## 1bwaea2023003

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---

### Classification of SOEs — overview and institutional context
- SOEs have a major influence on productivity and competitiveness in Botswana, with prevalence in transport, energy, communications, and financial services.
- Since adoption of a privatization policy in 2000, limited privatization progress occurred (transformation of Botswana Telecommunications Company (BTC) into a limited liability company and establishment of BOCRA; several new SOEs such as Mineral Development Company of Botswana (MDCB) were created).
- Chapter scope: overview of SOE performance, policy options for reform, application of IMF SOE Health Check and SOE Stress Test Toolkits.
- IMF classification of SOEs uses eight indicators (Government Finance Statistics Manual, 2014):
  - Ownership of the majority of the voting interest.
  - Control of the board or other governing body.
  - Control of the appointment and removal of key personnel.
  - Control of key committees of the entity.
  - Golden shares and options.
  - Regulation and control.
  - Control by a dominant public sector customer or group of public sector customers.
  - Control attached to borrowing from the government.
- A single indicator may suffice to establish control; government control is broader than capital share.

### Botswana’s SOE landscape — size, ownership, and fiscal footprint
- Total parastatals: 62, accounting for about 5 percent of total formal employment (as of 2021).
  - Of the 62 parastatals:
    - 42 parastatals fully financed by the state.
    - 20 are revenue-generating SOEs (referred to as SOEs in the chapter), comprising 16 non-financial and 4 financial corporations.
- Shareholdings where government is not sole shareholder:
  - Botswana Stock Exchange (BSE): 76 percent government shareholdings.
  - Botswana Telecommunications Corporation (BTCL): 51 percent.
  - Banyana Ltd.: joint venture.
- Total SOE assets: 32 percent of GDP in 2021.
  - Financial SOEs account for 14 percent of total assets.
  - Financial SOEs generated about 12 percent of total operating revenues.
- Largest non-financial SOEs by assets/revenues include Botswana Power Corporation (BPC) and Water Utilities Corporation (WUC).
- SOEs often dominate their sectors and are state-mandated monopolies (examples: Botswana Meat Commission (BMC), WUC, Botswana Railways, BPC).
- Administered prices in Botswana: 32 (including fuel, electricity, water, some forms of housing).
- Botswana’s financial SOEs are small relative to the banking system (4 percent of banking system assets); besides Botswana Savings Bank (BSB), these entities do not take deposits from the public.

### Privatization history and recent SOE creation
- Privatization Policy for Botswana adopted in 2000; first Privatization Master Plan approved in 2005.
- Major privatization steps and outcomes:
  - January 2016: sale offer of 49 percent of Botswana Telecommunications Corporation to Botswana citizens.
  - February 2017: expression of interest for privatization of national airline; airline remains wholly government owned.
  - Announced privatization of Botswana Meat Commission is still under way.
- Since 2012, new SOEs created: Okavango Diamond Company, Mineral Development Company, Botswana Oil Limited.
- National Development Bank (NDB) Transition Act passed in December 2013 to transform NDB into a limited liability company; privatization did not take place.
  - NDB non-performing loan ratio is around 40 percent.
  - Government proposed NDB focus more lending towards the agriculture sector.

### Institutional framework and oversight
- SOE management is decentralized; no overarching policy on state ownership or governance of parastatals.
- Ministries can constitute parastatals as statutory corporations or companies under the Companies Act; governance rules differ and are not always consistent with private sector norms.
- Ministries provide policy/strategic direction, funding, regulation, and reform strategies; parastatals sign shareholder compacts with ministers via board chairpersons.
- Two oversight entities create potential overlap:
  - Public Enterprises Evaluation and Privatization Agency (PEEPA): responsible for monitoring parastatals and advising on privatization.
  - Enterprise Development Policy Unit within the Ministry of Finance: building capacity and tools to monitor SOE financial performance.
- Work underway to establish a Fiscal Risk Framework and to introduce provisions in the PFM Act (or an overarching SOE Act) to improve access to SOE financial performance information (strategies, plans, annual reports).
- A draft ownership policy is pending stakeholder verification.

### Fiscal implications and concentration of fiscal support
- Fiscal year definition: runs from April 1 of the calendar year to March 31 of the following year.
- Recent fiscal support trends:
  - FY2021 direct transfers to SOEs: 0.4 percent of GDP (compared to an average of 1 percent from FY2016 to FY2020).
  - Government guarantees on SOE borrowing in FY2021: 1.8 percent of GDP (decline from an average of 3.5 percent during FY2016 to FY2020).
- Fiscal support concentration (FY2016–FY2021):
  - BPC accounted for more than half of total transfers to SOEs and almost 90 percent of government guarantees.
  - Transportation sector (Botswana Air (BA), Botswana Railways (BR), Botswana Post (BP)) received about 10 percent of total transfers.
  - Telecommunication sector (BoFiNet and BTCL) received about 1 percent of transfers.
  - MDCB received about 12.5 percent of government transfers and about 10 percent of government guarantees.
- Returns to government as shareholder are low; dividends from SOEs have been minimal over the past five years.
- Medium-term budget for FY2023–25 (published February 2023) projects declining fiscal transfers to SOEs; these may be insufficient if SOE restructuring plans (especially in electricity) do not accelerate.

### Mandates, quasi-fiscal activities (QFAs), and information gaps
- SOEs have both commercial and social mandates; distinction is not always clear.
- Some SOEs engage in QFAs by charging less than cost-recovery prices, worsening SOE financial positions relative to strictly commercial levels.
- Overlaps in SOE mandates can result in inefficient resource use and budgetary allocations.
- No comprehensive information or estimated cost exists for SOE obligations arising from QFAs.

### SOE performance, sectoral variation, and ownership effects
- Financial SOEs generally achieved better returns than non-financial SOEs.
  - On average, from FY2016–FY2020, the four financial SOEs earned a small net profit.
- Sectoral performance (FY2016–FY2020 averages):
  - Net profits: transportation, telecommunications, and water.
  - Losses: energy, manufacturing, and mining.
- Ownership and returns (as of FY2020):
  - Government majority-owned SOEs generated better average returns (ROE or ROA) than fully government-owned SOEs.
- Return metrics definitions:
  - ROA: net profit divided by total assets.
  - ROE: net profit divided by total equity.

### Wage premium for parastatals (empirical result)
- Data and methodology:
  - Based on Multi-Topic Survey data for 2020 (Statistics Botswana, Q4 2020, Quarterly Multi-Topic Survey: Labor Force Module).
  - Traditional Mincer equation with propensity score matching; controls included education, age, age squared, gender, marital status, region, household size and composition.
  - Regressions are heteroscedasticity robust and clustered to the district level.
  - Survey sample: almost 2,500 observations.
- Key result:
  - Estimated parastatal wage premium: 56 percent compared to central and local governments, the private sector, and other sectors.
- Robustness: alternative scenarios control for additional factors beyond baseline specification.

