5,207 5,288 5,658 63,812 2.24% 1.71% -Without Phase II0 4,582 4,661 4,781 4,900 5,083 57,274 0.74% 0.95% -Impact [With-Without 112 765 426 388 574 6,538 1.50% 0.76% -Impact as % of Base 2.4% 14.1% 8.2% 7.3% 10.2% 10.2%

1 Water sales included for both phase 1A and Phase II

Exports

The same type of arguments that were made for Phase IB are also valid for Phase II, i.e. the impact of Phase II on exports of goods and services will be limited to the income of water sales to the RSA, which is by definition royalties received. Other exports are mostly determined by exogenous variables, i.e. world demand and world inflation, which will not be impacted by Phase II.

Interestingly, exports may not be impacted to the extent that one would have expected. The main reason for this is that Phase IB water exports will only start to have a significant impact towards the end of Phase II.

Imports

The impact of Phase II on imports will be significant. In 2013, the impact on imports (i.e. the difference between the “with Phase II” and “without Phase II” scenarios) may be as much as 14.1%, and imports might increase by 10.2 % as a result of Phase II on average over the total period. Lesotho is a very “open” economy and depends heavily,

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specifically on the RSA, for manufactured goods. This includes both Capital and Consumption goods.

5.3.2.1.4 Inflation and Employment

Inflation

Although prices are determined internally in DSAS (i.e. endogenously), the impact of Phase II on the inflation of Lesotho is very small (or even zero). Lesotho is a very open economy and is influenced to a large extent by price changes in the South African economy. On a micro level, there is possibly some pressure on wages and on the prices of certain products that are produced in Lesotho. However, this effect is so small that it does not affect the DSAS model.

Employment

As is the case with Phase IB, the inclusion of Phase II will have a marked effect on the economy’s demand for labour. It is expected that a total of 41,614 person-years will be created over the 2009 to 2020. Included in this figure, is 29,201 person-years representing direct job opportunities created by Phase II – this figure has been obtained from the latest micro-economic impact analysis conducted by LHDA.

The balance of 12,413 person-years is made up of indirect and induced

job opportunities.

Indirect job opportunities refer to employment opportunities created in those sectors that link backwards to the construction activities of Phase II due to the supply of intermediate inputs. Induced employment opportunities refer to the employment opportunities created as a result of salaries and profits that are ploughed back into the economy in the form of private consumer spending.

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5.3.2.2 Impact on Economic Sectors

Table 5.8 and Figure 5.7 reflects the impact of Phase II (i.e. the difference between the “with Phase II” and the “without Phase II” scenarios) on the primary, secondary and tertiary sectors of the Lesotho economy.

FIGURE 5.7 PROJECTED IMPACT ON KEY ECONOMIC SECTORS [GDP PROJECTIONS, IMPACT PERCENTAGES]

- Construction38%

- Electricity and water15%

- Manufacturing11%

- Mining and quarrying

0%

- Agriculture1%

- Trade & accommodation

10%

- Transport and communication

3%

- Financial & business services

3%

- Community social & personal services

19%

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TABLE 5.8 PROJECTED IMPACT ON GDP FOR KEY ECONOMIC SECTORS (2009 - 2020)

2009-2020

ECONOMIC SECTOR TOTAL OVER PERIOD

Annuity Growth Point-to-Point Growth

Primary sector - Agriculture -With Phase II [BASE] 9,212 0.90% 1.15% -Without Phase II 9,176 0.64% 0.70% -Impact as % of Base 0.4% 0.26% 0.45% - Mining and quarrying -With Phase II [BASE] 36 0.40% 0.28% -Without Phase II 36 0.24% 0.28% -Impact as % of Base 0.0% 0.16% 0.01% Secondary sector - Manufacturing -With Phase II [BASE] 9,447 1.13% 1.36% -Without Phase II 8,864 0.89% 0.89% -Impact as % of Base 6.2% 0.24% 0.47%

- Electricity and water -With Phase II [BASE] 4,502 3.74% 3.97% -Without Phase II 3,745 0.61% 0.45% -Impact as % of Base 16.8% 3.29% 3.36% - Construction -With Phase II [BASE] 9,278 4.19% 1.97% -Without Phase II 7,264 1.05% 1.33% -Impact as % of Base 21.8% 3.15% 0.63% Tertiary sector - Trade & accommodation -With Phase II [BASE] 6,005 2.52% 2.35% -Without Phase II 5,498 1.04% 1.40% -Impact as % of Base 8.4% 1.48% 0.95% - Transport and communication -With Phase II [BASE] 2,368 2.23% 2.04% -Without Phase II 2,233 1.19% 1.37% -Impact as % of Base 5.7% 1.04% 0.67% - Financial & business services -With Phase II [BASE] 6,486 1.51% 1.47% -Without Phase II 6,343 1.03% 1.03% -Impact as % of Base 2.2% 0.48% 0.44% - Community social & personal services -With Phase II [BASE] 11,858 3.53% 3.35% -Without Phase II 10,829 2.04% 2.56% -Impact as % of Base 8.7% 1.49% 0.79% Total GDP (Producers' Prices) -With Phase II [BASE] 59,192 2.44% 2.15% -Without Phase II 54,960 1.22% 1.37% -Impact as % of Base 7.1% 1.23% 0.78% Net Taxes on Products -With Phase II [BASE] 6,313 1.20% 1.38% -Without Phase II 6,155 0.64% 0.82% -Impact as % of Base 2.5% 0.56% 0.56% Total GDP (Market Prices) -With Phase II [BASE] 65,505 2.32% 2.07% -Without Phase II 61,115 1.18% 1.26% -Impact as % of Base 6.7% 1.14% 0.81%

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5.3.2.2.4 Sectoral Results

- Primary Sector

As is the case with Phase IB, the primary sector will not be significantly affected by Phase II. As shown in Table 5.8, the “with Phase II” scenario indicates that both the agriculture and mining and quarrying sectors will display moderate growth rates i.e. more or less in line with their long-term growth potential. The reason for this is not so much that the demand for agricultural products will not increase, but because this sector can’t really respond to increased demand because it consists mostly of subsistence farming that is not commercially driven. Consequently, most of the additional food required as a result of the impact of Phase II will have to be imported.

- Manufacturing Industry

The manufacturing sector shows no clear relationship with Phase II activities in view of the small estimated impact of Phase II. Lesotho’s manufacturing sector is still underdeveloped and it is not envisaged that this will change significantly over the period 2009 to 2020. Products that are used in significant volumes in the construction of Phase II (i.e. cement, steel, fuel, etc.) will still have to be imported.

