A Fiscal Vulnerability Indicator for Lesotho

The objective of this paper is to construct a fiscal vulnerability indicator for Lesotho using annual fiscal and macroeconomic data from 1993 to 2017 and a Dynamic Debt Equation for calculating Fiscal Vulnerability (DDE-FV) that estimates a debt stabilising primary balance. A normal fiscal vulnerability range of 2 to 4 percent of GDP and a severe fiscal vulnerability range of 8 to 10 percent of GDP were identified. Results show few periods of severe fiscal vulnerability compared to normal fiscal vulnerability episodes from 1993 to 2017. The severe fiscal vulnerability was observed in two out of the 25 years. The normal fiscal vulnerability was observed for 11 out of the 25 periods. Lesotho’s fiscal policy was above the normal fiscal vulnerability threshold between 1992 and 2001 before returning to levels largely within the tolerable fiscal vulnerability level for the remainder of the 1993-2017 period.


Introduction
In the immediate aftermath of the global financial crisis of 2007/08, interest in literature on fiscal policy experienced a significant rise. This is evidenced by an increase of empirical studies whose themes range from fiscal stress, public debt, debt limits, and fiscal solvency (Mendoza & Ostry, 2008;Berti et al., 2012;Ghosh et al., 2013;Mauro et al., 2015;Lorenzoni & Werning, 2019) to studies with a focus on fiscal vulnerability and fiscal sustainability (Stoian, 2010;Baldacci et al., 2011;McHugh et al., 2011;Jedrzejowicz & Koziński, 2012;Stoian et al., 2018). Similarly, in the wake of the global outbreak of the Corona Virus Disease of 2019 , fiscal policy literature finds itself back in vogue with policymakers as broader implications of unsustainable fiscal positions are discussed, including the consequences for monetary policy and financial stability. This owes to the How to cite this paper: Damane, M. (2022). A Fiscal Vulnerability Indicator for Leso-financial and economic consequences of the COVID-19 outbreak which are expected to lead to sizeable increases in fiscal deficits and public debt ratios around the world. The fiscal costs of the virus will mainly be the result of infection-control measures that will necessitate sharp increases in health expenditure by governments, coupled with tax and spending initiatives to support people and firms affected by the disease. Based on anticipated policy responses 1 , fiscal balances are expected to severely deteriorate around the globe. This is especially true in emerging markets and developing economies. The reason is their heavy reliance on commodity exports and their relatively greater vulnerability to various shocks that include the pandemic, worsening financing conditions, weak external demand and declining terms of trade (lower prices of export commodities) (IMF, 2020;World Bank, 2020).
In the case of Lesotho, a small open economy that operates under a fixed exchange rate regime 2 with strong macroeconomic linkages with the rest of the world, COVID-19 infection-control measures are anticipated to result in significant tax revenue declines together with large scale public spending pressures as the government moves to mitigate the health and economic impacts of the disease. This likelihood would be coming on the heels of an already stressful fiscal situation for the country. Lesotho's main source of revenue is its receipts from the Southern African Customs Union (SACU 3 ) revenue-sharing pool 4 . The aftermath of the global financial crisis of 2007/08 brought with it a significant slowdown in economic growth and a deterioration in the fiscal balances of SACU member countries. This weakened fiscal position was largely the result of significant reductions in SACU transfers and elevated levels of government expenditure 5 . Figure 1 presents trends in the government of Lesotho's (GOL's) revenue components as percentages of total revenue for the period 1991M1 to 2018M12.
Over the review period, Lesotho's share of SACU receipts roughly averaged 46.29 percent of total revenue, with domestic tax revenue's share of the same averaging 37.69 percent. From the 2005/06 to the 2013/14 financial years, Lesotho's SACU receipts grew from roughly 14 percent of GDP to 24 percent of GDP. This development was coupled with high levels of government expenditure, most notably the wage bill, which doubled as a percent of GDP on account of salary hikes. SACU receipts (and GOL total revenue, by extension) started to dwindle 1 Stabilisation packages to mitigate the effects of unemployment and business closures given infection-control actions (that have disrupted the economy) can include 1) government purchases, 2) income tax cuts 3) unconditional transfers, unemployment income 4) and 5) liquidity assistance to distressed firms (Faria-e-Castro, 2020). 2 Lesotho operates under a fixed exchange rate regime where the country's currency, the loti is pegged at par with the South African currency, the rand. 3 The Southern African Customs Union (SACU) consists of Botswana, Lesotho, Namibia, South Africa, and Eswatini. The SACU Secretariat is located in Windhoek, Namibia. SACU was established in 1910, making it the world's oldest Customs Union. 4 Customs and excise duties collected by SACU members are pooled and distributed quarterly, based on a revenue-sharing formula negotiated by the member countries. 5 When SACU revenues were buoyant (around the 2005/06 to the 2013/14 financial years), the public sector wage bill expanded to one of the largest in the world thus creating fiscal rigidities that manifested into financing challenges (IMF, 2019).  considerably after the 2014/15 financial year alongside a slowdown in South African import growth. This reflected the procyclical nature of the SACU receipts that largely follow economic growth conditions in the region. During this time, the GOL wage bill remained stubbornly high, causing a depletion of the fiscal and reserve buffers in subsequent years. At the tail end of the 2017/18 financial year, the GOL ran out of the fiscal space to draw down on its deposits with the Central Bank of Lesotho (CBL) without threatening the level of reserves required to support monetary policy operations. Consequently, rather than jeopardize the rand-loti peg, the government (not able to fully finance the deficit via shallow domestic markets 6 ) experienced delays in certain domestic payments. The result was a build-up of GOL payment arrears (IMF, 2019). With Lesotho's fiscal difficulties in mind, one of the major lessons from the 2007/08 global financial crisis was the emphasis on the importance of having in place early warning systems that can be used to identify risks and vulnerabilities to fiscal and macro-financial stability. Analytical work on the assessment of fiscal vulnerability and early warning systems of potential fiscal distress (see IMF, 2008IMF, , 2011IMF, and 2012Jedrzejowicz & Koziński, 2012;Berti et al., 2012;Stoian et al., 2018) has proven that a country's ability to detect fiscal risks early allows for the effective coordination of timely policy responses that are crucial in an interconnected and globalised world. Against the foregoing background, the objective of this paper is to develop a fiscal vulnerability 7 indicator for measuring fiscal vulnerability in Lesotho. The indicator is expected to provide early warning (short-term) signals on roll over problems by being able to track key fiscal indi-6 Efforts to finance the deficit initially fell short as only 50 percent of the bonds auctioned in the first half of the 2018/19 fiscal year were subscribed (IMF, 2019). 7 In a similar way to Hemming et al. (2003); Hemming and Petrie (2002) and Stoian (2010Stoian ( , 2012Stoian ( , 2013, the paper defines fiscal vulnerability in the context of the government's ability to achieve its macroeconomic objectives. A detailed explanation is offered in Section 3. cators while also providing policymakers with room to adjust policy given signs of fiscal vulnerabilities or extreme fiscal stress. Currently, Lesotho does not have a fiscal vulnerability indicator. Our study, therefore, looks to add to the existing fiscal policy tool kit by providing policymakers with a framework for assessing fiscal vulnerability in Lesotho. The rest of the paper is organised as follows: Section 2 discusses recent fiscal developments in Lesotho. Section 3 presents the theoretical and empirical review of the literature. Section 4 outlines the data and methodology used in the paper. Section 5 discusses the results. Last, Section 6 gives the conclusion and policy recommendations. Rena and Kefela (2011) explain fiscal policy as a government tool designed to monitor and influence a nation's economy through its control over the size and structure of the government's revenues and expenditures. Fiscal policy can therefore be recognised as a macroeconomic stabilisation instrument. The purpose of this section is to offer a review and discussion of the most recent fiscal developments in Lesotho. The review uses annual time series data and some stylised facts on the impact of fiscal policy in the country. The fiscal policy analysis is in terms of government expenditure, tax revenue, debts, and debt service.

