## _wp0880

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---

### I. INTRODUCTION — role of diamonds and fiscal context
- The diamond industry has been a major contributor to Botswana’s growth:
  - Mining sector has contributed an average of 38.5 percent to GDP over the past 10 years.
  - Diamonds constitute nearly 94 percent of the sector’s total exports.
  - Half of Botswana's diamonds are used industrially; the remainder used for jewelry, accounting for about 80 percent of diamond sales revenue.
  - Diamond exports averaged 75 percent of total annual exports over the past 10 years.
  - Botswana’s diamond resources are mostly mined by Debswana, Botswana’s joint venture with De Beers.
- Institutional and macroeconomic context:
  - Botswana appears to have avoided the “resource curse.”
  - The latest Mines and Minerals Act, passed in 1999, automated the process and made it more predictable at all stages.
  - No major political tensions or corruption have been linked to diamond resources in Botswana.
  - Dutch disease does not appear to have affected nondiamond sectors (Iimi, 2006).
- Fiscal management of diamond-related revenue:
  - Botswana implicitly applies the Sustainable Budget Index (SBI), under which mineral revenue roughly matches investment expenditure.
  - Since 1990, mineral revenue has averaged 20.9 percent of GDP.
  - Investment expenditure, broadly defined (including capital expenditure and expenditure on health and education), has averaged 19.9 percent of GDP.
  - Analyzing the sustainability of expenditure is crucial given significant development needs intensified by the HIV/AIDS pandemic.
- Analytical approach used in the study:
  - Applies lifecycle approach (Modigliani and Brumberg, 1954) and the permanent income hypothesis (Friedman, 1957).
  - Steps: (i) estimate total diamond resource; (ii) take its net present value (NPV) as a financial asset generating a permanent income; (iii) use the income estimate to determine sustainable government spending without eroding long-term financial position.
  - Provides quantitative and simple benchmark scenarios to guide policy discussions.
  - Shows increased public savings in the short term could help avoid too sharp a fiscal adjustment in the medium term as diamond resources are depleted.
  - The study treats the current fiscal rule of no deficit as given; government expenditure over medium and long term must be within fiscal revenue.
  - Any level of expenditure permanently above fiscal revenue is unsustainable.
- Key numerical finding on savings needed:
  - Revenue savings must be increased 1.2 points of GDP a year to limit the adverse impact on government spending once diamond production ends.
  - Botswana adopted a fiscal rule imposing a non-negative fiscal balance as set out in the Mid-Term Review of the Ninth National Development Plan (NDP 9).
  - Fiscal revenue is expected to fall from 42 percent of GDP to about 33 percent once diamond resources are exhausted, implying the need to accumulate savings of about 1.2 percentage points of GDP per year to smooth expenditure reduction under the current fiscal rule.
- Additional policy considerations as diamond production declines:
  - A convincing fiscal adjustment may be needed to ensure diamond revenue benefits future generations.
  - Revenue-raising measures would help preserve expenditure either in level (Section III) or per capita terms (Section IV).
  - Unless the economy is diversified to create additional sources of revenue before diamond resources are fully depleted, the contraction of fiscal revenue would be steep and significantly constrain expenditure (Section IV).

### II. DIAMOND RESOURCES COULD BE DEPLETED BY 2029 — production, prices, and fiscal implications
- Projections and data sources:
  - Stylized projections for diamond production and prices use data from Debswana and the Ministry of Minerals and Water Resources.
  - Stylized data on production and prices are used to derive projections for diamond-related fiscal revenue feeding into a baseline scenario of fiscal viability under the current fiscal rule using a permanent income approach (Section III.A).
- Diamond production, reserves, and prices:
  - Botswana’s diamond reserves could be depleted by 2029 (Figure 1.A).
  - Diamond production is expected to increase from 32 million carats to 44 million carats from 2005 to 2017, largely because a new plant to be opened by Debswana.
  - The new plant will use modern techniques to extract more (though smaller and thus less profitable) diamonds from mine tailings and to recycle large stocks of waste.
  - The plant is expected to increase the company’s diamond extraction by an estimated 35 percent and its income by a more modest 12–15 percent.
  - From 2017 to 2021, diamond production is expected to decrease as diamond reserves are drawn down and surface mines are closed.
  - From 2021 to 2029, as resources draw down, Debswana will need to shift to underground mining; higher extraction costs and decreased output will result in lower profits, and it is not clear that underground mining in Botswana will be economically feasible or profitable.
  - The average diamond price is assumed to be constant in real terms at US$120 per carat, except during 2013–17 (the waste recycling period) when the average price is assumed to drop by about 10 percent to US$110 per carat (hypothesis assumes diamonds extracted from waste are of lower quality).
- Fiscal impacts and key statistics:
  - As diamond resources are drawn down, diamond-related fiscal revenue is expected to shrink by about two-thirds in 2021–29 (Figure 1.C and D).
  - Botswana’s diamond resources generate about 60 percent of tax revenue.
  - Over the past 10 years, mineral revenues, 95 percent of which were from diamonds, accounted for 63 percent of tax revenues.
  - Diamond-related fiscal revenue (constant US$ billions, 2006–29) follows a downward path associated with declining production and shifts in extraction methods.
  - Total fiscal revenue, baseline scenario, is shown in percent of GDP for 2006–50 (Figure 1.D), with fiscal revenue decreasing from about 46 percent of GDP in 2006 to 33 percent of GDP in the long run.