- Electricity, Gas and Water

Average growth of this sector is expected to be in the region of 3.29% per annum. To some extent, this is misleading as the impact of additional water and electricity sales will only be experienced towards the end of the period. It is important to note that the impact on electricity, gas and water will be substantially higher if the method of valuing water sales is changed to the approach set out in Chapter 6.

- Construction

Construction is expected to experience a high level of growth and may contribute 21.8% to total GDP activity over the period. Average growth per annum is expected to be in the region of 3.16%. However, it is important to bear in mind that the benefits from the construction of Phase II will come to an end once construction is complete.

- Tertiary Sector

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The tertiary sector is projected to increase its share of total GDP over time and will comprise approximately 44% of Lesotho’s GDP over the period. The impact of Phase II on this sector will be a broad, indirect effect. As in the case with Phase IB, the Trade and Accommodation industry will receive a substantial boost from construction activities associated with Phase II. This is mostly based on a significantly higher level of indirect wholesale and retail trade stemming from demand for materials and consumer products stimulated by the project. In addition, Community, Social and Personal services will be positively impacted by Phase II. This is due to the additional revenue earned by government that will have a positive effect on social services.

5.3.2.3 Government Accounts

In Table 5.9, totals for important government income and expenditure aggregates for the period 2009 to 2020 are reported for the “with Phase II” and “without Phase II” scenarios.

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TABLE 5.9 PROJECTIONS OF GOVERNMENT ACCOUNT COMPONENTS, 2009-2020 [CURRENT PRICES]

2009-2020 GOVERNMENT ACCOUNT COMPONENT

2009 2013 2015 2017 2020 TOTAL OVER

PERIOD

TOTAL REVENUE AND GRANTS -With Phase II [BASE] 5,270 7,143 7,789 10,914 8,935 94,757 -Without Phase II 5,195 6,457 7,260 8,185 9.796 86,648 -Impact [With-Without] 76 686 530 750 8,109 1,118 -Impact as % of Base 1.4% 8.6%9.6% 6.8% 8.4% 10.2%Tax revenue * Customs 2,452 3,447 3,649 4,085 5,059 44,491 -With Phase II [BASE] 2,394 2,961 3,350 3.786 4,545 39,942 -Without Phase II 58 486 299 299 4,549 514 -Impact [With-Without] 2.4% 8.2%14.1% 7.3% 10.2% 10.2% -Impact as % of Base * Non Customs 1,460 1,882 2,110 2,414 2,947 25,387 -With Phase II [BASE] 1,461 1,818 2,018 1,278 2,732 24,264 -Without Phase II -1 64 92 136 215 1,124 -Impact [With-Without] -0.1% 3.4% 4.4% 5.6% 7.3% 4.4% -Impact as % of Base Non Tax Revenue 2 -With Phase II [BASE] 1,113 1,391 1,624 2,015 2,372 19,915 -Without Phase II 1,113 1,391 1,555 1,738 2,051

18,481 -Impact [With-Without] - - 68 277 321 1,434 -Impact as % of Base 0.0% 0.0% 4.2% 13.8% 13.5% 7.2%Grants -With Phase II [BASE] 245 423 407 421 536 4,964 -Without Phase II 227 287 336 383 467 3,962 -Impact [With-Without] 18 137 70 38 69 1,002 -Impact as % of Base 7.5% 32.3% 17.3% 8.9% 12.9% 20.2%TOTAL EXPENDITURE -With Phase II [BASE] 4,923 6,529 7,511 8,631 10,610 89,461 -Without Phase II 4,849 5,891 7,001 7,901 9,518 81,703 -Impact [With-Without] 74 639 511 730 1,092 7,758 -Impact as % of Base 1.5% 9.8% 6.8% 8.5% 10.3% 8.7%SURPLUS [Million Maloti] 348 614 278 304 304 5,296 SURPLUS [ % of GDP ] 3.0% 3.87% 1.57% 1.5% 1.22% 2.49%

5.3.2.3.1 Income

As is the case with Phase IB, the inclusion of Phase II in Lesotho’s economy will have a significant impact on the income side of the government accounts.

Additional revenue of M8, 109 million (in current prices) will be collected by government as a result of Phase II over the period from 2009 to 2020. This additional revenue will be derived from:

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Source Additional Revenue Percentage Tax Revenue: Customs 4,549 56,1%Tax Revenue: Non-Customs 1,124 13.9%Non-Tax Revenue (incl. Royalties) 1,434 17,7%Grants 1,002 12,4%TOTAL 8, 109 100%

It is important to note that the main source of additional revenue is from Customs. This income stems from SACU receipts, which are based on the significant increase in imports associated with construction of Phase II.

5.3.2.3.2 Expenditure

As far as government expenditure is concerned, it was accepted that this will have to be adjusted downwards in the “without Phase II” scenario in order to keep the deficit on the current account expressed as a percentage of GDP at the same level on a yearly basis as in the “with Phase II” scenario. The impact of this is that government expenditure in total is M7 758 million (in current terms) less in the “without Phase II” scenario than in the “with Phase II” scenario.

The impact of Phase II on the Balance of Payments is reflected in Table 5.10.

5.3.2.3.3 Surplus on the Government Account

As a result of keeping the deficit on the current account, expressed as a percentage of GDP, at the same level in both the “with Phase II” and “without Phase II” scenarios, the absolute surplus on the government account will be negligible. This is because the expenditure will been reduced by more or less the same amount as revenue decreased in the “without Phase II” scenario.