Evolution of Tax and Expenditures in Lesotho: 1982-2015
Similar to most governments around the globe, the Government of Lesotho (GoL) collects revenues to finance infrastructure projects, social protection and well-being, and other public needs. From the early 1980s to the early 2010s, Lesotho's revenues (tax and non-tax) and expenditures have been volatile. The volatility has in part been driven by significant changes in the country's political economy. For instance, the year 1993 marked the country's political transition into a democracy after the coup de tat of 1986. This time also reflected a drastic change in fiscal policy as income tax rates were increased markedly from the rates of 1962. Specifically, the upper bracket of the income tax rate was adjusted from 12.5 percent in 1962 to 35 percent in 1993.  1982-1988 1989-1995 1996-2002 2003-2009  Between 1996 and 2002 the GoL registered an average fiscal deficit of 5.1 percent of GDP. The government's biggest expenditure emanated from the liquidation and privatisations of State-Owned Enterprises (SOEs) including two indigenous banks; Lesotho Bank and Lesotho Agricultural Development Bank. The cost of privatisation was estimated at M605.00 million that was spent on, among others, retrenchment packages. This led to an accumulation of public debt that was used for financing (Damane et al., 2018). There was also a rise in public capital expenditure from the implementation of the infrastructure related to the Lesotho Highlands Water Project 8 (LHWP). Spending on the LHWP constituted a major part of the government's capital expenditure during the period from 1996 to 1999. From a broader perspective, the period between 1996 and 2002 saw the real GDP growth increase marginally to 3.3 percent from 3.1 percent recorded between 1989 and 1995. Figure 2 presents a graphical relationship between government revenue, expenditure, the fiscal balance, and real GDP growth from 1982 to 2015. The fiscal balance exhibited a surplus of approximately 2.2 percent of GDP between 2003 and 2015. According to Tsekoa (2002)  The Lesotho Highlands Water Project was signed in 1986 by the GoL and the Government of the Republic of South Africa (RSA) aiming to transfer water to RSA and generate hydropower for Lesotho. Upon completion, this introduced two revenue items that expanded the revenue base: royalties paid by the RSA on water transfer from Lesotho to RSA, and cash flows on electricity sales from hydropower component of the project. between 2003 and 2015 compared to 6.6 percent of GDP between 1982 and 2002. Another important contribution to Lesotho's revenue during the period 2003 and 2015 was the sizeable inflows of Southern African Customs Union (SACU) receipts that registered 40.3 percent of GDP. Thahane (2005) pointed out that together with domestic tax revenue (income tax and value-added tax), foreign grants from the United States (US) Millennium Challenge Account (MCA) also boosted Lesotho's revenue base during the 2003 to 2015 period.
Total government spending from 2003 to 2015 stood at an average of 56.3 percent of GDP. This included the redemption of 5-year and 10-year bonds related to the privatisation process of SOEs, spending on Old Age Pension Scheme, pension liability to Public Officers Defined Contribution Pension Fund, unitary payments on health projects through public-private partnership financing, expenses related to government fleet management as well as international transport costs. There was also a significant increase in capital spending to finance the cost of building the Metolong Dam project, road networks linking highlands and lowlands districts, and other MCA-funded projects. The real GDP growth registered an average of 5.0 percent. Table 2 shows Lesotho's history of lending arrangements with the International Monetary Fund (IMF) as of the end of May 2020 in thousands of Special Drawing Rights (SDRs). The country's lending arrangements with the IMF date as far back as 1988 and as recent as 2010. They have mainly consisted of the IMF's standby arrangements and extended credit facilities. Despite the existence of standby arrangements among the list of facilities, only the extended credit facilities, and one structural adjustment facility were drawn upon. The extended credit facilities are used by the IMF to provide a balance of payments support to member states experiencing external financing problems. Table 2, therefore, reflects that Lesotho was faced with episodes of medium-term macroeconomic instability in the form of balance of payments problems around 1994, 2001 and 2010.  ratio of public debt to GDP has been below the SADC threshold of 60 percent (averaging 42.8 percent of GDP) but above the World Bank-IMF threshold of 35 percent. Figure 5 provides trends in total public stock as divided into its external and domestic components from 2000 to 2017. Figure 6 provides the same variables as percentages of GDP. Lesotho's stock of public debt was largely dominated by external debt (most of which is concessional) over the review period. The external debt component accounted for roughly 84.4 percent of public debt and 46.8 percent of GDP around the entire period. Figure 7 displays the fiscal balance as a ratio of GDP from 2000 to 2017. Furthermore, Figure 8 shows the ratios of government revenue and expenditure to GDP, respectively over the same period. During this time the government revenue averaged 53.1 percent of GDP while the government expenditure was less at Source: Central Bank of Lesotho.