### Diagnostic tools applied: Health Check and Stress Test
- IMF SOE Health Check Tool applied to 9 SOEs for FY2021: BHC, BTCL, NDB, BPS, BOCRA, BOL, BPC, WUC, and BSB, representing 70 percent of SOE assets.
- Health Check compares profitability, liquidity, and solvency measures against international risk thresholds and produces composite risk categories: low (Category 1 and 2), moderate (Category 3), high and very high risk (Category 4 and 5).
- The Stress Test Tool assesses strength and resilience relative to SOEs in other countries, focusing on relative performance by sector.

### Health Check and Stress Test — key findings
- Risk distribution:
  - 7 out of 9 SOEs fall into the moderate and high risk categories against international benchmarks.
  - Three SOEs in Category 4—BPC, WUC, BSB—account for most of the energy and utility sectors and exhibit especially weak indicators.
  - BTCL, the only partially-privatized company in the group, has stronger debt-to-equity, debt-to-asset, and debt coverage ratios.
- Profitability and solvency:
  - ROA and ROE remain low across the SOE sample.
  - SOEs have struggled to service debt—reflected in low debt coverage ratio and high debt to EBITDA (calculated by total liabilities divided by earnings before interest, tax, depreciation, and amortization).
- Liquidity and cost recovery:
  - Almost all SOEs pass cost recovery by generating adequate revenues to cover operating expenses.
  - A majority of SOEs are able to meet short-term liabilities with enough liquid short-term assets; liquidity has been relatively stable and has mostly recovered.
- Pandemic impact and trends:
  - On average, all 9 SOEs have yet to recover fully from the COVID-19 pandemic.
  - Profitability remained low in 2022, as reflected in their collective ROA and ROE.
  - Liabilities have increased significantly since the pandemic and the ability to service debt has markedly deteriorated.
- Sectoral comparative results:
  - Median ROA in 35 international SOEs operating in electricity and gas supply was 2.7 percent for 2010–17; BPC’s return on assets was negative during the same period.
  - 61 international SOEs operating in the telecom sector produced a median ROA of 3.6 percent for 2010–17; the BTC averaged 0.1 percent.
  - Botswana SOEs performed in line with international benchmark ranges for some measures, including the current ratio and labor cost per operating revenue.

### International risk thresholds used (selected)
- Profitability:
  - Return on Assets: very low risk > 8.0; low risk 4.0; moderate risk 0.0-5.0
  - Return on Equity: very low risk > 15.0; low risk 8.0; moderate risk 0.0-10.0
  - Cost Recovery: very low risk > 1.5; low risk 1.3; moderate risk 1.0-0.8
- Liquidity:
  - Current Ratio: very low risk > 2.0; low risk 1.5; moderate risk 1.3-1.0
  - Quick Ratio: very low risk > 1.2; low risk 1.0; moderate risk 0.8-0.7
- Solvency:
  - Debt to Assets: very low risk < 0.3; low risk 0.5; moderate risk 0.8-1.0
  - Debt to Equity: very low risk < 0.5; low risk 1.0; moderate risk 1.5-2.0
  - Debt to EBITDA: very low risk < 1.5; low risk 2.0; moderate risk 3.0-5.0
  - Debt Coverage: very low risk > 0.5; low risk 0.3; moderate risk 0.2-0.1

### SOE policy recommendations and reform options
- Short term priorities:
  - Undertake a comprehensive analysis of the SOE sector, including subnational SOEs and SOE subsidiaries, assessing commercial viability, public policy objectives, track record, and market failures.
  - Ensure all annual financial statements are published in a timely manner and shared with the Ministry of Finance.
  - Compare SOE performance with private firms or international SOEs to establish efficiency benchmarks, prioritizing SOEs targeted for privatization and those operating in sectors where private firms are present.
  - Strengthen monitoring and oversight by clarifying roles and avoiding duplication between PEEPA and the Enterprise Development Policy Unit; ideally vest monitoring, governance enhancement, and reform implementation in a single unit.
- Medium term measures:
  - Devise and implement an SOE governance reform strategy based on the OECD Guidelines (2015), including a formal ownership policy describing roles and responsibilities of institutions involved in SOE oversight and governance.
  - Assign an inter-ministerial working group to design and implement the strategy and develop policies to guide SOE activities and limit overlap between SOEs.
  - Mandate transparent disclosure and cost coverage for any obligations beyond normal commercial functions; develop criteria for prioritization and sequencing of reforms (fiscal impact, sectoral importance, market readiness, cost of reform).
  - Strengthen independence of SOE boards and management by clarifying roles of boards, management, and the state as owner; formalize board nominations via the oversight unit; establish a single public database of potential candidates; enhance monitoring of shareholder’s compacts focusing on high-level financial and non-financial objectives and make them public.
- Additional reform levers:
  - Enhance competition with the private sector, separate accounts for commercial and non-commercial activities, set financing guidelines and financial performance targets, and remove special advantages of SOEs where appropriate.
  - Professionalize governing bodies, including promoting independence of board members and establishing policies for executive and director remuneration outside civil service frameworks.
  - Improve data transparency and integrity: adopt international accounting standards, independent external audits, internal audit procedures, and compile SOE data in line with the Government Finance Statistics Manual 2014.
  - Increase private sector participation through broadened ownership structures or management contracts; consider partial or full privatization where market conditions warrant.
  - Strengthen regulation and safeguards to limit monopolistic pricing power and protect private suppliers.
- Conclusions:
  - The financial performance of Botswana’s SOEs has generally been weaker than international benchmarks.
  - The sector is an outlier because of the high percentage of government ownership and limited progress in advancing private sector involvement.
  - Although direct fiscal support to SOEs has declined in recent years, the weak recovery since the pandemic represents a fiscal risk.
  - Immediate actions should accelerate comprehensive analysis and clarify oversight roles; medium-term reforms should update SOE governance strategy and strengthen boards and management.

---

### Review of Botswana’s REER targeting regime — purpose and mechanics
- Objective: promote export competitiveness and economic diversification by maintaining REER stability.
- Historical actions:
  - Two discrete devaluations in 2004 and 2005.
  - Since May 2005, the Bank of Botswana (BoB) implements an automatic nominal adjustment of the Pula—the “crawling band exchange rate mechanism.”
- Main operational rule:
  - The projected inflation gap (measured by headline CPI) between Botswana and countries in the defined basket is offset by an announced annual “crawl rate” (the nominal growth rate of the Pula against the basket over the next 12 months).
  - The crawl rate is announced every year in December but can be changed later in case of large and unexpected shocks.
  - The annual crawl rate is divided by the number of trading days and implemented gradually daily throughout the year.
  - FX transactions: BoB quotes bid and offer rates to authorized primary dealers and will buy or sell unlimited quantities of foreign currencies against Pula; there is no maximum cap on trading but a minimum amount of USD 1 million equivalent for each trade.
- Currency-basket weights and evolution:
  - Weights went from 60 percent ZAR and 40 percent SDR in 2007 to 45 percent ZAR and 55 percent SDR in 2017; those weights have not changed since then.
- Monetary policy framework and instruments:
  - BoB has a price stability mandate and an inflation objective range of 3–6 percent for headline inflation over the medium term, defined as a 3-year rolling window.
  - Main policy instrument is a 7-day Bank of Botswana Certificate (BoBC) rate—also called the monetary policy rate (MOPR)—with certificates auctioned on a weekly basis since May 2022.
  - De facto framework: “two targets, two instruments” where the policy rate targets inflation and FX interventions target the exchange rate objective.
- Financial openness and capital controls:
  - Relatively low de facto financial openness: the local capital market is small and pension funds are required to invest 50 percent of their assets locally, resulting in imperfect capital mobility and a low risk of speculative inflows.