5.3.2.4 Balance of Payments

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TABLE 5.10 PROJECTED IMPACT ON BALANCE OF PAYMENTS COMPONENTS, 2009 - 2020 [CURRENT PRICES]

2009-2020

BOP ACCOUNT COMPONENT 2009 2013 2015 2017 2020 Total Over Period

I. CURRENT ACCOUNT -With Phase II [BASE] -2,870 -5,783 -6,496 -72,082-5,834 -8,947 -Without Phase II -2,601 -4,586 -53,807-3,528 -5,613 -7,240 -Impact [With-Without] -268 -2,255 -1,248 -883 -1,707 -18,275 -Impact as % of Base 9.4% 39.0% 21.4% 13.6% 19.1% 25.4%a) GOODS & SERVICES - Exports: goods and services -With Phase II [BASE] 3,995 4,890 5,518 6,308 7,357 69,753 -Without Phase II 3,995 5,142 5,701 6,283 7,288 67,774 -Impact [With-Without] 0 -252 -183 25 69 1,979 -Impact as % of Base 0.0% -5.2% -3.3% 0.4% 0.9% 2.8% - Imports: goods and services -With Phase II [BASE] -11,353 -15,958 -16,892 -18,913 -23,419 -205,965 -Without Phase II -11,083 -13,708 -15,510 -17,527 -21,041 -184,906 -Impact [With-Without] -270 -2,250 -1,382 -1,386 -2,378 -21,059 -Impact as % of Base 2.4% 14.1% 7.3% 10.2%8.2% 10.2% b) INCOME & TRANSFERS -With Phase II [BASE] 4,488 5,048 5,311 5,889 6,911 65,683 -Without Phase II 4,487 5,053 5,246 5,663 6,561 64,334 -Impact [With-Without] 1 -5 65 226 350 1,350 -Impact as % of Base 0.0% -0.1% 1.2% 5.1% 3.8% 2.1%

II. CAPITAL AND FINANCIAL ACCOUNT -With Phase II [BASE] 1,366 4,033 3,568 3,784 5,953 46,434 -Without Phase II 1,057 1,956 2,623 3,500 5,356 32,832 -Impact [With-Without] 309 2,076 946 597 284 13,602 -Impact as % of Base 22.6% 51.5% 26.5% 7.5% 10.0% 29.3%III. OVERALL BALANCE OF PAYMENTS 1 -With Phase II [BASE] -1,431 -1,678 -2,193 -2,640 -2,922 -24,780 -Without Phase II -1,472 -1,499 -1,891 -2,041 -1,812 -20,107 -Impact [With-Without] 41 -179 -599 -4,673-303 -1,110 -Impact as % of Base -2.8% 10.7% 13.8% 22.7% 38.0% 18.9%

Current account as % of GNP -With Phase II [BASE] -20.7% -32.6% -29.6% -29.0% -33.1% -30.4% -Without Phase II -18.8% -20.8% -24.5% -26.8% -29.0% -23.9% -Impact [With-Without] -1.9% -11.8% -5.2% -2.2% -4.1% -6.5% Capital and Financial as % of GNP -With Phase II [BASE] 9.8% 22.8% 18.1% 16.9% 22.0% 19.6% -Without Phase II 7.6% 11.5% 14.0% 16.7% 21.5% 14.6% -Impact [With-Without] 2.2% 11.2% 4.1% 0.2% 0.5% 5.0%

Balance of Payments account as % of GNP -With Phase II [BASE] -10.3% -9.5% -11.1% -11.8% -10.8% -10.5% -Without Phase II -10.6% -8.8% -10.1% -9.7% -7.3% -8.9% -Impact [With-Without] 0.3% -2.1% -1.5%-0.6% -1.0% -3.5%

1 Errors and Omissions included 5.3.2.4.1 Current Account

As is the case with Phase IB, the deficit on the current account of the balance of payments as a percentage of GDP worsens as a result of Phase II activities.

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This is brought about by a relatively small increase in exports as a result of the inclusion of Phase II water sales (note should be taken of the fact that water sales are only included for a short period).

The net impact on the overall balance of payments is an improvement as a result of the construction of Phase II.

Imports, on the other hand, increase significantly due to the high import content of capital expenditures and the outflow of capital and labour remuneration. However, the negative impact on the trade account of the balance of payments in the “with Phase II” scenario is not offset by increases in components in the income account – i.e. SACU-non-duty receipts, royalties, etc.

5.3.2.4.2 Capital and Financial Account

With regard to the capital and financial account, the construction of Phase II will have a huge positive impact as a result of capital inflows from the RSA to fund Phase II. To a large extent, this is a “book entry” to reconcile the investment that has taken place in Lesotho. The financial burden of this investment is the responsibility of the RSA government and the TCTA is the implementing body situated outside of Lesotho in the RSA.

5.3.2.4.3 Overall Balance of Payments

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CHAPTER 6: THE TREATMENT OF THE VALUATION OF WATER SALES FROM THE LHWP IN THE LESOTHO AND RSA NATIONAL ACCOUNTS

SUMMARY This chapter contains a broad discussion on an alternative approach to capture the impact of water sales in the Lesotho National Accounts.

This alternative approach suggests that the LHWP on the Lesotho economy, than currently reflected in the National Accounts. Recommendations are made on how to address this issue.

6.1 Current stance on classifying water sales in the national accounts

The reason for only using the royalty amount as a proxy of water sales is that

this is the only real “flow of funds” that reaches Lesotho and that can be recorded by the CBL. This is due to the fact that the TCTA, which is responsible for managing all of the financing aspects of the LHWP, is situated in South Africa and not in Lesotho. The largest part of the gross income derived from water sales is used by the TCTA to repay loans and other debt servicing costs (including depreciation, operational costs, royalties to Lesotho, LHDA’s budget etc.).

The manner in which the value of water sales is dealt with will determine the magnitude and the nature of the impact of the LHWP on the economy of Lesotho. Currently, the Lesotho Bureau of Statistics only incorporates water royalties paid to Lesotho by the RSA in the Lesotho national accounts as the income received from the sales of water. This income is shown as an export item in the current account of the balance of payments and as an income item in the government’s account. However, this royalty amount does not represent the total economic value of the water delivered to South Africa, based on the total cost to deliver the water.

One of the arguments that has been put forward for using only the royalty

amount as a reflection of the impact on the Lesotho economy is that this is the only injection of funds experienced.

6.2 Defining the Problem In the course of the research undertaken by Conningarth Economists, it was

established that the manner in which the actual impact of the LHWP was being incorporated into Lesotho’s system of National Accounts does not comply fully with national accounting principles per se. The contention is that this has led to a significant underestimation of the impact of the operational part of the project on the main economic aggregates in Lesotho.

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It is important to note that the actual economic value of the water exported to

South Africa is much more than just the royalties received. This is based on the fact that TCTA actually sells the water to the South African Department of Water Affairs (DWAF) at a predetermined raw water price/tariff.

In order to better understand the flaw in the argument that the only impact on

the Lesotho economy is based on the funds (royalties) that Lesotho receives directly from the TCTA, it is necessary to examine the definitions of Gross Domestic Product (GDP), and Gross National Product (GNP) – the two main criteria used for evaluating economic growth.

GDP is defined as the measure of the total value added of final goods and

services produced within the boundaries of a country within some specific time period (i.e. total value of goods and services produced within the country, less the value of raw materials and other goods and services consumed in the production process)1). It is important to note that this definition does not specify the owner of the product being produced, only the location where the products and services are produced.