Theoretical Review
According to Hemming et al. (2003); Hemming and Petrie (2002) and Stoian (2010Stoian ( , 2012Stoian ( , 2013, fiscal vulnerability is best defined in the context of the government's ability to achieve its macroeconomic objectives, such as; 1) avoiding excessive fiscal deficits and public debt stocks that can threaten macroeconomic stability in the short run and fiscal sustainability 9 in the long run; 2) designing a flexible fiscal policy that assures the immediate reaction to domestic and external disequilibrium; and 3) assuring stable and proper taxation rate that allows for collecting sufficient fiscal revenues for the public budget. Under this operational definition, fiscal policy could be considered as being vulnerable when the government is not able to generate current primary surpluses to meet its financial needs without increasing the rate of taxation, without reducing its spending, and without contracting public debt. A key risk in this context emanates from frequent fiscal imbalances that have the potential to lead to elevated levels of public debt, sovereign debt roll over challenges, and ultimately, insolvency. The theoretical literature on indicators of fiscal vulnerability predominantly sets off with the satisfaction of three important features, namely; 1) the determination of thresholds or limits for public debt, 2) the choice of appropriate fiscal variables to estimate roll over risks and fiscal challenges and 3) the long-term sustainability of public debt (Mendoza & Ostry, 2008;Stoian, 2010;McHugh et al., 2011;Jedrzejowicz & Koziński, 2012;Berti et al., 2012;Ghosh et al., 2013;Mauro et al., 2015;Stoian et al., 2018;Lorenzoni & Werning, 2019). The remainder of this section provides a discussion of the three features as mentioned.

