Public Information Notice No. 99/105

Public Information Notice: IMF Concludes Article IV Consultation with Botswana

November 17, 1999

On October 6, 1999, the Executive Board concluded the Article IV consultation with Botswana.¹

Background

Abundant diamond resources coupled with sound macroeconomic policies have enabled Botswana to achieve one of the highest growth rates in the world: during 1980/81-1997/98 (July-June), real GDP growth averaged almost 8½ percent a year. Although economic diversification away from the diamond sector, which accounts for more than one-third of GDP and 70 percent of exports earnings, is under way, Botswana remains vulnerable to the global diamond market, which has recently experienced a severe downturn.

Real GDP growth slowed to an estimated 4 percent in 1998/99, reflecting, inter alia, the impact of the significant slowdown in the global diamond market. As De Beers' Central Selling Organization, a diamond marketing cartel, imposed a sales quota of 80 percent (subsequently lowered to 75 percent) on its purchases from its mining companies, diamond exports fell by almost 30 percent in U.S. dollar terms in 1998.

Consumer price inflation (12-month basis) continued to decelerate during the first three quarters of 1998, reaching a 13-year low of 5.9 percent in July, as it benefited from a sharp decline in inflation in South Africa. However, inflation in Botswana picked up subsequently, reaching 7.2 percent in June 1999, owing to expansionary fiscal and monetary policies, as well as the effect of the pass-through of the depreciation of the pula.

The overall fiscal balance moved from a surplus of 4½ percent of GDP in 1997/98 (April-March) to an estimated deficit of 5¼ percent in 1998/99. The significant deterioration in the budgetary outcome mostly reflected the sharp drop in mineral revenue, which fell by almost one-third. In addition, civil servants' salaries were raised by 25 percent in July 1998, which contributed to an increase in the government wage bill of 23 percent. Nonwage recurrent expenditure also rose sharply.

Monetary developments in 1998 and the first quarter of 1999 were characterized by an excessive expansion of credit to the private sector. Bank credit to the private sector surged by 46 percent, supported initially by an accommodating monetary policy stance. The central bank rate, which was lowered in two steps from 12½ percent to 11¾ percent in April 1998, was subsequently raised in phases to 13¼ percent by March 1999. Commercial bank lending rates followed closely these rate adjustments, but this did little to stem the growth of credit.

The surplus in the external current account fell by 13 percentage points of GDP in 1998 to 1 percent, largely on account of the 30 percent decline in U.S. dollar diamond exports and the continued upward pressure on imports, which, in turn, reflected continued strong domestic demand. The external capital and financial account moved from a small surplus in 1997 to a modest deficit in 1998, as net outflows of portfolio and other investments outpaced net inflows of foreign direct investments. Overall, gross international reserves rose by US$266 million to US$5.9 billion at end-1998, equivalent to 29 months of imports of goods and services. The exchange rate of the pula, which is determined on the basis of a basket in which the South African rand has a significant weight, depreciated in nominal and real effective terms in 1998, by some 3 percent and 2 percent, respectively. Botswana continued to make progress in liberalizing external transactions by abolishing all remaining exchange control regulations in February 1999.

Executive Board Assessment

Executive Directors commended the authorities for their impressive record of implementing sound macroeconomic policies over the years, which has enabled Botswana to achieve high growth rates, low inflation, and a strong external position. However, Directors noted the recent slowdown in economic growth and the marked deterioration of the fiscal position in 1998/99, which reflected not only adverse external developments brought about by the weakening of world diamond demand, but also expenditure pressures. Noting the vulnerability of the economy because of Botswana's large dependence on the diamond sector, Directors underscored the need to pursue structural policies aimed at diversifying the economy.

Directors welcomed the more restrained fiscal stance envisaged in the 1999/2000 budget, and emphasized the need to strictly adhere to the overall budget deficit target, notwithstanding the possible significant shortfall in mineral revenue. To this end, they encouraged the authorities to prepare contingency measures to deal with such a shortfall and/or expenditure overruns. Directors urged the authorities to apply strict control over new hirings and to abstain from supplementary budgets.

Directors expressed concern about the recent unsustainable growth of credit to the private sector, which could undermine macroeconomic stability. They urged the authorities to bring credit expansion under control rapidly. Directors welcomed the central bank's strengthening of prudential regulation, both with respect to capital adequacy and foreign exchange exposure, and its intention to broaden its supervisory authority to the nonbank financial sector. They underscored that these measures would contribute to maintaining the soundness of Botswana's financial system.

Directors welcomed the recent elimination of all remaining exchange controls, which had resulted in the full convertibility of the pula in external current and capital account transactions. They recommended that liberalization should be supported by continued prudent demand management and further strengthening of the financial system. Further, Directors considered the continuation of the current exchange rate arrangement of pegging the pula to a currency basket (in which the South African rand has a significant weight) to be appropriate.

Directors supported the authorities' efforts to initiate a program of privatization of public enterprises, and stressed the need to press ahead with its implementation with a view to further increasing the efficiency of the parastatal sector.

Directors noted that Botswana's principal challenge over the medium term is to arrest the rising trend of unemployment by diversifying the economy away from the diamond sector. They stressed the importance of maintaining Botswana's competitiveness by limiting wage increases to productivity gains, and by building on efforts to improve workers' skills. Wage moderation in the public sector was considered to be the key to achieving this aim. Directors also attached importance to improving the availability of skilled labor to meet the requirements of the nontraditional sectors.

Directors welcomed the strong gains in per capita incomes and the improvement in social indicators. However, pointing to the still high incidence of poverty, they considered that better targeting of social programs was important. They also saw a need to improve and update data on poverty and income distribution.

While noting that the economic and financial statistics are broadly adequate for surveillance purposes, Directors urged the authorities to lessen the considerable time lag in compiling labor market data, to unify the different accounting periods for key economic statistics, and to reconcile the large discrepancies between recent national accounts and balance of payments data. They also encouraged the authorities to subscribe to the Special Data Dissemination Standard, which would help foster international confidence in the country and facilitate the planned establishment of an international financial services center.

Directors expressed appreciation for Botswana's contribution to the enhanced ESAF-HIPC Initiative.