The measure of GNP is very similar to GDP. However, it does differ in one

important respect. GDP measures the value of domestic production, i.e. the value of production within the boundaries of a country. GNP, on the other hand, measures the value of remuneration of Lesotho’s own production factors (labour and capital), irrespective of where they reside.

GNP = GDP – foreign factor payments + foreign factor receipts

In national income accounting convention the inclusion of the word ‘Gross’ indicates that the measure includes depreciation of existing capital stock. Hence GDP, GNP, gross domestic fixed investment, etc., all include the value of depreciation. It will be realised that the definition of GDP as the value of final goods and services produced within national boundaries automatically includes depreciation. This happens because producers make provision for

In Lesotho, there is a marked difference between the value of GDP and GNP.

The difference lies with Basothos who live and work outside the country (mostly mine workers) and remit income back to Lesotho. The correct terminology for these financial transfers is “net foreign factor receipts” – the difference between factor payments remitted to Lesotho and those leaving the country. Therefore, the definition of GNP is as follows:

A further concept that is critical to understanding the counter argument to the use of royalties only as a measure of water sales, is Net National Product (NNP). In national income accounting convention the inclusion of the word “Gross” indicates that the measure includes depreciation of existing capital stock, hence GDP, GNP, Gross Domestic Fixed Investment, etc.

1) The definitions of National Accounting Measure are taken from Economics, Principles & Practice

by Black, Hartzenburg and Standish. Pitman Publishing, 1995. Pages 140 to 142.

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depreciation which is included in the sales price of their goods and services. At its simplest level depreciation can be seen as the value of machinery “used” during the course of the production process. When producers plan their marketing strategies, prices will include not only the returns to factors of production (wages, profits, etc.) but also the cost of new machinery needed to replace worn out machines.

The technically correct way of dealing with the economic impact of water sales on the Lesotho economy would be as follows:

NNP: finally, this is derived by deducting depreciation from GNP. This value should not be less than be almost equal to the value of the royalties.

GDP and GNP therefore include not only the returns to the owners of factors of production but also provisions for depreciation and gives, as a result, a better indication of the return to the owners of factors of production. This is generally considered a more accurate way of assessing changes in the economic welfare of a country.

NNP = GNP - depreciation

These definitions demonstrate that by only using royalties as the return to owners of production, the value of water is based on a grossly underestimated value added configuration. The fact that only royalties are currently being used as the measure of the value added of water sales in the calculation of both GDP and GNP in Lesotho’s national accounts therefore does not comply with the definition of these two gross aggregates. This leads to an underestimation of these national accounting measures with the result that all of the indicators of economic performance that are based on these measures (i.e. GDP growth, per capita GDP, etc) and that are used to evaluate the success of an economy are incorrect and give an undervalued perspective of Lesotho’s economic performance. This means that Lesotho is being incorrectly evaluated by providers of loans, investors, etc. with the result that Lesotho may well not receive its fair share of international financial support.

GDP = C + G + J + X - M GDP: in this instance, the total gross value added of water production (sales)

should be included in GDP via exports less imports. GNP: this is derived by deducting from GDP interest payments on loans

associated with the LHWP, remuneration paid to foreign employees, and profits (dividends) that are remitted to RSA.

Given the fact that the total value of water sales will be significantly higher

than the royalty figure, GDP and GNP will now be a more accurate reflection of Lesotho’s overall level of economic activities.

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Impact of the Alternative Water Valuation Approach on the Lesotho Economy in respect of Phase 1A

In this section, the impact of the alternative method of accounting for the total value of water sales associated with Phase 1A in the broader national accounts of Lesotho will be demonstrated. The actual position in respect of the Phase IA water industry production structure is given in Table 6.1.

5.01 Value added (GDP) = M360.93 million

TABLE 6.1: WATER INDUSTRY PRODUCTION STRUCTURE:

PHASE IA FULL CAPACITY [MILLION MALOTI – 1995 PRICES]

Intermediate inputs Salaries and wages Gross operating surplus (GOS) Government revenue (water royalties)

109.26

6.33 245.34

Total water sales 365.94

- Volume (million cubic metres)

529.8704

Source: Trans-Caledon Tunnel Authority (TCTA)

Total water sales is derived by multiplying the Tariff (M0.69 per cubic meter) with the average volume of water delivered by Phase 1A at full capacity (529.9 mcm). The tariff is equal to the so called unit reference value of water that is calculated by taking into account the full costs of the water delivered by the project over the period, and multiplied by the volume of water delivered over time.

Intermediate inputs consist mainly of operational and maintenance costs e.g.

spares, administration etc – calculated by TCTA

Salaries and wages include annual expenses on operational staff as well as head office allocated salaries and wages– calculated by TCTA

Water royalties is determined by the treaty– calculated by TCTA

Gross Operating Surplus is calculated as a residual by taking total water sales and deducting intermediate inputs, salaries and wages and government revenue (water royalties).

Water sales:

- Tariff (cents per cubic metre)

mcm 69 c

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Currently, only M109.26 million is being reflected as the value of water sales in GDP, GNP and NNP in the Lesotho national accounts. However, using the alternative proposed method of valuing water sales, M360.93 million (salaries and wages: M6.33 million + GOS: M245.34 + water royalties: M109.26 – see Table 6.1) would be included in GDP, GNP and NNP. The difference between these two approaches to valuing water sales amounts to an underestimation of GDP of M251.67 million. The GNP will be less effected due to the fact that the outflow of interest on capital borrowed and remuneration paid to foreign workers would reduce GDP substantially. However, the positive impact on GNP is still more than the impact of the royalties because it includes the value of depreciation.

The different results produced by the two alternative methods of valuing water

sales associated with Phase 1A is shown in Table 6.2. Results are given for GDP and GNP.

TABLE 6.2: GROWTH RATE OF THE GROSS DOMESTIC PRODUCT AND THE GROSS NATIONAL PRODUCT, 1994-2002

Growth rates1) (1994 - 2002) Actual Adjusted Percentage

Point values values Difference Gross Domestic Product 3.53% 4.41% 0.87% Gross National Product 0.26% 0.57% 0.31%

1) Growth rates based on data expressed in 1995 prices.

The officially reported value of GDP (based on royalty income only) has increased at a rate of 3.53% per annum over the period 1994-2002. Adjusting this figure to incorporate the total value of water sales will increase the growth rate of GDP over the period to 4.41%, an increase of 0.87 percentage points per annum. This amounts to a 25% increase in GDP growth, which is a substantial improvement.