1) Determination of Public Debt Thresholds
When measuring government solvency, the most commonly used metric is the headline ratio of public debt to GDP. In this case, the government budget constraint dictates that future surpluses be sufficient to repay the current level of public debt. In this regard, a higher debt to GDP ratio implies greater difficulty for the government to generate sufficient surpluses. Although the debt ratio is useful and widely employed, it is not a comprehensive measure of government solvency. A key caveat in this respect lies in the lack of consensus in the literature on what constitutes a safe public debt level. On one hand, some guidance on critical levels uses lessons from the examination of public debt developments in 9 Fiscal sustainability is attained when (among other things) 1) public debt does not explode, nor are governments forced to increase taxes, decrease spending, monetise fiscal deficits or repudiate public debt, 2) public debt, as a ratio of GDP does not increase faster than the gap between real interest and real growth rate or 3) governments have the ability to generate future primary surpluses to meet the current government expenditure needs and debt service costs, without any fiscal adjustment measures having to be taken (Hemming et al., 2003;Hemming & Petrie, 2002;Stoian, 2010).
i. emerging market countries undergoing financial crises, including sovereign defaults. In such circumstances, a foreign debt level of around 35 to 60 percent of GDP may indicate an insolvency risk. On the other hand, recent studies seek to define safe debt levels from the perspective of debt's effect on economic growth. In general, such studies reveal evidence to suggest that public debt's impact on economic growth is non-linear and becomes significantly stronger when debt exceeds a critical level of around 90 to 100 percent of GDP (Abiad & Ostry, 2005;Mendoza & Ostry, 2008;Stoian, 2010;Baldacci et al., 2011;McHugh et al, 2011;Jedrzejowicz & Koziński, 2012;Berti et al., 2012;Ghosh et al., 2013).
In some cases, debt to GDP ratio of 60 percent is cited as the requisite prudential limit for developed countries while debt to GDP ratio of 40 percent is suggested for developing emerging economies. Given such divergent views, a critical point to note is that although thresholds provide some psychological level that if crossed is believed to signal threats to public debt sustainability, they need not necessarily be the main focus. Instead, the focus should be on achieving faster growth of gross national product (GNP). The argument is that government will be under less pressure to repay debt as long as the interest on the debt grows at a slower rate than the annual increase in nominal GDP (Berg et al., 2014;Mauro et al., 2015;Cassimon et al., 2017;Stoian et al., 2018;Lorenzoni & Werning, 2019). Medium-term dynamics of public debt as reflected in the change in the debt-to-GDP ratio may be decomposed into the primary balance, interest rate on government debt, and the growth rate of the economy. This is reflected in Equation (1).
where: d, r, g and p are the debt-to-GDP ratio, interest rate, GDP growth rate, and the primary balance ratio to GDP, respectively. The equation indicates that the medium-term trajectory of a country's debt-to-GDP ratio hinges on its primary balance, its economic growth prospects, and the risk premium attached to its sovereign debt (Berg et al., 2014;Mauro et al., 2015;Cassimon et al., 2017;Stoian et al., 2018;Lorenzoni & Werning, 2019).

2) Choice of Appropriate Fiscal Variables
The choice of appropriate fiscal variables to use in the measurement of fiscal vulnerability has to take into consideration the structure of the government's balance sheet or the structure of its public debt and its exposure to roll over needs. This is critical since it can be a channel or source of vulnerability to the real economy and the financial system. The government is said to have high exposure to solvency problems if it needs to roll over huge amounts of its debts in the near term. In this case, there are two main sources of vulnerability, namely; foreign currency-denominated liabilities and short-term liabilities. Literature suggests that the level of short-term debt usually rises in periods directly preceding a financial crisis. This comes on account of the excessive reliance on short-term funding leading to a self-fulfilling sudden stop crisis (Abiad & Ostry, 2005;Mendoza & Ostry, 2008;Stoian, 2010;Baldacci et al., 2011;McHugh et al., 2011;Jedrzejowicz & Koziński, 2012;Berti et al., 2012;Ghosh et al., 2013). Given the above discussion, Table 3 presents some asset and liability management indicators that can be useful in the development of a fiscal vulnerability indicator.

