Chapter four: Economic governance and management promote the establishment of potentially viable and self-sustaining microfinance and other financial institutions such as savings and credit associations. (CBL) • As part of its efforts to learn from recent global events, the CBL should tighten its supervisory and regulatory functions over the financial system. Available evidence indicates that Lesotho has signed the Basel I Convention on bank regulation and supervision. It should also take steps to sign and ratify the more far-reaching Basel II convention. (CBL) Fiscal policy 395. Given the near absence of monetary and exchange rate policy, the burden for effective demand management falls on government tax and expenditure policies. In this context, fiscal prudence is critical to economic policy. Thus one of the medium-term aims of the government is to limit fiscal deficits to levels that can contain aggregate demand, and which can be financed by external grants and concessional loans in order to avoid crowding out the private sector. This requires intensified efforts to mobilise revenue and contain expenditure. The government has been relatively successful in this regard. 396. The maintenance of budgetary discipline has been attributed to the adoption of the MTEF, which came into effect in 2004/2005. The MTEF is a transparent planning and budget-formulation process within which the Cabinet and central government agencies establish contracts for allocating public resources to their strategic priorities. It ensures overall fiscal discipline and facilitates the annual planning and budgeting process. Perhaps more importantly, it serves as the necessary link between the budget and the PRS. 397. Lesotho pursued the objective of macroeconomic stability by recording budgetary surpluses throughout most of the 1990s. This contributed to reducing the cost of servicing debt and ensured that the public sector did not crowd out the private sector through public sector borrowing from the domestic capital market. However, several factors have been responsible for turning the surpluses into deficits since 1998/1999. These include the political unrest of 1998, the resulting large-scale disruption of economic activity, and declining revenues and grants. 398. The deficit situation has since been turned into a surplus by a combination of two factors. One was the large windfall from SACU receipts in 2004/2005 and the other was the large inflow of grants. These two factors have enabled the government to achieve an overall annual average fiscal balance of 4.9 per cent between 2002/2003 and 2007/2008. During the same period, domestic revenue, which was 45.1 per cent of GDP in 2002/2003, has averaged 52 per cent of GDP at market prices. The increase can be partly attributed to the establishment of the LRA in January 2003. This body was charged, among other things, with promoting a more efficient system of collecting revenue. 399. Figure 4.3 shows the trend in SACU revenue between 2001/2002 and 2007/2008. The figure shows that there has been a considerable increase in customs receipts from the SACU revenue pool. These recorded an average annual growth rate of 22.8 per cent between 2002/2003 and 2007/2008. SACU revenues had stabilised at around M1.4 billion between 2001/2002 and 2003/2004, but jumped to M2 billion in 2004/2005 as Lesotho benefited from the impact of intermediate inputs imported for use in the textile industry. The new SACU revenue-sharing formula came into effect on 1 April 2005. Its application, combined with the expansion of the customs pool and the excise pool, generated significantly higher revenues in both 2005/2006 and 2006/2007. In addition, Lesotho 111