In order to calculate GNP, the GOS of M245.34 million must be broken down into its two main components, i.e. capital remuneration and depreciation. Table 6.3 reflects the percentages used to achieve this breakdown, and the parts of these two components that flowed out of the Lesotho economy, expressed as a “leakage %”. It is further assumed that ± 16% of the labour remuneration of M6.33 million that is associated with Phase IA for operational purposes flows directly out of the country.

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TABLE 6.3: IMPORT LEAKAGE RATIOS

GOS components Breakdown % Leakage % Interest payments/profits/dividends Depreciation

70,0 30,0 0,0

100,0

Total GOS (excluding royalties) 100,0 100,0

Impact of Phase 1B on the Lesotho Economy using the Alternative Water Valuation Methods

A similar analysis has been undertaken for Phase 1B. The differential impacts

on both GDP and GNP are presented in Table 6.4.

TABLE 6.4: IMPACT OF PHASE 1B ON THE LESOTHO ECONOMY USING THE ALTERNATIVE WATER VALUATION METHODS

Impact expressed as a Percentage of the “with Phase 1B”

scenario for the year 2007 Royalty Income Only Alternative Proposed Water

Valuation Method GDP 3.44% 5.32% GNP 2.81% 4.3%

Table 6.4 indicates that for that particular year, GDP in particular shows a

significant rise.

The way forward

The peculiar characteristics of the management structure of the operational part of the LHWP, based on the Treaty, gave rise to the fact that the intrinsic size and value of the impact of Phase I of the LHWP on the Lesotho economy is somewhat underestimated in terms of the main national accounting aggregates. The relative size of the deviations are demonstrated in the tables above.

It is recommended that in future the national accounts of Lesotho be adjusted

to incorporate this alternative method of valuing water. This alternative method should also be used for future planning purposes so that future exports of water reflect its full economic value and not just the royalties received.

Furthermore, cognisance must be taken of the proposal made that this issue of

water valuation be pursued by a committee of experts from the BOS, the IMF and the World Bank to establish the appropriate method of valuing the sales of water from the LHWP to the RSA in Lesotho’s national accounts.

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CHAPTER 7: SUMMARY, CONCLUSIONS AND RECOMMENDATIONS

Chapter 7 provides a summary of each of the previous chapters in chronological order. This is followed by a summary of guidelines/recommendations on both the macro and micro levels.

SUMMARY

7.1 Introduction

The main objective of the study was to “…establish systems to monitor the actual LHWP macroeconomic impact to date, and forecast the economic impact of likely Phase II activities on key indicators in the economy…”1) . In the process of doing this, it was required that the consultant would make a thorough study of Lesotho’s economic performance since the commencement of the LHWP, as well as review previous studies that have analysed the impact of the LHWP on Lesotho’s economy.

7.2 Overview of the LHWP and the Lesotho Economy (Chapter 2) Chapter 2 provides a summary of the main characteristics of the Lesotho

economy over the period 1990 to 2001. From this analysis, it is clear that the LHWP has had a significant impact over this period. The economy went through a period of slow growth in the first half of 1980s. Since the inception of the Project in 1986/87, the economy’s performance level has improved considerably.

On the fiscal front, a combination of fiscal restraints, tax reforms and increased imports (and, hence, SACU receipts) have jointly benefited the fiscal stance directly. Through the introduction of policies designed to raise revenue and cut expenditure, government has managed to secure a surplus in its budget for a number of years.

Increased LHWP capital expenditures, which also contributed to an improved fiscal position, plus foreign direct investment in the textile industry, have counteracted the fall in foreign labour income derived from miners working in the RSA, and the resultant decline in private consumption expenditures. On the supply side, these changes have jointly increased the relative share of domestic output in GDP through the increased value added of the manufacturing, electricity and construction sub-sectors in particular. It appears from this analysis that LHWP expenditures have produced responses from specific sectors of the economy and, hence, have had positive

1) Terms of Reference – Scope of Services. Methodology Supplement.

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implications for the growth of output, employment and stability in the balance of payments. The project’s major lasting effect has been on the contribution of the electricity and water sectors and, to a lesser extent, the construction sector. Together with increased water exports, the LHWP has succeeded in cushioning the rather serious decline in the remittances of Lesotho mine workers from the RSA.

7.3 Review of Previous Studies Relevant to the LHWP (Chapter 3)

Based on the injunction from the client (LHDA), the consultants were obliged to use the current macroeconometric model of the Central Bank of Lesotho’s (CBL) modelling system as a main driver of a new sectoral orientated impact modelling system. Also, a condition was that, whatever the outcome of the model building exercise, the CBL –model should remain technically intact for the purposes of the Central Bank.

After a thorough investigation by the consultants in collaboration with the CBL-staff and Mr. Doggett, who undertook the previous macroeconomic comparative study in 1996, it was found for a number of reasons, that a new framework for the analysis of Phase IB and forecasting of Phase II, had to be constructed. This new framework consists of the following:

- A linkage between the CBL macroeconomic demand variables and the

final demand components of the various sectors, as presented in the SAM, forms the basis of the new modelling system

- Equations were developed to estimate the total output of each sector as a function of its sales to all other sectors and each category for total final demand in the macro model, with appropriate adjustments for imports.

- Solving the system requires an iterative solution procedure within the sectoral component itself, before going on to the estimated value added / GDP at factor costs for the iteration of the CBL model

The main benefits of this DSAS system are that, for the first time, information on gross domestic product (GDP), production and labour can be provided by both the macroeconomic model and the sectoral system in a coordinated and interactive way. Thus, the sectoral system enhances the entire modelling system and is able to provide much more data than the aggregated annual data that is characteristic of macroeconomic models in general.

7.4 The Impact of Phase IB of the LHWP on the Lesotho economy 7.4.1 Background

In Chapter 4, the asset and activity structure of Phase IB is reclassified in order to derive the exogenous variables that “kick start” the DSAS

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model. Both the capital expenditure and operational elements of Phase IB are analysed.