3) Long-term Public Debt Sustainability
Another critical determinant of fiscal solvency beyond the current fiscal position is the extent to which a country's long-term demographic and economic trends will put pressure on the budget. Some crucial long-term factors to consider when developing a fiscal vulnerability indicator include trends in health care and pension expenditure that are affected by demographic trends such as the rate of fertility and the aging population. Low levels of fertility have the potential to lead to declines in labour force participation and economic activity. Subsequently, this could compromise the fiscal position of a country, especially in the face of low migrant labour inflows. Similarly, a rapidly aging population places stress on the government's primary balance given the increased need to provide social safety nets for the elderly (Stoian, 2010;Baldacci et al., 2011;McHugh et al., 2011;Jedrzejowicz & Koziński, 2012;Mauro et al., 2015;Berg et al., 2014;Cassimon et al., 2017;Stoian et al., 2018;Lorenzoni & Werning, 2019).

Empirical Review
The purpose of this section is to provide a survey of empirical studies that have been undertaken to measure fiscal vulnerability across various countries. Particular attention is placed on how the fiscal vulnerability indicator developed in Table 3. Asset and liability management indicators.

Indicator Name Usefulness
• Gross Financing Needs • Also known as the total stock of maturing public debt, it serves as a good measure of the requirements for government roll over.
• Share of short-term government debt to total public debt • Countries with a typically higher need for short-term funding are more exposed to sudden stops when solvency risks are high. A large share of short-term debt compared to total debt signals a high exposure to roll over and solvency risks.
• Ratio of short-term external debt to international reserves • This indicator is useful in providing insight on the likely amount of foreign currency needed to service short-term foreign debt obligations. It is particularly useful in countries that follow a fixed exchange rate regime.
• Share of external debt to total debt • A high level of foreign currency-denominated debt exposes a country to foreign exchange rate risk and raises the possibility of a negative impact on the government's ability to service its debt in light of unfavourable exchange rate shocks. each study has captured the three salient features of fiscal vulnerability theory, namely: a) the determination of thresholds or limits for public debt, b) the choice of appropriate fiscal variables to estimate roll over risks and fiscal challenges and c) the long-term sustainability of public debt, as discussed above. Given the dearth of empirical work on fiscal vulnerability indicators (especially in less developed and developing countries), the studies were chosen on the basis that they had an exclusive objective to develop a fiscal vulnerability indicator as a short-term early warning system of fiscal stress. This meant that the studies had to provide a clear definition of fiscal vulnerability and underscore the three salient features of fiscal vulnerability theory. The studies considered consist of work by Hemming and Petrie (2000) Although the measures of fiscal vulnerability developed and outlined in the handful of studies surveyed in the literature show some aspects that make them dissimilar (e.g., the choice of fiscal variables to focus on, the use of nominal or cyclically adjusted primary balance, etc.), a unifying feature is in the definition of fiscal vulnerability. Fiscal vulnerability is defined as aligned to the government's ability to meet its macroeconomic objectives and thus fulfil its intertemporal budget constraint. In this regard, all studies underscore the need to measure and/or track a country's debt dynamics (i.e., solvency is the debt ratio stable or increasing?) in conjunction with developments in other vulnerability components considered to be of import in determining the public debt trajectory. These generally involve a) fiscal financing needs and debt composition, b) external financing dependence, c) financial sector health and institutional strength, d) long-term sustainability of public debt, and e) fiscal rules and institutions.

Research Gap
The review of literature uncovers that the debt ratio is useful and widely employed as a measure of government solvency. However, it is not comprehensive on its own. It is best complemented by fiscal variables that consider the balance sheet and public debt structure of government as well as its exposure to roll over needs. Additionally, long-term factors such as trends in health care and pension expenditure that are affected by demographic trends such as the rate of fertility and the aging population can be useful in the development of a fiscal vulnerability indicator. Although there have been insightful empirical studies undertaken on the development of fiscal vulnerability indicators, there remains a shortfall of such studies specifically in the context of less developed and developing countries, especially those with fixed exchange rate regimes.