### III. SAVING DIAMOND-RELATED REVENUE — permanent income vs quasipermanent income
- Conceptual framing:
  - The net present value (NPV) of expected diamond-related fiscal revenue at date t can be viewed as a financial asset A_t; T is the time-horizon after which diamond resources will be depleted (2029).
- Permanent income hypothesis findings:
  - A_t is used to generate a permanent income growing at the same rate as long-term GDP growth.
  - Assuming long-term real GDP growth rate of 4.0 percent and real interest rate of 4.5 percent, the long-run annuity (long-term government expenditure) implied by converting A_t is equal to 1.5 percent of GDP (Figure 2.A and equation (3) discussion).
  - The permanent income exercise yields an NPV of diamond revenue in 2006 equal to 291.2 (percent of GDP units as reported in Figure 2.A table).
  - The permanent income hypothesis implies a sharp immediate cut in government expenditure; spending would need to be slashed by about 20 percent of GDP in the first few years under strict application.
- Quasipermanent income approach findings:
  - The time horizon is shortened from infinity to a period T (2050 in the baseline), leaving 20 years of annuities after diamond production ends.
  - The sequence of government expenditure G_j, j∈{t,...,T}, satisfies ∑_{j=0}^{T} (1/(1+i))^{j} G_{j} = A_{t}.
  - A hypothetical pattern for G_j implies saving fiscal revenue of about 1.2 percent of GDP a year, smoothing the fiscal impact on development and poverty-related expenditures once diamond production declines.
  - The quasipermanent approach provides more revenue in the short term and smoothes the adjustment compared with the permanent income hypothesis.
- Trade-off:
  - Quasipermanent income smooths short-term adjustment but sacrifices a long-run permanent income stream.

### IV. SENSITIVITY ANALYSIS — uncertainty in NPV, prices, and production
- NPV uncertainty:
  - The NPV of diamond revenue is uncertain because the extent of existing resources is unknown and diamond prices could change.
  - Botswana is a price maker in the diamond market; if production falls, world diamond prices are likely to rise, but the extent is unknown.
  - Even a 10 percent increase in the NPV would have a negligible impact on the long-term annuity; an expenditure adjustment would still be needed.
- Reported NPV values (Table 1):
  - NPV baseline: 291.2
  - 5 percent increase: 305.7
  - 10 percent increase: 320.3
- Illustrative scenarios that could change NPV:
  - one more year of ground extraction at a high level of about 30 million carats;
  - two more years of ground extraction at a high level of about 30 million carats;
  - price increase of 75 percent once production starts declining;
  - price increase of 150 percent once production starts declining.
- Conclusion from sensitivity analysis:
  - Even with optimistic scenarios, the life span of Botswana’s diamond resources is far shorter than oil reserves in many oil-producing countries and cannot generate a permanent source of income.

### V. PRESERVING DEVELOPMENT OBJECTIVES AND DIVERSIFICATION RISKS
- Growth and fiscal per capita risks:
  - The end of diamond production could induce lower growth, which could impede development objectives.
  - If diversification is slower, growth is likely to flag in 2022–29 when diamond production slows and reserves are depleted; this does not fundamentally alter the fiscal analysis in percent of GDP but reduces resources available for development objectives.
  - Without diversification, government revenue per capita would fall sharply at the end of diamond production:
    - Botswana could experience a period of low growth in 2018–24, including a steep recession in 2022 of -9.5 percent as diamond production declines sharply.
    - Government revenue per capita after 2021 would fall by 27 percent (temporary; recovery depends on diversification).
- Early additional savings option:
  - Increasing savings an average of 2.5 percentage points of GDP through 2021 could prevent a decrease in per capita expenditure from 2022 on, but would require committed political and social support.
- Diversification impediments:
  - Over the past 15 years, the share of nondiamond sectors in total GDP has been roughly constant at about 38 percent, indicating lack of diversification.
  - Two notable impediments to diversification: the labor market (public sector wages exceed, on average, private sector wages by about 60 percent) and slow privatization.
- Health-related risk:
  - The HIV/AIDS epidemic is likely to lower growth potential while increasing government expenditure; a growth rate of 2 percent would leave little scope for expenditure per capita to increase over the medium and long term.
  - This reinforces the need to initiate adjustment soon.