Using the latest available data from the LHDA database regarding expenditures on Phase IB, and breaking these down into the levels required by DSAS, the construction and operational parts of Phase IB will impact on the Lesotho economy on the following levels:

• The demand for the products of the various sectors

of the economy of Lesotho through the direct investment in project deliverables

• Induced private investment in Lesotho • The value added of construction activities • Exports from Lesotho in terms of the royalties paid

to South Africa • Factor payments flowing out of the Lesotho

economy and impacting on the current account of the balance of payments

7.4.2 Results for Phase IB: Impact on the Lesotho Economy, 1994 – 2007

(including the operational phase)

There is no doubt that Phase IB’s impact on the Lesotho economy over the above mentioned period can be regarded as significant. Its impact on the main economic aggregates is summarized in Chapter 4.

Macro level

In the case of the “without Phase IB” scenario, GDP grew at a slower rate (i.e. by 0.71 percentage points per annum using the annuity principle, and by 0.19 % using the point-to-point growth rate). To some extent, the same tendency was experienced with GNP. However, the discrepancy over the total period is much less, and amounts to 0.16 % per annum.

The impact of Phase IB has elevated GDP per capita by approximately 4.79 percent over the period, but due to leakage factors, the GNP per capita increases by only 3.70%

In overall terms, the presence of Phase IB has increased growth rates in private consumption expenditure, private fixed investment, however, not materially.

Sectoral level

The electricity and water and construction sectors benefited quite substantially from Phase IB activities. It is important to note that Phase IB’s export income was included for only 4 years (i.e. 2004 – 2007).

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However, if Phase II does not materialise, the construction industry will slow down dramatically.

Employment It is expected that Phase IB will crate new employment opportunities equivalent to 29,030 person-years over the period 1994 to 2007. Included in this figure is 14,500 person-years derived from direct job opportunities created by Phase IB.

The balance of 14,530 person-years is made up of indirect and induced job opportunities, mainly created in those sectors that link backwards from the construction activities of Phase IB and the employment opportunities created as a result of salaries and profits that are ploughed back into the economy.

Government Accounts The impact on Government’s accounts are noteworthy. The surplus before borrowing averages about 3.8 percent of GDP over the entire period. Balance of Payments As far as the current account of the balance of payments is concerned, the construction phase has had a negative impact on the current account of the balance of payments. However, as construction activities taper off, the effect on imports subsides. With regard to the capital and financial account, the construction of Phase IB has had a huge positive impact as a result of capital inflows from the RSA to fund Phase IB. The net impact of Phase IB on the total balance of payments is an improvement in the overall position

7.4.3 Comparing Results with Earlier Studies

The key objective in reviewing earlier studies was to determine to what extent future phases of the LHWP could be managed so as to ensure that the developmental impact on the Lesotho economy and its citizens could be maximized.

The studies under consideration can be divided in to two broad categories, i.e:

• those that were done before Phase 1A actually commenced, which

concentrated on establishing its economic/financial viability and possible economic impacts on important elements of the Lesotho economy; and

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• those that were undertaken at a later stage, when Phase 1A was nearing completion and Phase IB was in its initial phase.

There is no doubt that the LHDA has commissioned a number of very valuable studies that have provided a far better insight into the actual workings of such a large capital intensive project in all its main facets. This is particularly true of the lessons that have been learned regarding what can be done at a micro level to enhance the Lesotho component’s chances of obtaining a larger slice of the economic impact of the LHWP. By studying previous investigations of the possible and actual impacts of Phase 1A on the Lesotho economy, a sound base was provided for the consultants to create a new macroeconometric modelling system that would more closely match the peculiarities of the Lesotho economy and the LHWP. One example is the use of the Social Accounting Matrix (SAM) in conjunction with a macroeconometric model developed by Coopers and Lybrand in 1989/90.

Another study that deserved attention was the so-called TRC study2 commissioned by the LHDA in 1996 to investigate the actual outcome of Phase 1A activities on a micro level, and compare these with the projections made in previous studies. This important study presented a wide range of findings and made a number of recommendations for improving the situation with regard to Phase IB and further phases of the LHWP.

The Doggett Study

One of the most important requirements of this study was a comparison of the actual outcomes of the Phase IB impacts on the Lesotho economy with the forecasts made by Doggett in 1996.

This comparison was bedevilled by the fact that the actual time path of Phase IB expenditures was shifted forward by about 3 years as compared to Doggett’s forecast. As a result, it was practically impossible to make year-by-year comparisons that make any meaningful sense. This problem was overcome by comparing the total impact over the entire period. Using this approach, the nature and magnitude of the impacts of Phase IB on the Lesotho economy were in fact very similar. Due to structural changes in the Lesotho economy, the actual impact of Phase IB investments was slightly larger than Doggett had foreseen in 1996, except in the case of the impact on GDP.

Specifically, building and construction received a much larger “kick” from Phase IB than was originally foreseen. From a developmental perspective, this is positive as this signifies that the LHDA has succeeded in enhancing the

2) Freeman “Economic Impact” 1996.

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economic impact of Phase IB on Lesotho citizens through a broad range of policy initiates.

7.5 The Impact of Phase II of LHWP on the Lesotho Economy (Chapter 5)

7.5.1 Background

The LHDA required that the consultants estimate the impact of Phase II of the Lesotho Highlands Water Project on the Lesotho economy. The main objective of this portion of the study is to use information presently available on the nature and magnitude of Phase II of the LHWP, as well as other relevant data, to appropriately adjust and populate the relevant exogenous variables of the DSAS model for the purpose of quantifying Phase II impacts.

Main Characteristics of Phase II

Phase II of the LHWP consists of a storage dam of about 170m high at Mashai site (Mashai dam), a pumping station, and a 19km long conveyance between the Mashai and Katse reservoirs, plus an additional conveyance system from the Katse reservoir northwards to the Vaal River system, and another hydropower plant at Muela.

The additional conveyance system from Katse to the North will be designed to pass the total firm yield added by Phase II, III and IV - if and when they occur. Phase II will increase the yield of the LHWP by about 25 m3//ss and will increase hydropower by approximately 85 MW. In addition to these direct physical structures of the project, additional power and telecommunication lines will have to be constructed to transport increased power and to connect the Mashai, Muela and Katse stations respectively. New roads will also have to be built to connect project areas. As in Phase I, Phase II will also have social and environmental costs associated with the loss of arable and grazing lands and dwellings due to flooding of reservoirs and construction works.

Main Expenditure Components

The original planning and costing of the Phase II element of the LHWP was undertaken by Macdonald and Shand in 1986 (using 1985 prices). Conningarth Consultants used this information, updated the prices to 1995 levels and used the original time scheduling of the different project deliverables to estimate the expected course of developments if Phase II was to start in 2009. The whole project will take ± 13 years to complete and, in current prices, would amount to ± M1.5 billion.