Data
The study makes use of annual fiscal and macroeconomic data from 1993 to 2017. Table 4 shows the names and sources of the data. The variables include public debt to GDP ratio, primary balance to GDP ratio, debt service to GDP ratio, nominal interest rate on public debt, the real GDP growth rate and the rate of inflation. Descriptive statistics are offered in Appendix 2. The study timeline and the choice of fiscal variables was made on the basis of readily available data.

Methodology
For purposes of our study, we adopt the Dynamic Debt Equation for calculating Fiscal Vulnerability (DDE-FV), as advanced by Stoian (2012) and Stoian (2013).
The DDE-FV method defines fiscal policy as being vulnerable when the government cannot fulfil its intertemporal budget constraints and thus faces a liquidity or fiscal solvency risk. It studies fiscal vulnerability on the assumption that the government aims to stabilise public debt at a predetermined level when confronted with large indebtedness ratios or increasing indebtedness rates. The model has four key strengths. First, it uses annual data to estimate the primary balance which stabilises public debt. This means that it provides a way to evaluate and avoid excessive fiscal deficits and public debt stocks that have the potential to threaten macroeconomic stability in the short run and fiscal sustainability in the long run. This provides policymakers with a valuable early warning system to inform the design of flexible fiscal policy to correct any disequilibrium.
Second, it is able to check whether the government can generate sufficient revenues to finance its primary expenditures without increasing public debt. Third,  where: i: nominal interest rate on public debt.
Rearranging Equation (2), Equation (3) is obtained: Expressing the variables as ratios of GDP (where small caps denote this) and using GDP deflator ( t P ) and real GDP ( t Y ), equation (3) becomes: Defining inflation rate as 1 1 t t t P P π − = − , and growth rate as Equation (4) can be written as: where: p t = primary balance-to-GDP ratio (−surplus; +deficit), at time t Given Equation (5), if the government confronts increasing public debt/and or large indebtedness ratio over time, it will have to aim at stabilizing public debt in order to fulfil the intertemporal government budget constraint in the long-run. That is, it will have to ensure that the public debt to GDP ratio remains unchanged ( (5) can be re-written as Equation (6): where: p t = primary balance-to-GDP ratio (+surplus; −deficit), at time t.
From Equation (6), the assumption is that the government chooses the stabilized public debt at the level from the previous time (t − 1) and not immediately. This is on account of possible operational delays that might occur in the public debt stabilization initiative from the moment fiscal policy was found to be vulnerable.
Rearranging Equation (6), Equation (7) is obtained: Considering small variations in g π * , Equation (7) can be re-written as Equation (8): Equation (8) is the primary balance that should be achieved by the government if its aim is to stabilize public debt. Stoian (2012) points out that ( * t p ) can almost be viewed as a fiscal rule 10 that sets the financing requirements for the government considering the rate of growth, the price movement, the implicit rate on public debt and the public debt from the previous year.
Fiscal vulnerability is assessed each year through the primary gap, which is the difference between the debt stabilizing primary balance and current primary balance, ( * t t p p − ). The current value of the primary balance is important because it shows the extent to which the government may need to adjust to fulfil the intertemporal budget constraint. Fiscal policy is said to be good and nonvulnerable when * t t p p = , or * t t p p < . This means that if the government's aim is to keep the rate of public debt growth down to zero, it should strive for the equality between the current primary balance and the debt stabilising primary balance. Fiscal policy is vulnerable when * t t p p > . In this case, the implication is that the government is not able to achieve the required primary balance to stabilise the public debt. The size of public debt is growing on account of debt being raised to finance government's payment obligations. Should the level of public debt continue to grow unabated for many consecutive years, with the government unable to fulfil the debt stabilising primary balance, this will affect fiscal solvency and sustainability in the long run.