### Recent performance, challenges, and empirical evidence
- General performance:
  - The regime has delivered relatively low and stable inflation between the Global Financial Crisis (GFC) and the Covid-19 pandemic and contributed to closing the historical inflation gap with South Africa and larger advanced economies.
- REER trajectory and trade outcomes:
  - Rapid NEER appreciation and higher domestic inflation in early 2000s led to severe REER appreciation.
  - After appreciation between 2005 and 2013, the REER held steady around its 2014 value in subsequent years, implying REER stability.
  - Despite REER stability, export performance has slowly deteriorated and diversification has stalled:
    - Evidence of a steady deterioration in the trade balance and foreign exchange reserves since the GFC.
    - The share of non-mineral goods—particularly manufacturing goods—has shrunk since 2012 as a share of both exports and GDP.
- Inflation resurgence and policy conflict:
  - The pandemic and the Ukraine war produced a resurgence of inflation via global food and energy prices.
  - The ER regime implied a negative crawl rate of 2.87 percent during these two years to offset positive inflation differentials between Botswana and its trading partners.
  - Given a large weight of imported tradables in the CPI and significant exchange rate pass-through (ERPT), such nominal depreciation is likely to have generated additional inflation pressures, creating potential tensions between competitiveness and price stability objectives.
  - Prior IMF work estimates a pass-through of roughly 0.5 after one year from changes in the NEER to the headline CPI in Botswana.
- Foreign exchange reserves:
  - There has been a persistent decline in foreign exchange reserves over the past two decades.
- Measurement and parameter sensitivity:
  - The regime’s parameters (trading partners/currencies in the basket, weights, price indices) have changed little since inception and are critical to outcomes; choices are subject to measurement challenges and potential implementation mistakes.

### Conceptual assessment — benefits and costs of REER targeting
- Benefits:
  - A competitive REER can support growth by promoting exports and economic diversification; literature links undervalued REER to short- and long-run growth benefits.
  - For commodity exporters, maintaining competitiveness can help contain “Dutch disease” effects and support tradable-sector development.
  - A stable REER can increase investment by reducing uncertainty, with empirical benefits primarily when the REER is also competitive.
  - Nominal depreciations via FX intervention are practical: easy to design, fast to implement, circumvent political-economy barriers, and, in Botswana’s case, unlikely to cause major financial instability because unhedged currency mismatches are limited; fiscal revenues (in Pula terms) may also benefit from depreciation.
- Costs and trade-offs:
  - A constant REER may hinder structural adjustment to large shocks by preventing relative price adjustment.
  - Implementation complexity: many parameters and inputs with little theoretical guidance create risks of mis-specification and large gaps between observed REER and its “right” level.
  - Potential tensions between monetary policy and exchange rate policy:
    - The crawl rate consistent with stabilizing the REER may be inconsistent with the inflation target, generating conflicts and making it harder for the central bank to achieve its inflation objective in the short run.
    - Botswana is more exposed to the scenario where a nominal depreciation conflicts with the need to tighten monetary stance (upper-right consistency concern).
  - Sterilization costs:
    - FX operations to enforce REER stability can be costly to sterilize because foreign reserves (e.g., US Treasuries) tend to earn lower returns than domestic assets issued by BoB (e.g., BoBCs).

### Policy implications; marginal and structural reforms
- Marginal adjustments recommended:
  - Small changes to the existing framework—related to the choice of currency weights and price indices—could mitigate some current implementation problems, including the gradual deterioration of price competitiveness.
- More structural reform option:
  - Transition to a nominal (NEER) targeting regime where the crawl rate is adjusted to meet the inflation target (i.e., aligning crawl with inflation objectives) could make Botswana’s monetary framework more robust and more in line with international best practices.
  - Benefits of NEER-targeting include reduced tensions between exchange rate adjustments and inflation control.
  - Implementation requirements for a NEER-targeting regime:
    - Would require institutional reforms, including assigning all responsibilities for exchange rate policy to the central bank.

### Evidence on REER movements and competitiveness (additional findings)
- BoB’s official REER estimate has been relatively stable over the last ten years, but a trade-based REER index based on non-diamond exports points to a 10 percent appreciation of the price of tradables in Botswana since 2013.
- Using Unit Labor Costs (ULC), rather than CPI, to measure inflation in trading partners suggests an appreciation of larger magnitude, implying a potentially large loss of competitiveness over the same period (~20 percent).
- The deterioration is mainly explained by the large appreciation of the pula against the South African Rand (ZAR) since 2012 (~40 percent).
- These REER measures could explain the poor performance of non-mineral tradables and motivate changes in basket weights and/or price indices.

### Tweaks and transition paths — operational choices and trade-offs
- Two concrete adjustments to better support competitiveness:
  - Use non-diamond trade weights instead of current basket weights that give too much weight to developed economies.
  - Use ULC rather than headline CPI to capture relevant price developments.
- Operational considerations:
  - Implementing non-diamond trade weights would be operationally faster and easier to communicate than transitioning to ULCs.
  - Projecting ULCs in trading partners might be challenging, and market participants might be more familiar with CPI indices.
- Effects and trade-offs:
  - Reducing advanced countries' weights would mechanically increase South Africa's weight, likely resulting in (i) more frequent two-sided adjustments to the crawl rate and (ii) potentially higher (ex-post) volatility in the REER.
  - Adjusting parameters would help maintain competitiveness going forward but would not compensate past losses; offsetting past losses would require a large nominal depreciation:
    - A 10–15 percent real depreciation would probably be required to offset past losses; this would require a 20–30 percent nominal depreciation and generate a 10–15 percent inflation increase over one year (assuming a pass-through of 0.5).
- Transparency and communication:
  - Improving transparency and explaining temporary deviations from the mechanical REER stabilization rule (e.g., adopting a smaller crawl rate during temporary inflation pressures) could help manage policy tradeoffs and anchor expectations.

### Complementary measures outside monetary policy
- Tweaking the ER framework alone is unlikely to be sufficient; complementary reforms are critical:
  - Contain other sources of price pressures in the non-mineral sector (e.g., wage pressures).
  - Keep demand pressures (potentially stemming from loose fiscal policy) under control.
  - Ensure supply-side conditions so that firms can respond when price competitiveness improves (access to credit, skilled labor).
  - Improve broader determinants of competitiveness: infrastructure quality, governance, competition policy.
- Botswana ranks 91st among 141 countries in the latest Global Competitiveness Index, indicating significant scope to improve the business environment and infrastructure.