7.5.2 Comparative Results With and Without Phase II

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A number of noteworthy aspects came to the fore out of the forecasting exercise with Phase II of the LHWP included in the Lesotho economy and one where it is excluded.

• One important aspect is that with Phases IA and IB well

embedded in the Lesotho economy ex – 2009, the structure of the Lesotho economy has become more diversified. The inclusion of Phase II will push the GDP growth rate up by more than 1 percentage point per annum – which is not to be discarded as a long-term goal.

• The private fixed investment prognosis do not seem so dependent on the inclusion of Phase II anymore as compared with the same exercise for Phase IB. (See Chapter 4, Table 4.9). Nevertheless, private fixed investment growth will rise by ± 1.5 percent per annum faster, on average, over the period if Phase II is included. However, one can expect it to decline towards the end of the period.

• Perhaps the most interesting result of this comparative exercise is re-establishing the fact of the government’s benefitting from the additional tax and non-tax related income generated by such a big project.

• As is the case with Phase IB, the deficit on the current account of the balance of payments as a percentage of GDP worsens as a result of Phase II activities.

With regard to the capital and financial account, the construction of Phase II will have a huge positive impact as a result of capital inflows from the RSA to fund Phase II. To a large extent, this is a “book entry” to reconcile the investment that has taken place in Lesotho. The financial burden of this investment is taken care of by the TCTA, which is situated outside of Lesotho in the RSA. The net impact on the overall balance of payments is an improvement as a result of the construction of Phase II.

• In general, the exercise has provided sufficient information that the inclusion of a Phase II type of project in the Lesotho economy as soon as possible would, on balance, have beneficial results for the community as a whole. Assuming further that a new institutional arrangement between South Africa and Lesotho, to manage the construction and operation of such a project, could come about, it would hopefully strengthen Lesotho’s ability to secure a larger portion of the project’s developmental impacts over the short as well as longer term. It is also clear , however, that the project would not serve as a panacea for Lesotho’s well known structural problems such as poverty; low skills

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levels; high propensity to import; low savings ratios etc.

7.6 The Treatment of the Valuation of water sales of the LHWP in the

Lesotho and RSA National Accounts (Chapter 6)

Currently, the Lesotho Bureau of Statistics (BOS) only incorporates water royalties paid to Lesotho by the RSA in the Lesotho national accounts as the income received form the sales of water. This income is shown as an export item in the current account of the balance of payments and as an income item in the government’s account. However, this royalty amount does not represent the total economy value of the water delivered to South Africa, based on the total cost to deliver the water. It was further established that this practice does not comply fully with international guidelines for national accounting compilation. The contention is further that this has led to a significant underestimation of the impact of the operational aspect of the project on certain economic aggregates in Lesotho, especially GDP. It is important to note that the actual economic value of the water exported to South Africa is much more than just the royalties received. This is based on the fact that the TCTA actually predetermines raw water prices/tariffs so that all reasonable costs are covered. For the purpose of the present study, it was decided to adhere to the existing practice of incorporating only royalties paid in the Lesotho national accounts and, specifically, in GDP and GNI aggregates. It is recommended that this practice be rectified as soon as possible and brought into line with international norms.

7.7 Guidelines/Recommendations for Future Projects

7.7.1 Background

- The main objective of this study has been to measure the actual macroeconomic impact of Phase IB on Lesotho’s economy, and to project the impact of Phase II. The study has generated estimates for the actual impacts of Phase IB and forecasts of Phase II’s impacts on total GNP and GDP, and on per capita GDP and GNP, as well as key sectoral impacts. It also identifies the impact on public finances and the current account of the balance of payments. Given the summary of the findings provided above, it is reasonable to assume that these objectives have been attained.

- Another important aim of this study was to develop guidelines for

measuring Phase II impacts, based on Phase IB experience, and to compare these results with other similar studies. Furthermore, the

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study was required to identify missed opportunities and constraints to maximizing the phase IB budget, as well as to provide preliminary, broad guidelines for estimating and optimizing the economic impact of phase II of the LHWP.

7.7.2 Guidelines / Recommendations

(i) Macro – Level

(a) The exercise of quantifying the impact of Phase II of the LHWP on the Lesotho economy proved that, in terms of the parameters set, it is a sound infrastructural investment project. (Determining the financial viability of Phase II was not part of the consultant’s brief). There is no reason to believe that implementation of this second phase would lead to serious distortions in the Lesotho economy.

(b) The study has determined that the way in which the exports of water

have historically been recorded in Lesotho’s National Accounts might not be the most appropriate method for planning purposes. It has also been established that the current approach does not conform with the guidelines provided by the United Nations for treating this issue in a country’s National Accounts. This has led to an under-accounting of up to 1 percentage point per year in GDP for Phase IA.

It is

It is recommended that, for future planning purposes, this adjustment to the national accounts be made so that the exports of Lesotho’s water to South Africa reflects its full economic value and not just the royalties paid. In this regard, cognisance should be taken of the proposal made by the World Bank that the issue be pursued by a committee consisting of experts from the BOS, the IMF and the World Bank. This committee should determine in more detail how this would affect the relevant components of the national accounts of Lesotho.

(c) The major responsibility for managing the operational side of Phases

IA and IB rests with the TCTA, which is a South African based parastatal. This situation contributes to the measure of confusion that exists regarding whether, in Lesotho’s national accounts, the full economic value of water exports should be incorporated or not.

recommended that an investigation be undertaken to examine the possibility and implications of Lesotho taking greater responsibility for the management of future phases of the LHWP. Such an investigation should be completed before renegotiations commence for a new bilateral Treaty involving future phases of the LHWP. Most likely, there were sound technical and financial reasons for using the TCTA as a management vehicle. However, the situation may well have changed to the extent that it is now worth while for Lesotho to take more direct responsibility for the management of future water transfer schemes.

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This would most certainly enhance Lesotho’s accessibility to the net benefit of the utilization of its main renewable economic resource.

(d) The government sector plays a pivotal role in the Lesotho economy. As

such, it presence should feature correctly in the DSAS model policy for future planning purposes. Government’s expenditure activities are mostly regarded as exogenous (independent) in nature. In other words the government (through political processes) is the main determinant of the structure and growth of its spending activities. On the income side, it does have the power to influence expenditure through tax policies. However, much also depends on the growth in the economy and these various tax bases. It was, therefore, incumbent on the researchers to forecast as accurately as possible, probable outcomes of government spending and income tendencies over time. In previous exercises, assumptions were made that historical tendencies in government expenditures of such activities will continue into the future. On the income side, so called behavioural functions were used to forecast government income components over time. It is believed that it has improved the outcomes of Phase II forecasts.