Results
This section discusses results of the fiscal vulnerability assessment for Lesotho using annual fiscal and macroeconomic data from 1993 to 2017 and the DDE-FV technique as advanced by Stoian (2012Stoian ( , 2013. The discussion is divided into four parts. Part 1 presents results of the primary gap. Part 2 details the primary gap distribution. Part 3 compares the primary gap and the normal fiscal policy vulnerability range. Last, Part 4 offers a robustness check of the computed fiscal vulnerability indicator. Table 5 presents the primary gap (i.e., the difference between the debt stabilising primary balance and current primary balance) over the period from 1993 to 2017 as a percent of GDP. The primary gap is obtained by taking a yearly com-  both markedly lower than they were in 1994 and 2001, respectively. Assuming that Authorities in Lesotho intently wanted to stabilise public debt at levels consistent with the predetermined primary balance ( * t p ), the findings imply that in these times, the government did not achieve the required primary balance consistent with the stabilisation of public debt. normal fiscal vulnerability by positive gap ranges with the highest frequency while severe fiscal vulnerability is identified in ranges with the most extreme positive values. From Table 6, Lesotho's primary gap distribution ranged within (−3, 10) percent of GDP from 1993 to 2017. The country had relatively few periods of severe fiscal vulnerability compared to normal fiscal vulnerability during this time. Severe fiscal vulnerability was in the range of (8, 10) percent of GDP and was observed in two out of the 25 observations. The normal state of fiscal vulnerability was in the range of (2, 4) percent of GDP during this period and it was observed for 11 out of the 25 periods. The range does not represent the government's failure to accomplish the stabilising primary balance, but rather the government's failure to aim at stabilising public debt. In a sense, the government can be seen to have put off achieving a primary surplus that could have reduced the size of the public debt growth to zero during this time. It is noteworthy that according to Stoian (2010Stoian ( , 2012 as well as Stoian and Alves (2012), registering positive primary gaps over consecutive years may expose fiscal policy to solvency risk that may negatively affect fiscal sustainability in the long run.

Comparison of Primary Gap with Normal
Fiscal Vulnerability Range Figure 9 graphs the relationship between the computed primary gap and the mean of the normal fiscal vulnerability range for the period 1993 to 2017. Figure  10 graphs the primary gap with the normal fiscal vulnerability range for the same period. The mean of the normal fiscal vulnerability range, which in this case is 2.86 percent of GDP, signifies the value at which the primary gap reflects a tolerably vulnerable fiscal policy. Conversely, values that lie above the upper tolerance level of the normal fiscal vulnerability range signal a more severe fiscal vulnerability condition. Lesotho's fiscal policy was severely vulnerable between 1993 and 1997 before improving to within the tolerable level in 1998. The improvement was shortlived as the fiscal vulnerability worsened to severe levels from 1999 to 2001 before Source: Author's Estimation.  returning to levels roughly within the tolerable fiscal vulnerability level for the remainder of the period. It is important to reflect that the country had an IMF ECF in 1991, 2001. It also had a series of IMF SBA in 1994, 1995and 1996, respectively, although none of them were drawn on.

Robustness
For purposes of robustness, the study uses two criteria, namely: Correlation with selected fiscal variables and two, synchronicity with IMF external financing support agreements.

Correlation with Selected Fiscal Variables
The computed DDE-FV fiscal vulnerability indicator is tracked against four fiscal indicators, namely: a) the ratio of public debt to GDP, b) the ratio of debt service to GDP, c) the ratio of external debt to GDP and last, d) the ratio of the primary balance to GDP. Each indicator i t x is transformed into a standardised score i t z as shown in Equation (9) as per the method used by Hayes (2011) and Baldacci et al. (2011).
where µ is the ten-year average (from for 2008 to 2017). Standardising the indicators allows them to be used with reference to their historical norms or past performance trends. Standardised scores close to zero are a reflection that the particular indicator is close to its historical average. Figures 11-14 track the relationship between the computed fiscal vulnerability indicator (DDE-FV primary gap) and the ratio of public debt to GDP, the ratio of debt service to GDP, the ratio of external debt to GDP and the ratio of the primary balance to GDP for the period from 2008 to 2017, respectively. In addition, Table 7 displays the correlation coefficients between the primary gap and respective fiscal indicators over the same period.
Source: Author's Estimation.    From 2008 to 2017, the computed DDE-FV fiscal vulnerability indicator is positively correlated with all but one of the four fiscal variables (i.e., the ratio of debt service to GDP). However, the primary gap is positively correlated with all four fiscal indicators between 2015 to 2017. This period also reflects the strong-est level of positive correlation between the computed fiscal vulnerability indicator and all fiscal variables except the ratio of external debt to GDP (the strongest positive correlation between it and the primary gap is in the period 2008 to 2012). It is interesting to note that the primary gap has a positive correlation with the ratio of the primary balance to GDP in all periods. The strong positive correlation between the computed fiscal vulnerability indicator and the selected fiscal variables, especially in the last three years of the 2008 to 2017 period, indicates its potential usefulness to policymakers in the evaluation of fiscal vulnerability in the country.

Synchronicity with IMF External Financing Support
The computed DDE-FV has identified a normal fiscal vulnerability range of 2 to 4 percent of GDP. It has also identified a serve fiscal vulnerability range of 8 to 10 percent of GDP. Results from the DDE-FV show that Lesotho was in periods of above normal to severe fiscal vulnerability between 1993 to 2001. This state of fiscal stress synchronises with the same period as when the country undertook SBA and ECF facilities with the IMF. Lesotho had an IMF ECF in 1991, 2001. It also had a series of IMF SBA in 1994, 1995and 1996, although none of them were drawn on.