### NEER targeting proposal — design, feasibility, and transition
- NEER targeting regime definition and operational design:
  - A nominal crawling peg where the crawl rate and basket weights are calibrated to achieve the inflation target, using two operational targets: (i) the short-term interest rate and (ii) a NEER crawling peg.
  - The desired NEER would be achieved through FX interventions.
  - This formally establishes the primacy of internal price stability.
- Operational feasibility:
  - BoB already implements a crawl, implying adequate analytical and operational capacity.
  - Economic agents are familiar with current procedures; "The current operational set-up, which includes a standing facility, could easily be adjusted to fit the new regime."
- Institutional implications:
  - Exchange rate decisions are currently made by the President on the recommendation of the Minister of Finance after consultation with the Bank.
  - The new regime would imply that the exchange rate becomes an official monetary policy tool under the direct control of BoB, possibly requiring changes to Bank of Botswana Act.
- Transition path and long-term considerations:
  - The NEER targeting regime could serve as an intermediate step toward more exchange rate flexibility.
  - Preconditions for successful transition include: clearly formulated framework supported by legislation; central bank operational capacity and communication strategy; sufficiently deep FX and financial markets; private sector capacity to manage exchange rate risk.
  - Transition should be gradual, carefully planned and sequenced; a hybrid regime (NEER targeting cohabiting with 'light' inflation targeting) is relatively common and could serve as a transitional arrangement toward a floating regime.
- Boxed policy guidance — key elements and lessons:
  - Clear central bank mandate and operational independence with public accountability.
  - Price stability as the primary objective; a medium-term inflation objective as cornerstone.
  - Consideration of macroeconomic activity and financial stability when adjusting policy.
  - Clear operational framework, forward-looking strategy, and transparent communications.
  - Examples of gradual transitions: Israel and Poland (multi-decade gradual moves), Morocco (progressive widening of exchange rate bands between 2016 and 2020).

### NEER targeting — conclusion
- The current REER targeting regime has generated benefits historically but is now challenged by conjunctural and structural factors.
- A NEER targeting regime—where the crawl rate would be adjusted to meet the inflation target—could provide a more robust monetary policy framework for Botswana and re-align the country's exchange rate regime with international best practices.
- Over the longer term, a gradual move to greater exchange rate flexibility may become necessary as financial integration deepens and external pressures evolve; a hybrid NEER + 'light' inflation targeting arrangement could be an effective transitional framework.

*Source: IMF staff chapter "1. Classification of SOEs" and selected issue paper on REER targeting (1bwaea2023003).*

### 1. Classification of SOEs ________________________________________________________________ 3

### 1. Classification of SOEs

### A. Introduction
- SOEs have a major influence on productivity and competitiveness in Botswana, with prevalence in transport, energy, communications, and financial services.
- SOEs often have monopoly powers and operate in heavily regulated sectors; they receive budgetary support in the form of transfers, guarantees and on-lending and are therefore sources of fiscal costs and risks.
- Since adoption of a privatization policy in 2000, limited privatization progress has occurred: transformation of Botswana Telecommunications Company (BTC) into a limited liability company and establishment of BOCRA; several new SOEs (e.g., Mineral Development Company of Botswana (MDCB)) were created.
- Chapter scope: overview of SOE performance, policy options for reform, application of IMF SOE Health Check and SOE Stress Test Toolkits.

### B. IMF classification of SOEs (Box 1)
- Eight indicators used to assess SOE status (IMF Government Finance Statistics Manual, 2014):
  - Ownership of the majority of the voting interest.
  - Control of the board or other governing body.
  - Control of the appointment and removal of key personnel.
  - Control of key committees of the entity.
  - Golden shares and options.
  - Regulation and control.
  - Control by a dominant public sector customer or group of public sector customers.
  - Control attached to borrowing from the government.
- A single indicator may suffice to establish control; government control is broader than capital share.

### C. Botswana’s SOE Landscape — Basic characteristics
- Total parastatals: 62, accounting for about 5 percent of total formal employment (as of 2021).
- Of the 62 parastatals:
  - 42 parastatals fully financed by the state.
  - 20 are revenue-generating SOEs (referred to as SOEs in the chapter), comprising 16 non-financial and 4 financial corporations.
- Shareholdings where government is not sole shareholder:
  - Botswana Stock Exchange (BSE): 76 percent government shareholdings.
  - Botswana Telecommunications Corporation (BTCL): 51 percent.
  - Banyana Ltd.: joint venture.
- Total SOE assets: 32 percent of GDP in 2021.
  - Financial SOEs account for 14 percent of total assets.
  - Financial SOEs generated about 12 percent of total operating revenues.
- Largest non-financial SOEs by assets/revenues include Botswana Power Corporation (BPC) and Water Utilities Corporation (WUC).
- SOEs often dominate their sectors and are state-mandated monopolies in some markets (examples: Botswana Meat Commission (BMC), WUC, Botswana Railways, BPC).
- Administered prices in Botswana: 32 (including fuel, electricity, water, some forms of housing).
- Botswana’s financial SOEs are small relative to the banking system (4 percent of banking system assets); besides Botswana Savings Bank (BSB), these entities do not take deposits from the public.

### D. Privatization history (Box 2)
- Privatization Policy for Botswana adopted in 2000; first Privatization Master Plan approved in 2005.
- Major privatization steps and outcomes:
  - January 2016: sale offer of 49 percent of Botswana Telecommunications Corporation to Botswana citizens.
  - February 2017: expression of interest for privatization of national airline; airline remains wholly government owned.
  - Announced privatization of Botswana Meat Commission is still under way.
- Since 2012, new SOEs created: Okavango Diamond Company, Mineral Development Company, Botswana Oil Limited.
- National Development Bank (NDB) Transition Act passed in December 2013 to transform NDB into a limited liability company; privatization did not take place.
  - NDB non-performing loan ratio is around 40 percent.
  - Government proposed NDB focus more lending towards the agriculture sector.

### E. Institutional framework
- SOE management is decentralized; no overarching policy on state ownership or governance of parastatals.
- Ministries can constitute parastatals as statutory corporations or companies under the Companies Act; governance rules differ and are not always consistent with private sector norms.
- Ministries provide policy/strategic direction, funding, regulation, and reform strategies; parastatals sign shareholder compacts with ministers via board chairpersons.
- Two oversight entities create potential overlap:
  - Public Enterprises Evaluation and Privatization Agency (PEEPA): responsible for monitoring parastatals and advising on privatization.
  - Enterprise Development Policy Unit within the Ministry of Finance: building capacity and tools to monitor SOE financial performance.
- Work underway to establish a Fiscal Risk Framework and to introduce provisions in the PFM Act (or an overarching SOE Act) to improve access to SOE financial performance information (strategies, plans, annual reports).
- A draft ownership policy is pending stakeholder verification.