### VI. POLICY CONCLUSIONS AND RECOMMENDATIONS
- Main conclusion:
  - Botswana’s diamond reserves cannot generate enough permanent revenue to sustain high expenditures.
  - To observe the fiscal rule forbidding the accumulation of debt, Botswana needs to save more to avoid a painful medium-term adjustment in public expenditure.
- Key policy recommendations:
  - Political consensus on saving more in the short and medium term is needed; adjustment will be viable only with sufficient political and social support because any adjustment is likely to restrain expenditure.
  - To diversify the economy and improve growth, Botswana would likely need to attract more foreign investment; new partnerships with the private sector might be considered to finance infrastructure improvements.
  - Budget contingency planning might be needed to accommodate uncertainty about the actual stock of diamonds and future prices.
  - The nondiamond fiscal deficit may need to be adjusted given that the economy cannot rely on diamond resources over the long term.
- Role of debt and investment:
  - Investment in infrastructure and human capital, critical for diversification and growth, could be financed with debt to reduce the magnitude of the short-term fiscal adjustment.
  - An alternative is to change the fiscal rule to allow debt accumulation to finance investment in infrastructure and human capital, substituting deficit financing for mineral revenues to preserve more expenditure than under the current rule strictly applied.
  - To keep debt sustainable, authorities would have to balance expected fiscal revenue with debt service and assess carefully the macroeconomic impact of expenditure financed by debt.
  - The positive impact of public investment in human capital on growth takes 10 to 15 years to fully materialize and is dependent on the quality of public institutions.

*Source: IMF staff calculations and estimates, based on stylized data from _wp0880 - conclusions (Section III.B).*

### References..............................................................................................................

### _wp0880 - References..............................................................................................................

### I. INTRODUCTION
- The diamond industry has been a major contributor to Botswana’s growth:
  - Mining sector has contributed an average of 38.5 percent to GDP over the past 10 years.
  - Diamonds constitute nearly 94 percent of the sector’s total exports.
  - Half of Botswana's diamonds are used industrially; the remainder used for jewelry, accounting for about 80 percent of diamond sales revenue.
  - Diamond exports averaged 75 percent of total annual exports over the past 10 years.
  - Botswana’s diamond resources are mostly mined by Debswana, Botswana’s joint venture with De Beers.
- Institutional and macroeconomic context:
  - Botswana appears to have avoided the “resource curse.”
  - The latest Mines and Minerals Act, passed in 1999, automated the process and made it more predictable at all stages.
  - No major political tensions or corruption have been linked to diamond resources in Botswana.
  - Dutch disease does not appear to have affected nondiamond sectors (Iimi, 2006).
- Fiscal management of diamond-related revenue:
  - Botswana implicitly applies the Sustainable Budget Index (SBI), under which mineral revenue roughly matches investment expenditure.
  - Since 1990, mineral revenue has averaged 20.9 percent of GDP.
  - Investment expenditure, broadly defined (including capital expenditure and expenditure on health and education), has averaged 19.9 percent of GDP.
  - Analyzing the sustainability of expenditure is crucial given significant development needs intensified by the HIV/AIDS pandemic.
- Analytical approach used in the study:
  - Applies lifecycle approach (Modigliani and Brumberg, 1954) and the permanent income hypothesis (Friedman, 1957).
  - Steps: (i) estimate total diamond resource; (ii) take its net present value (NPV) as a financial asset generating a permanent income; (iii) use the income estimate to determine sustainable government spending without eroding long-term financial position.
  - Provides quantitative and simple benchmark scenarios to guide policy discussions.
  - Shows increased public savings in the short term could help avoid too sharp a fiscal adjustment in the medium term as diamond resources are depleted.
  - The study treats the current fiscal rule of no deficit as given; government expenditure over medium and long term must be within fiscal revenue.
  - Any level of expenditure permanently above fiscal revenue is unsustainable.
- Key numerical finding on savings needed:
  - Revenue savings must be increased 1.2 points of GDP a year to limit the adverse impact on government spending once diamond production ends.
  - Botswana adopted a fiscal rule imposing a non-negative fiscal balance as set out in the Mid-Term Review of the Ninth National Development Plan (NDP 9).
  - Fiscal revenue is expected to fall from 42 percent of GDP to about 33 percent once diamond resources are exhausted, implying the need to accumulate savings of about 1.2 percentage points of GDP per year to smooth expenditure reduction under the current fiscal rule.
- Additional policy considerations as diamond production declines:
  - A convincing fiscal adjustment may be needed to ensure diamond revenue benefits future generations.
  - Revenue-raising measures would help preserve expenditure either in level (Section III) or per capita terms (Section IV).
  - Unless the economy is diversified to create additional sources of revenue before diamond resources are fully depleted, the contraction of fiscal revenue would be steep and significantly constrain expenditure (Section IV).

