IMF Executive Board Concludes 2006 Article IV Consultation with BotswanaPublic Information Notice (PIN) No.07/73
June 28, 2007
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
On December 13, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Botswana.1
Botswana has been among the world's fastest growing economies over the past 40 years. Diamond-led growth combined with sound macroeconomic policies and good governance has moved Botswana from being one of the poorest countries in the world to the upper-middle income range. Nevertheless, Botswana faces serious challenges to continued economic development. The country remains heavily dependent on the diamond production, which accounts for about three-fourths of exports, one-third of GDP, and half of government revenue. However, diamond output, which almost doubled over the past decade, is projected to plateau roughly at current production levels for the next decade and a half and decline sharply thereafter. Notwithstanding past efforts by the authorities to diversify the economy, activity in non-mining sectors remains weak and, as a result, unemployment and poverty rates remain high. The share of households below the poverty line stood at 30 percent in 2002/03. Botswana also has one of the world's highest HIV/AIDS infection rates (estimated by UNAIDS at over 35 percent of the adult population), which places a burden on human welfare and public finances.
Botswana's recent economic performance has been generally good, apart from an upsurge in inflation following the May 2005 devaluation and adoption of the crawling peg regime. Real GDP growth has rebounded in 2004/05 (July-June), mainly due to growth in the mining sector. The current account surplus has expanded in 2005, and international reserves rose to the equivalent of 21 months of goods and services imports. The fiscal surplus rose substantially in 2005/06 as a result of higher diamond revenues and lower-than-budgeted spending. (The authorities maintain a fiscal rule that sets a ceiling on expenditure at 40 percent of GDP.)
At the time of the May 2005 devaluation, the authorities announced a shift in the exchange rate regime from an adjustable peg against a basket to a crawling peg against a basket comprising the South African rand and the SDR. According to the 2006 Monetary Policy Statement of the Bank of Botswana (BoB), the rate of crawl is set as the difference between Botswana's inflation objectives (4-7 percent for 2006 and an average of a 3-6 percent range for the 2006-08 period) and forecast average inflation of the trading partner countries. The weights and the rate of crawl have not been announced.
Coinciding with the devaluation and the change in exchange rate regime, consumer price inflation accelerated from about 6 percent on a year-on-year basis to May 2005 and peaked at about 14 percent in April 2006. It began declining and was leveling off at about 8 percent in October 2006, above the authorities' objective range of 4 to 7 percent inflation for the December 2005-December 2006 period. The real effective exchange rate has appreciated with the increase in inflation, offsetting some of the real effect of the May 2005 devaluation in the period through September 2006.
Executive Board Assessment
Executive Directors commended Botswana's impressive record of prudent macroeconomic policy making, sound management of its diamond resources, and good governance, which has moved Botswana from one of the poorest countries in the world to the upper-middle income range. Directors noted that macroeconomic performance has continued to be strong over the last two years, with the exception of inflation, which accelerated substantially, partly as a result of the May 2005 devaluation and the introduction of a crawling peg. The current level of the exchange rate was also seen as broadly appropriate in light of the strong current account, growing non-diamond exports, and the high and stable level of reserves.
Notwithstanding this positive performance, Directors noted that Botswana still faces serious challenges to continued economic development and poverty reduction. Of particular importance are the country's heavy dependence on diamond production, which is projected to plateau over the next fifteen years and decline sharply thereafter, and the high prevalence of HIV/AIDS infection rates. Against this background, Directors stressed the need for vigorous efforts to diversify the economy and to continue the fight against the HIV/AIDS pandemic, while preserving macroeconomic stability.
Directors cautioned that the authorities' announced policy of using interest rates and monetary policy to achieve the inflation target while using the crawling peg exchange rate regime to target a real effective exchange rate level could generate conflict among policy objectives. In this context, most Directors recommended that the authorities give priority to meeting their inflation objective in setting the rate of crawl and not seek to achieve a real exchange rate target.
Announcement of the parameters of the regime should also help to increase transparency and anchor exchange rate and inflation expectations. Further, given the authorities' intention to use interest rates and monetary policy to rein in inflation, Directors thought that a tighter monetary policy would be needed if inflation does not soon decline.
Directors considered the authorities' policy of maintaining a balanced budget to be prudent but, to anticipate the projected decline in diamond revenues, recommended that the authorities pursue measures aimed at putting the share of government expenditure on a sustained, downward path. For 2006/07, in view of the large fiscal impulse implied by the budget, Directors called on the authorities to maintain the pace of expenditure growth below budgeted levels until inflationary pressures subside, and for the medium term to target fiscal surpluses associated with a declining expenditure path. Reducing the size of government and the public sector wage bill should remain a priority, while preserving HIV/AIDS-related and development spending through reallocation from nonpriority areas as well as revenue increases. To this end, Directors welcomed the efforts to broaden the tax base, improve tax administration, and implement user fees, but advised that increases in tax rates should not be ruled out in light of the scale of the projected decline in diamond revenue.
Directors welcomed the authorities' plans for labor market-related reforms, privatization, and improvements in the investment environment, which should help promote competitiveness and diversification of the economy with attendant reductions in unemployment and poverty.
Directors considered the banking sector sound, profitable, and generally well supervised, while welcoming the planned strengthening of supervision of the non-bank financial institutions. They looked forward to a further analysis of financial sector issues in the Financial Sector Assessment Program (FSAP) slated for early 2007, and welcomed the planned adoption of the Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) legislation.
Directors noted that Botswana maintains a multiple currency practice (MCP) relating to exchange rate guarantees on one loan, and urged the authorities to take early action to remove the practice.