### F. Fiscal implications and concentration of fiscal support
- Fiscal year definition: runs from April 1 of the calendar year to March 31 of the following year.
- Recent fiscal support trends:
  - FY2021 direct transfers to SOEs: 0.4 percent of GDP (compared to an average of 1 percent from FY2016 to FY2020).
  - Government guarantees on SOE borrowing in FY2021: 1.8 percent of GDP (decline from an average of 3.5 percent during FY2016 to FY2020).
- Fiscal support concentration (FY2016–FY2021):
  - BPC accounted for more than half of total transfers to SOEs and almost 90 percent of government guarantees.
  - Transportation sector (Botswana Air (BA), Botswana Railways (BR), Botswana Post (BP)) received about 10 percent of total transfers.
  - Telecommunication sector (BoFiNet and BTCL) received about 1 percent of transfers.
  - MDCB received about 12.5 percent of government transfers and about 10 percent of government guarantees.
- Returns to government as shareholder are low; dividends from SOEs have been minimal over the past five years.
- Medium-term budget for FY2023–25 (published February 2023) projects declining fiscal transfers to SOEs; these may be insufficient if SOE restructuring plans (especially in electricity) do not accelerate.

### G. SOE mandates, quasi-fiscal activities, and information gaps
- SOEs have both commercial and social mandates; distinction is not always clear.
- Some SOEs engage in quasi-fiscal activities (QFAs) by charging less than cost-recovery prices, worsening SOE financial positions relative to strictly commercial levels.
- Overlaps in SOE mandates can result in inefficient resource use and budgetary allocations.
- No comprehensive information or estimated cost exists for SOE obligations arising from QFAs.

### H. SOE performance: profitability, sectoral variation, and ownership effects
- Financial SOEs generally achieved better returns than non-financial SOEs.
  - On average, from FY2016–FY2020, the four financial SOEs earned a small net profit.
- Sectoral performance (FY2016–FY2020 averages):
  - Net profits: transportation, telecommunications, and water.
  - Losses: energy, manufacturing, and mining.
- Ownership and returns (as of FY2020):
  - Government majority-owned SOEs generated better average returns (ROE or ROA) than fully government-owned SOEs.
- Return metrics definitions:
  - ROA: net profit divided by total assets.
  - ROE: net profit divided by total equity.

### I. Wage premium analysis for parastatals (Box 3)
- Data and methodology:
  - Based on Multi-Topic Survey data for 2020 (Statistics Botswana, Q4 2020, Quarterly Multi-Topic Survey: Labor Force Module).
  - Traditional Mincer equation with propensity score matching to ensure comparability across samples.
  - Controls included: education, age, age squared, gender, marital status, region, household size and composition (baseline controls listed explicitly in Box 3).
  - Regressions are heteroscedasticity robust and clustered to the district level.
  - Survey sample: almost 2,500 observations.
- Key result:
  - Estimated parastatal wage premium: 56 percent compared to central and local governments, the private sector, and other sectors (e.g., non-governmental organizations, self-employed).
- Robustness: alternative scenarios control for additional factors beyond baseline specification.

### J. Diagnostic tools applied (overview)
- The chapter applies two IMF toolkits to Botswana SOEs:
  - SOE Health Check Tool (results referenced; detailed outputs follow in the chapter beyond provided excerpt).
  - SOE Stress Test Tool (results referenced; detailed outputs follow in the chapter beyond provided excerpt).

*Source: IMF staff chapter "1. Classification of SOEs" (July 26, 2023).*

### 18.      To gauge levels of financial vulnerability, the IMF SOE Health Check Tool

### To gauge levels of financial vulnerability, the IMF SOE Health Check Tool

### Application and methodology
- The IMF SOE Health Check Tool is applied to 9 SOEs based on data availability for FY2021.
- The 9 SOEs are BHC, BTCL, NDB, BPS, BOCRA, BOL, BPC, WUC, and BSB, which represent 70 percent of SOE assets.
- The tool compares profitability, liquidity, and solvency measures against international risk thresholds and produces a composite indicator ranking overall risk from low (Category 1 and 2), to moderate (Category 3), to high and very high risk (Category 4 and 5).
- The Stress Test Tool complements the Health Check Tool by assessing strength and resilience of SOE financial position relative to SOEs in other countries, with a focus on relative performance by sector.

### Key findings from the Health Check and Stress Test
- Risk distribution:
  - 7 out of 9 SOEs fall into the moderate and high risk categories against international benchmarks.
  - Three SOEs in Category 4—BPC, WUC, BSB—account for most of the energy and utility sectors and exhibit especially weak indicators.
  - BTCL, the only partially-privatized company in the group, has stronger debt-to-equity, debt-to-asset, and debt coverage ratios.
- Profitability and solvency:
  - ROA and ROE remain low across the SOE sample.
  - SOEs have struggled to service debt—reflected in the low debt coverage ratio and high debt to EBITDA (calculated by total liabilities divided by earnings before interest, tax, depreciation, and amortization).
- Liquidity and cost recovery:
  - Almost all SOEs pass cost recovery by generating adequate revenues to cover operating expenses.
  - A majority of SOEs are able to meet short-term liabilities with enough liquid short-term assets; liquidity has been relatively stable and has mostly recovered.
- Pandemic impact and trends:
  - On average, all 9 SOEs have yet to recover fully from the COVID-19 pandemic.
  - Profitability remained low in 2022, as reflected in their collective ROA and ROE.
  - Liabilities have increased significantly since the pandemic and the ability to service debt has markedly deteriorated.
- Sectoral comparative results (Stress Test Tool):
  - Median ROA in 35 international SOEs operating in electricity and gas supply was 2.7 percent for 2010–17; BPC’s return on assets was negative during the same period.
  - 61 international SOEs operating in the telecom sector produced a median ROA of 3.6 percent for 2010–17; the BTC averaged 0.1 percent.
  - Botswana SOEs performed in line with international benchmark ranges for some measures, including the current ratio and labor cost per operating revenue.

### International benchmarks used (selected thresholds from Table 1)
- Profitability:
  - Return on Assets: very low risk > 8.0; low risk 4.0; moderate risk 0.0-5.0
  - Return on Equity: very low risk > 15.0; low risk 8.0; moderate risk 0.0-10.0
  - Cost Recovery: very low risk > 1.5; low risk 1.3; moderate risk 1.0-0.8
- Liquidity:
  - Current Ratio: very low risk > 2.0; low risk 1.5; moderate risk 1.3-1.0
  - Quick Ratio: very low risk > 1.2; low risk 1.0; moderate risk 0.8-0.7
- Solvency:
  - Debt to Assets: very low risk < 0.3; low risk 0.5; moderate risk 0.8-1.0
  - Debt to Equity: very low risk < 0.5; low risk 1.0; moderate risk 1.5-2.0
  - Debt to EBITDA: very low risk < 1.5; low risk 2.0; moderate risk 3.0-5.0
  - Debt Coverage: very low risk > 0.5; low risk 0.3; moderate risk 0.2-0.1