It is recommended that more intensive research be done on a future long-term fiscal strategy for the Lesotho Government, especially if Phase II of the LHWP is to become a reality. This would ensure the optimal utilization of “surplus” resources that will be generated by such a big project. An important aspect is that care should be taken not to unnecessarily base long-term expenditure plans on short-term income movements caused by a large capital project such as the LHWP.

(e) All phases of the Lesotho Highlands Water Project were planned

simultaneously. Except for the initial planning that was already undertaken in 1985, no further development work has been done on Phase II of the project. As such, the validity of the data (although adjusted for inflation) could be questioned as a result of the time that has elapsed. It would be more appropriate that all aspects of the project (even the engineering aspect) be fundamentally reviewed before a more reliable forecasting exercise in respect of its expected costs is undertaken.

It is recommended that a more up-to-date costing and engineering study of Phase II should be performed before analysing the impact of its expected capital expenditure on the Lesotho economy. Such up-to-date information on crucial aspects of the project (i.e. the import content of capital goods, labour skills needs and indigenous inputs, phasing of sub-divisions of the project, etc) could enhance the quality of the DSAS model’s outputs on projected economic impacts. It will also improve the efforts of the LHDA to secure a larger slice for Lesotho citizens in the overall budget of the project through more specific contractual requirements that can then be entrenched in a new bilateral Treaty.

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(ii) Micro - Level

As indicated in this report, since 1999, the LHDA has commissioned a study to assess the actual impact of Phase IB expenditures on Lesotho citizens. This has been, to some extent, an extension of the TRC project undertaken in 1996 and other studies.. Having evaluated as much of the information emanating from these studies as was possible within the constraints of the brief, the consultants’ assessment of progress in this regard is presented in the Methodology supplement. However, a number of important areas that require further attention are as follows:

(a) The TRC report recommended that the LHWP Treaty be amended to

affect a more enabling environment for local participation. Based on information provided by the LHDA, many of these areas have, de facto, been successfully addressed in Phase IB without re-negotiation of the Treaty. Nevertheless, it is recommended that, for future large water transfer projects, the Treaty be reviewed in the light of the findings of the LHDA’s studies. This will be of particular importance given Lesotho’s proposed more direct responsibility in the management of the operational aspect of the project.

(b) Research has shown that the Lesotho Fund for Community

Development (LFCD) should become more important as a vehicle through which the financial benefits of the LHWP will be channeled back to the nation to strengthen its long-term growth and development potential. It is recommended that the LFDC’s delivery capacity be strengthened, including its long-term funding position:.

(c) The ability of Lesotho to secure more of the benefits of future LHWP projects will, to a large extent, be determined by the level of skills available to assume the various ranges of tasks that involve the building and construction of huge water delivery systems. The LHDA, in liaison with government departments, has invested a considerable amount of effort in determining the skills needs of the LHWP, and has been establishing training programs to provide the local people with the opportunities to take part in construction related activities.

It is recommended that the system structures that were put in place to enlarge the pool of skills (especially semi-skilled and skilled) in respect of Phases IA and IB of the LHWP should be retained in order to enhance the response capability of the Lesotho manpower resources with regard to further phases of the LHWP.d) Linking up with the previous recommendation, it is further recommended that additional measures be taken to enhance the capacity of local entrepreneurs to supply goods and services on a much larger scale than has been the case until now (with the exception of main contractors, sub-contractors, consultants

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etc.). However, the sectoral impact results did not point towards any noteworthy improvements for manufacturing.

(e) The project development areas and their natural environments appear

to represent potential for tourism. It is, therefore, recommended that the tourism potential of the large dams and the natural environment surrounding them should be exploited more vigorously. The creation of the new Tourist Development Corporation is a step in the right direction. The participation of local SMMEs in the tourist industry is of vital importance. Liaison with South Africa and other international tour operators and tourism parastatals can be of great help.

(f) In conclusion, reference should again be made to the transitional

benefits (e.g. training opportunities, construction jobs, local business contracts, etc.) and permanent benefits associated with Phase IB (e.g. upgraded water supply, sanitation, electricity, access roads, etc.). These benefits arise mainly at a micro level, whilst their maximization is largely dependent on the policy actions taken by government and the LHDA. In order to ensure that these benefits are realised, it is recommended that the policy guidelines developed in this report be embedded (as far as is practically possible) in a new Treaty.

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BIBLIOGRAPHY AD HOC STUDIES Black, Hartzenburg and Standish “Economics, Principles & Practice” Pitman Publishing, 1995. Pages 140 to 142. Conningarth Consultants “Socio-economic impact of the Komati River Basin Development Project with Special Reference to Irrigation Agriculture” Water Research Commission Report No. 888/1/00.

Ralph M. Doggett Economic Consulting “A Macroeconomic Analysis of the Lesotho Highlands Water Project, Volume I” May 1996.

Coopers and Lybrand “Lesotho Highlands Water Project Phase IA Economic Impact Study, Supplement to the Main Report” May 1990. Freeman, P.N.W. et al “LHWP Economic Impact Study Report, Volume 2, Assessment of the Economic Impact of Phase IA, Recommendations for Phase IB” Baffoe & Associates (Pty) Ltd. LHDA Contract No. 1023 1996. Lahmeyer Macdonald Consortium and Olivier Shand Consortium “Feasibility Study of the Lesotho Highlands Water Project” April 1986. Lesotho Highlands Development Authority Economics Section “The Economics of Phase IB” April 1998. Lesotho Highlands Development Authority “The Impacts of the LHWP: Analysis of the Microeconomic Impacts” April 2003.

World Bank “Lesotho Growth Options Study” January 2003. World Bank “Report No. 17727 – LSO Project Appraisal Document on a Proposed Loan to LHWP-Phase IB” April 1998.

INTERNAL LHDA SOURCES Lesotho Highlands Authority Database. Lesotho Highlands Development Authority Long Term Cost Plans.

INTERNAL CBL DOCUMENT

R. Masenyetse, G. Kamaray “Lesotho Macro- Econometric Model” Draft Final. PUBLICATIONS

163

Central Bank of Lesotho “Annual Report” 1990; 1992; 1994; 1996; 1998; 2000; 2001.

Bell, C. et al “Project Evaluation in Regional Perspective” World Bank 1980.