Conclusion and Policy Recommendations
The global outbreak of the Corona Virus Disease of 2019 (COVID-19) and subsequent infection-control measures are expected to lead to sizeable increases in fiscal deficits and public debt ratios around the world. This is especially likely for Lesotho, a small open market economy with a fixed exchange rate and close macroeconomic links to the rest of the world. This situation gives rise to an increased need for close monitoring of risks to fiscal vulnerability. The objective of this paper is to construct a fiscal vulnerability indicator for Lesotho using annual fiscal and macroeconomic data from 1993 to 2017 and a Dynamic Debt Equation for calculating Fiscal vulnerability (DDE-FV) that assumes that government aims at stabilising public debt. The computed DDE-FV identified a normal fiscal vulnerability range of 2 to 4 percent of GDP and a serve fiscal vulnerability range of 8 to 10 percent of GDP. Lesotho had relatively few periods of severe fiscal vulnerability compared to normal fiscal vulnerability during 1993 to 2017. Severe fiscal vulnerability was observed in two out of the 25 years. Normal fiscal vulnerability was observed for 11 out of the 25 periods. Lesotho's fiscal policy was above the computed normal fiscal vulnerability threshold of 4 percent of GDP between 1992 to 2001 before returning to levels roughly within the tolerable vulnerability level for the remainder of the 1993-2017 period. The results show a strong positive correlation between the computed fiscal vulnerability indicator and selected fiscal variables, especially in the last three years of the 2008 to 2017 period. In addition, the computed DDE-FV fiscal vulnerability indicator identifies periods of fiscal stress that synchronise with years in which the country un-dertook SBA and ECF facilities with the IMF. This indicates the potential usefulness of the computed fiscal vulnerability indicator for policymakers in the country.
The study recommends that policymakers in Lesotho adopt, as part of their existing toolkit, the computed DDE-FV fiscal vulnerability indicator to assess fiscal vulnerability in the country. The indicator is expected to provide early warning (short-term) signals on roll over problems by being able to track key fiscal indicators while also providing policymakers with room to adjust policy given signs of fiscal vulnerabilities or extreme fiscal stress. The fiscal vulnerability indicator developed for Lesotho allows for the estimation of the primary balance that stabilises public debt at the level from the previous year. In this way, it provides policymakers with a one-year lag to react to fiscal disequilibrium.
Authors are also confident that the ease of use of the Microsoft excel based Dynamic Debt Equation for calculating Fiscal vulnerability (DDE-FV) speaks to the model's general usefulness as a credible tool for policymakers in other jurisdictions.

Conflicts of Interest
The author declares no conflicts of interest regarding the publication of this paper. Modern Economy Stoian (2013) • The index was developed for 10 advanced economies in the European Union using annual data that ranged from 1971 to 2010. And fiscal variables that included the nominal interest rate on public debt, the GDP growth rate, the rate of inflation (i.e. changes in GDP deflator) and the ratio of public debt to GDP. • The model assumes that the government aims at stabilising public debt at the prior year's level. It calculates the primary balance that stabilises debt and compares it to the current primary balance using the dynamic public debt methodology. • Positive primary gaps indicate fiscal vulnerability. The highest frequency of positive primary gaps indicates normal fiscal vulnerability. • Fiscal severity is any positive primary gap above the upper limit of the normal fiscal vulnerability range.

Continued
• The study concluded that a country's fiscal policy is vulnerable if the government's primary balance that stabilizes debt is more than the ratio of the government's current primary balance to GDP. Stoian et al. (2018) • The study introduces a new framework, namely the V-L-D measure of fiscal vulnerability. The framework comprises two indicators, namely: 1) an indicator of level measuring vulnerability capture through the size of the cyclically adjusted balance and through distance-to-stability and 2) one indicator of dynamic quantifying the vulnerability denoted by the changes in the cyclically adjusted balance and in the public debt to GDP ratios over two consecutive years. • The index was developed for 28 advanced economies in the European Union using annual data that ranged from 1990 to 2013. In a similar way to the Stoian (2013) study, the point of departure was an evaluation of the primary balance that stabilizes public debt using the public debt equation methodology. • By defining and determining the primary gap (the difference between the current and stabilizing primary balance) the study was able to compute an index of fiscal vulnerability. • The study concluded that a country's fiscal policy is vulnerable if the government's primary balance that stabilizes debt is more than the ratio of the government's current primary balance to GDP. Source: Author's Estimation.