### Policy recommendations and options
- Short term priorities:
  - Undertake a comprehensive analysis of the SOE sector, including subnational SOEs and SOE subsidiaries, assessing commercial viability, public policy objectives, track record, and market failures.
  - Ensure all annual financial statements are published in a timely manner and shared with the Ministry of Finance.
  - Compare SOE performance with private firms or international SOEs to establish efficiency benchmarks, prioritizing SOEs targeted for privatization and those operating in sectors where private firms are present.
  - Strengthen monitoring and oversight by clarifying roles and avoiding duplication between PEEPA and the Enterprise Development Policy Unit; ideally vest monitoring, governance enhancement, and reform implementation in a single unit.
- Medium term measures:
  - Devise and implement an SOE governance reform strategy based on the OECD Guidelines (2015), including a formal ownership policy describing roles and responsibilities of institutions involved in SOE oversight and governance.
  - Assign an inter-ministerial working group to design and implement the strategy and develop policies to guide SOE activities and limit overlap between SOEs.
  - Mandate transparent disclosure and cost coverage for any obligations beyond normal commercial functions; develop criteria for prioritization and sequencing of reforms (fiscal impact, sectoral importance, market readiness, cost of reform).
  - Strengthen independence of SOE boards and management by clarifying roles of boards, management, and the state as owner; formalize board nominations via the oversight unit; establish a single public database of potential candidates; enhance monitoring of shareholder’s compacts focusing on high-level financial and non-financial objectives and make them public.
- Additional reform levers (drawn from international experience):
  - Enhance competition with the private sector, separate accounts for commercial and non-commercial activities, set financing guidelines and financial performance targets, and remove special advantages of SOEs where appropriate.
  - Professionalize governing bodies, including promoting independence of board members and establishing policies for executive and director remuneration outside civil service frameworks.
  - Improve data transparency and integrity: adopt international accounting standards, independent external audits, internal audit procedures, and compile SOE data in line with the Government Finance Statistics Manual 2014.
  - Increase private sector participation through broadened ownership structures or management contracts; consider partial or full privatization where market conditions warrant.
  - Strengthen regulation and safeguards to limit monopolistic pricing power and protect private suppliers.

### Conclusions
- The financial performance of Botswana’s SOEs has generally been weaker than international benchmarks.
- The sector is an outlier because of the high percentage of government ownership and limited progress in advancing private sector involvement.
- Although direct fiscal support to SOEs has declined in recent years, the weak recovery since the pandemic represents a fiscal risk.
- Immediate actions should accelerate comprehensive analysis and clarify oversight roles; medium-term reforms should update SOE governance strategy and strengthen boards and management.

*Source: 1bwaea2023003 - 18.      To gauge levels of financial vulnerability, the IMF SOE Health Check Tool (IMF).*

### 2.      This selected issue paper (SIP) reviews the key features of Botswana's REER targeting

### 2. This selected issue paper (SIP) reviews the key features of Botswana's REER targeting regime

### A. Overview: history, design, and operational features
- Objective: promote export competitiveness and economic diversification by maintaining REER stability.
- Key historical actions:
  - Two discrete devaluations in 2004 and 2005.
  - Since May 2005, the Bank of Botswana (BoB) implements an automatic nominal adjustment of the Pula—the “crawling band exchange rate mechanism.”
- Main operational rule:
  - The projected inflation gap (measured by headline CPI) between Botswana and countries in the defined basket is offset by an announced annual “crawl rate” (the nominal growth rate of the Pula against the basket over the next 12 months).
  - The crawl rate is announced every year in December but can be changed later in case of large and unexpected shocks.
  - The annual crawl rate is divided by the number of trading days and implemented gradually daily throughout the year.
  - FX transactions: BoB quotes bid and offer rates to authorized primary dealers and will buy or sell unlimited quantities of foreign currencies against Pula; there is no maximum cap on trading but a minimum amount of USD 1 million equivalent for each trade.
- Currency-basket weights and evolution:
  - Weights went from 60 percent ZAR and 40 percent SDR in 2007 to 45 percent ZAR and 55 percent SDR in 2017; those weights have not changed since then.
- Monetary policy framework and instruments:
  - BoB has a price stability mandate and an inflation objective range of 3–6 percent for headline inflation over the medium term, defined as a 3-year rolling window.
  - Main policy instrument is a 7-day Bank of Botswana Certificate (BoBC) rate—also called the monetary policy rate (MOPR)—with certificates auctioned on a weekly basis since May 2022.
  - De facto framework: “two targets, two instruments” where the policy rate targets inflation and FX interventions target the exchange rate objective.
- Financial openness and capital controls:
  - Relatively low de facto financial openness: the local capital market is small and pension funds are required to invest 50 percent of their assets locally, resulting in imperfect capital mobility and a low risk of speculative inflows.

### B. Recent performance and challenges (empirical findings)
- General performance:
  - The regime has delivered relatively low and stable inflation between the Global Financial Crisis (GFC) and the Covid-19 pandemic and contributed to closing the historical inflation gap with South Africa and larger advanced economies.
- Persistent and emerging challenges:
  - REER trajectory and trade outcomes:
    - Rapid NEER appreciation and higher domestic inflation in early 2000s led to severe REER appreciation.
    - After appreciation between 2005 and 2013, the REER held steady around its 2014 value in subsequent years, implying REER stability.
    - Despite REER stability, export performance has slowly deteriorated and diversification has stalled:
      - Evidence of a steady deterioration in the trade balance and foreign exchange reserves since the GFC.
      - The share of non-mineral goods—particularly manufacturing goods—has shrunk since 2012 as a share of both exports and GDP.
  - Inflation resurgence and policy conflict:
    - The pandemic and the Ukraine war produced a resurgence of inflation via global food and energy prices.
    - The ER regime implied a negative crawl rate of 2.87 percent during these two years to offset positive inflation differentials between Botswana and its trading partners.
    - Given a large weight of imported tradables in the CPI and significant exchange rate pass-through (ERPT), such nominal depreciation is likely to have generated additional inflation pressures, creating potential tensions between competitiveness and price stability objectives.
    - Prior IMF work estimates a pass-through of roughly 0.5 after one year from changes in the NEER to the headline CPI in Botswana.
  - Foreign exchange reserves:
    - There has been a persistent decline in foreign exchange reserves over the past two decades.
- Implementation rigidity and parameter sensitivity:
  - The regime’s parameters (trading partners/currencies in the basket, weights, price indices) have changed little since inception and are critical to outcomes; choices are subject to measurement challenges and potential implementation mistakes.