### II. DIAMOND RESOURCES COULD BE DEPLETED BY 2029, INDUCING A SHARP FALL IN FISCAL REVENUE
- This section presents stylized projections for diamond production and prices using data from Debswana and the Ministry of Minerals and Water Resources.
- Stylized data on production and prices are used to derive projections for diamond-related fiscal revenue.
- These data feed into a baseline scenario of fiscal viability under the current fiscal rule using a permanent income approach (Section III.A).
- The study tests how alternative assumptions for production and prices affect projections.

*Italic: Source: _wp0880 - References..............................................................................................................*

### conclusions (Section III.B).

### _wp0880 - conclusions (Section III.B)

### Diamond production, reserves, and prices
- Botswana’s diamond reserves could be depleted by 2029 (Figure 1.A).
- Diamond production is expected to increase from 32 million carats to 44 million carats from 2005 to 2017, largely because a new plant to be opened by Debswana.
- The new plant will use modern techniques to extract more (though smaller and thus less profitable) diamonds from mine tailings and to recycle large stocks of waste.
- The plant is expected to increase the company’s diamond extraction by an estimated 35 percent and its income by a more modest 12–15 percent.
- From 2017 to 2021, diamond production is expected to decrease as diamond reserves are drawn down and surface mines are closed.
- From 2021 to 2029, as resources draw down, Debswana will need to shift to underground mining; higher extraction costs and decreased output will result in lower profits, and it is not clear that underground mining in Botswana will be economically feasible or profitable.
- The average diamond price is assumed to be constant in real terms at US$120 per carat, except during 2013–17 (the waste recycling period) when the average price is assumed to drop by about 10 percent to US$110 per carat (hypothesis assumes diamonds extracted from waste are of lower quality).

### Fiscal impacts and key statistics
- As diamond resources are drawn down, diamond-related fiscal revenue is expected to shrink by about two-thirds in 2021–29 (Figure 1.C and D).
- Botswana’s diamond resources generate about 60 percent of tax revenue.
- Over the past 10 years, mineral revenues, 95 percent of which were from diamonds, accounted for 63 percent of tax revenues.
- Diamond-related fiscal revenue (constant US$ billions, 2006–29) follows a downward path associated with declining production and shifts in extraction methods.
- Total fiscal revenue, baseline scenario, is shown in percent of GDP for 2006–50 (Figure 1.D), with fiscal revenue decreasing from about 46 percent of GDP in 2006 to 33 percent of GDP in the long run.

### Saving diamond-related revenue: permanent income vs quasipermanent income
- The net present value (NPV) of expected diamond-related fiscal revenue at date t can be viewed as a financial asset A_t; T is the time-horizon after which diamond resources will be depleted (2029).
- Under the permanent income hypothesis:
  - A_t is used to generate a permanent income growing at the same rate as long-term GDP growth.
  - Assuming long-term real GDP growth rate of 4.0 percent and real interest rate of 4.5 percent, the long-run annuity (long-term government expenditure) implied by converting A_t is equal to 1.5 percent of GDP (Figure 2.A and equation (3) discussion).
  - The permanent income exercise yields an NPV of diamond revenue in 2006 equal to 291.2 (percent of GDP units as reported in Figure 2.A table).
  - The permanent income hypothesis implies a sharp immediate cut in government expenditure; spending would need to be slashed by about 20 percent of GDP in the first few years under strict application.
- Under the quasipermanent income approach:
  - The time horizon is shortened from infinity to a period T (2050 in the baseline), leaving 20 years of annuities after diamond production ends.
  - The sequence of government expenditure G_j, j∈{t,...,T}, satisfies ∑_{j=0}^{T} (1/(1+i))^{j} G_{j} = A_{t}.
  - A hypothetical pattern for G_j implies saving fiscal revenue of about 1.2 percent of GDP a year, smoothing the fiscal impact on development and poverty-related expenditures once diamond production declines.
  - The quasipermanent approach provides more revenue in the short term and smoothes the adjustment compared with the permanent income hypothesis.
- Trade-off: quasipermanent income smooths short-term adjustment but sacrifices a long-run permanent income stream.