### C. Conceptual assessment: benefits and costs of REER targeting
- Benefits emphasized:
  - A competitive REER can support growth by promoting exports and economic diversification; literature links undervalued REER to short- and long-run growth benefits.
  - For commodity exporters, maintaining competitiveness can help contain “Dutch disease” effects and support tradable-sector development.
  - A stable REER can increase investment by reducing uncertainty, but empirical benefits materialize primarily when the REER is also competitive.
  - Nominal depreciations via FX intervention are practical: easy to design, fast to implement, circumvent political-economy barriers, and, in Botswana’s case, unlikely to cause major financial instability because unhedged currency mismatches are limited; fiscal revenues (in Pula terms) may also benefit from depreciation.
- Main costs and trade-offs:
  - A constant REER may hinder structural adjustment to large shocks (e.g., persistent or transitory terms-of-trade shocks) by preventing relative price adjustment.
  - Implementation complexity: many parameters and inputs with little theoretical guidance create risks of mis-specification and large gaps between observed REER and its “right” level.
  - Potential tensions between monetary policy and exchange rate policy:
    - The crawl rate consistent with stabilizing the REER may be inconsistent with the inflation target, generating conflicts and making it harder for the central bank to achieve its inflation objective in the short run.
    - Botswana is more exposed to the scenario where a nominal depreciation conflicts with the need to tighten monetary stance (upper-right consistency concern).
  - Sterilization costs:
    - FX operations to enforce REER stability can be costly to sterilize because foreign reserves (e.g., US Treasuries) tend to earn lower returns than domestic assets issued by BoB (e.g., BoBCs).

### D. Policy implications and potential reforms explored
- Marginal adjustments recommended:
  - Small changes to the existing framework—related to the choice of currency weights and price indices—could mitigate some current implementation problems, including the gradual deterioration of price competitiveness.
- More structural reform option:
  - Transition to a nominal (NEER) targeting regime where the crawl rate is adjusted to meet the inflation target (i.e., aligning crawl with inflation objectives) could make Botswana’s monetary framework more robust and more in line with international best practices.
  - Benefits of NEER-targeting include reduced tensions between exchange rate adjustments and inflation control.
  - Implementation requirements for a NEER-targeting regime:
    - Would require institutional reforms, including assigning all responsibilities for exchange rate policy to the central bank.

*Prepared by Damien Puy (RES) with inputs and discussions from David Hofman (MCM), Romain Veyrune (MCM), Gunes Kamber (MCM), Nan Li (RES), Adrian Alter (MCD), Simon Gray (Consultant), and seminar participants from the joint MoF–BoB seminar in the context of the 2023 Article IV mission.*

### 15.      Botswana’s competitiveness problems could be partly caused by the currency regime,

### 15.      Botswana’s competitiveness problems could be partly caused by the currency regime

### Evidence on REER movements and competitiveness
- BoB’s official REER estimate has been relatively stable over the last ten years, but a trade-based REER index based on non-diamond exports points to a 10 percent appreciation of the price of tradables in Botswana since 2013.
- Using Unit Labor Costs (ULC), rather than CPI, to measure inflation in trading partners suggests an appreciation of larger magnitude, implying a potentially large loss of competitiveness over the same period (~20 percent).
- The deterioration is mainly explained by the large appreciation of the pula against the South African Rand (ZAR) since 2012 (~40 percent).
- These REER measures could explain the poor performance of non-mineral tradables and motivate changes in basket weights and/or price indices.

### Monetary policy and exchange rate policy interactions
- Conflicts between monetary policy and exchange rate policy have been limited until recently; inflationary spirals have not materialized since the introduction of the crawl mechanism in 2005.
- Since 2008, the monetary policy stance has generally been accommodative, while the REER targeting regime mainly called for nominal depreciations, implying limited de facto conflict during most of the period.
- The regime faces its first real test at the current juncture, with the combination of monetary policy tightening and nominal depreciation.
- Potential second-round effects of depreciations on inflation have been limited by structural forces, such as relatively tight financing conditions and prudent fiscal management.

### Sterilization and fiscal/financial costs
- If FX interventions are not sterilized, the cost will be borne in terms of additional tightening, since the extra liquidity injected will loosen monetary conditions when the monetary policy stance is tightening.
- Sterilization costs have likely been contained. Two factors dampened these costs:
  - Limited need to sterilize due to lack of conflict with the monetary policy stance over most of the period, suggesting potentially very low de facto sterilization.
  - Although returns on BOBCs have generally been higher than foreign interest rates, the gap is likely small after accounting for exchange rate movements, since the pula significantly depreciated against the SDR basket in the past two decades.

### Future risks to the REER targeting framework
- Trade benefits from the REER targeting framework have been limited and costs have been limited to date, but the trade-off could deteriorate in the future.
- Global demand for manufacturing goods is likely to deteriorate because of tighter monetary policy and recent deterioration in financial conditions, suggesting structurally limited growth for the non-mineral trade sector.
- The end of the global low inflation environment could increase the occurrence of large and persistent inflationary shocks (due to geopolitical tensions and climate change), raising the likelihood of conflicts with monetary policy and higher implementation costs.
- In such an environment, an alternative regime—or a modified version of the existing regime—might better serve Botswana.

### Reform options overview
- The analysis considers corner solutions (fixed and fully flexible) and intermediate regimes, arguing an intermediate exchange rate regime still seems warranted at the current juncture.
  - Hard peg: benefits of a hard peg to the Rand seem very limited given diamond invoicing in USD and weak business cycle correlation with South Africa.
  - Pure float: a pure float could increase FX volatility, risk of Dutch disease, and make inflation targeting harder given exchange rate pass-through and market thinness.
- Both fixed and fully flexible regimes could be contemplated in the longer term if necessary conditions are met (strong fundamentals, well-functioning monetary operations, deep capital and FX markets), but transitions would need careful planning and sequencing.

### Tweaking the current REER regime (adjustments to parameters)
- Two concrete adjustments to better support competitiveness:
  - Use non-diamond trade weights instead of current basket weights that give too much weight to developed economies (the United States in particular).
  - Use ULC rather than headline CPI to capture relevant price developments.
- Operational considerations:
  - Implementing non-diamond trade weights would be operationally faster and easier to communicate than transitioning to ULCs.
  - Projecting ULCs in trading partners might be challenging, and market participants might be more familiar with CPI indices.
- Effects and trade-offs:
  - Reducing advanced countries' weights would limit interference with monetary policy but mechanically increase South Africa's weight, likely resulting in (i) more frequent two-sided adjustments to the crawl rate and (ii) potentially higher (ex-post) volatility in the REER.
  - Adjusting parameters would help maintain competitiveness going forward but would not compensate past losses; offsetting past losses would require a large nominal depreciation.
    - A 10–15 percent real depreciation would probably be required to offset past losses; this would require a 20–30 percent nominal depreciation and generate a 10–15 percent inflation increase over one year (assuming a pass-through of 0.5).
- Transparency and communication:
  - Improving transparency and explaining temporary deviations from the mechanical REER stabilization rule (e.g., adopting a smaller crawl rate during temporary inflation pressures) could help manage policy tradeoffs and anchor expectations.

### Complementary measures outside monetary policy
- Tweaking the ER framework alone is unlikely to be sufficient; complementary reforms are critical:
  - Contain other sources of price pressures in the non-mineral sector (e.g., wage pressures).
  - Keep demand pressures (potentially stemming from loose fiscal policy) under control.
  - Ensure supply-side conditions so that firms can respond when price competitiveness improves (access to credit, skilled labor).
  - Improve broader determinants of competitiveness: infrastructure quality, governance, competition policy.
- Botswana ranks 91st among 141 countries in the latest Global Competitiveness Index, indicating significant scope to improve the business environment and infrastructure.

### Shifting to NEER targeting (nominal crawling peg calibrated to meet the inflation target)
- NEER targeting regime definition and operational design:
  - A nominal crawling peg where the crawl rate and basket weights are calibrated to achieve the inflation target, using two operational targets: (i) the short-term interest rate and (ii) a NEER crawling peg.
  - The desired NEER would be achieved through FX interventions.
  - This formally establishes the primacy of internal price stability.
- Trade-offs:
  - The exchange rate policy would no longer interfere with monetary policy, but competitiveness might suffer in the short run because calibrating to achieve the inflation objective could call for an appreciation of the NEER (rather than the depreciation implied by the current regime).
  - A large real appreciation is considered unlikely in the short run because the elevated exchange rate pass-through implies NEER appreciation would have significant disinflationary effects, mitigating impact on the REER.
  - In the long run, low and stable inflation would support price competitiveness; proximity between Botswana’s inflation target and those of main trading partners (e.g., South Africa) would minimize the risk of structural deterioration in relative price competitiveness.

*1bwaea2023003 - 15.      Botswana’s competitiveness problems could be partly caused by the currency regime*

### 31.      This new regime would be closer to international best practices and simple to operate

### 31.      This new regime would be closer to international best practices and simple to operate

### Proposal and rationale
- The NEER targeting regime would realign Botswana's exchange rate regime with current international standards by maintaining the benefits of a crawling peg arrangement—strong nominal anchor, operational simplicity—without the risk of interference with monetary policy.
- REER targeting regimes became rarer over time; real exchange rate targeting regimes were popular in the 1970s and 1980s but had mainly been abandoned by the late 1990s.
- Crawl or crawl-like arrangements are still widespread and used by low-, middle- and high-income countries alike; crawls have increasingly been used to pursue price stability rather than competitiveness or financial stability.

### International and empirical context (preserving source figures)
- "13 countries relying exclusively on a crawl to anchor inflation as of 2021."
- Among those, the use of a composite target—defined as the use of two or more currencies for the nominal anchor—is common.
  - "Singapore, Vietnam and Morocco all rely on a composite basket as their exchange rate anchor, with Singapore using a nominal effective exchange rate (NEER) crawling peg. Fiji and Kuwait also use a composite basket but are classified as 'other managed arrangement' which we do not count as 'crawls'."
- "As of 2021, eight countries were operating a crawl-like arrangement under an official inflation targeting regime (Costa Rica, Dominican Republic, Ghana, Philippines, Romania and Uzbekistan, Serbia, and Guatemala) and six others did it in the context of a transition towards inflation targeting (Egypt, Mongolia, Mozambique, Morocco, Tajikistan, and Tunisia)."

### Operational implications for Botswana
- Transitioning to a NEER targeting regime is operationally feasible because:
  - BoB already implements a crawl, implying adequate analytical and operational capacity.
  - Economic agents—firms and financial intermediaries—are familiar with current procedures.
  - "The current operational set-up, which includes a standing facility, could easily be adjusted to fit the new regime."
- Institutional changes likely required:
  - Exchange rate decisions are currently made by the President on the recommendation of the Minister of Finance after consultation with the Bank.
  - The new regime would imply that the exchange rate becomes an official monetary policy tool under the direct control of BoB, possibly requiring changes to Bank of Botswana Act.

### Complementary measures and policy trade-offs
- Under NEER targeting, exchange rate policy is geared towards price stability; achieving higher competitiveness would shift to structural and fiscal policies.
- Complementary measures required include:
  - Fiscal discipline.
  - Progress on structural reforms to mitigate Dutch disease effects, especially if the transition occurs while diamond proceeds are still large.
- Small framework changes (e.g., currency weights and price indices) could improve price competitiveness; more significant modifications may be warranted to address fundamental issues from pursuing dual objectives of competitiveness and low inflation.

### Transition path and long-term considerations
- The NEER targeting regime could serve as an intermediate step toward more exchange rate flexibility:
  - Many middle-income countries and emerging markets use mixed frameworks where a crawl or crawl-like arrangement coexists with inflation targeting or "light" inflation targeting.
  - Such combinations typically serve as intermediate steps allowing authorities to assemble key elements for a fully-fledged inflation targeting framework, after which the role of the nominal exchange rate anchor typically diminishes.
- Risks and drivers for later transition to greater flexibility:
  - As Botswana's economy deepens and external financing needs increase, maintaining any type of peg will become increasingly difficult.
  - Persistent downward pressure on foreign exchange reserves from lower diamond proceeds could undermine the central bank's ability to manage a peg over the long run.
- Transition should be gradual, carefully planned and sequenced; a hybrid regime (NEER targeting cohabiting with 'light' inflation targeting) is relatively common and could serve as a transitional arrangement toward a floating regime.

### Boxed policy guidance (key elements and lessons)
- Key elements of an effective monetary policy framework highlighted:
  - Clear central bank mandate and operational independence with public accountability.
  - Price stability as the primary or overriding objective; a medium-term inflation objective as cornerstone.
  - Consideration of macroeconomic activity and financial stability when adjusting policy.
  - Clear operational framework, forward-looking strategy, and transparent communications.
  - Botswana's BoB currently defines price stability as "a level of inflation within the medium-term objective range of 3 to 6 percent."
- Lessons from transitions to greater exchange rate flexibility:
  - Gradual, planned, and carefully sequenced transitions are preferable.
  - Preconditions for successful transition include: clearly formulated framework supported by legislation; central bank operational capacity and communication strategy; sufficiently deep FX and financial markets; private sector capacity to manage exchange rate risk.
  - Country experiences cited:
    - Israel and Poland: gradual moves from tight exchange rate targeting to crawling peg with widening bands, then to full-fledged inflation targeting (twenty and ten years respectively).
    - Morocco: moved to more flexible exchange rate in 2016 after pegging for over 40 years; bands widened progressively (increased the band to 5 percent from 0.6 percent in January 2018 and to 10 percent in March 2020 vis-à-vis a basket comprising the euro and the U.S. dollar, while keeping weights constant at 60 percent and 40 percent respectively). Morocco's transition featured favorable macro conditions, strong fundamentals, contained financial stability risks, sophisticated liquidity management, and gradual pace.

### Conclusion (policy recommendation summary)
- The current REER targeting regime has generated benefits historically but is now challenged by conjunctural and structural factors.
- A NEER targeting regime—where the crawl rate would be adjusted to meet the inflation target—could provide a more robust monetary policy framework for Botswana and re-align the country's exchange rate regime with international best practices.
- Over the longer term, a gradual move to greater exchange rate flexibility may become necessary as financial integration deepens and external pressures evolve; a hybrid NEER + 'light' inflation targeting arrangement could be an effective transitional framework.

*Source: IMF staff analysis as presented in the provided chapter.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1bwaea2023003.pdf_