### Sensitivity analysis (uncertainty in NPV, prices, and production)
- The NPV of diamond revenue is uncertain because the extent of existing resources is unknown and diamond prices could change.
- Botswana is a price maker in the diamond market; if production falls, world diamond prices are likely to rise, but the extent is unknown.
- Even a 10 percent increase in the NPV would have a negligible impact on the long-term annuity; an expenditure adjustment would still be needed.
- Table 1 (reported values):
  - NPV baseline: 291.2
  - 5 percent increase: 305.7
  - 10 percent increase: 320.3
- Corresponding illustrative scenarios that could change NPV include:
  - one more year of ground extraction at a high level of about 30 million carats;
  - two more years of ground extraction at a high level of about 30 million carats;
  - price increase of 75 percent once production starts declining;
  - price increase of 150 percent once production starts declining.
- Even with optimistic scenarios, the life span of Botswana’s diamond resources is far shorter than oil reserves in many oil-producing countries and cannot generate a permanent source of income.

### Preserving development objectives and diversification risks
- The end of diamond production could induce lower growth, which could impede development objectives.
- If diversification is slower, growth is likely to flag in 2022–29 when diamond production slows and reserves are depleted; this does not fundamentally alter the fiscal analysis in percent of GDP but reduces resources available for development objectives.
- Without diversification, government revenue per capita would fall sharply at the end of diamond production:
  - Botswana could experience a period of low growth in 2018–24, including a steep recession in 2022 of -9.5 percent as diamond production declines sharply.
  - Government revenue per capita after 2021 would fall by 27 percent (temporary; recovery depends on diversification).
- Additional savings early in the transition:
  - Increasing savings an average of 2.5 percentage points of GDP through 2021 could prevent a decrease in per capita expenditure from 2022 on, but would require committed political and social support.
- Diversification challenges:
  - Over the past 15 years, the share of nondiamond sectors in total GDP has been roughly constant at about 38 percent, indicating lack of diversification.
  - Two notable impediments to diversification: the labor market (public sector wages exceed, on average, private sector wages by about 60 percent) and slow privatization.
- Health-related risk:
  - The HIV/AIDS epidemic is likely to lower growth potential while increasing government expenditure; a growth rate of 2 percent would leave little scope for expenditure per capita to increase over the medium and long term.
  - This reinforces the need to initiate adjustment soon.

### Policy conclusions and recommendations
- Botswana’s diamond reserves cannot generate enough permanent revenue to sustain high expenditures.
- To observe the fiscal rule forbidding the accumulation of debt, Botswana needs to save more to avoid a painful medium-term adjustment in public expenditure.
- Key policy points emphasized:
  - Political consensus on saving more in the short and medium term is needed; adjustment will be viable only with sufficient political and social support because any adjustment is likely to restrain expenditure.
  - To diversify the economy and improve growth, Botswana would likely need to attract more foreign investment; new partnerships with the private sector might be considered to finance infrastructure improvements.
  - Budget contingency planning might be needed to accommodate uncertainty about the actual stock of diamonds and future prices.
  - The nondiamond fiscal deficit may need to be adjusted given that the economy cannot rely on diamond resources over the long term.
- Role of debt and investment:
  - Investment in infrastructure and human capital, critical for diversification and growth, could be financed with debt to reduce the magnitude of the short-term fiscal adjustment.
  - An alternative is to change the fiscal rule to allow debt accumulation to finance investment in infrastructure and human capital, substituting deficit financing for mineral revenues to preserve more expenditure than under the current rule strictly applied.
  - To keep debt sustainable, authorities would have to balance expected fiscal revenue with debt service and assess carefully the macroeconomic impact of expenditure financed by debt.
  - The positive impact of public investment in human capital on growth takes 10 to 15 years to fully materialize and is dependent on the quality of public institutions.

*Source: IMF staff calculations and estimates, based on stylized data from _wp0880 - conclusions (Section III.B).*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2008/_wp0880.pdf_