This Selected Issues paper and Statistical Appendix describes the evolution of Botswana’s exchange rate regime against the background of the country’s main economic developments and trade relations. The paper reviews the main changes that have taken place in Botswana’s exchange rate arrangement, and discusses the development of the country’s external trade. Indicators of competitiveness are presented, and some conclusions are drawn about the appropriateness of Botswana’s exchange rate regime and its role in economic diversification.

Abstract

This Selected Issues paper and Statistical Appendix describes the evolution of Botswana’s exchange rate regime against the background of the country’s main economic developments and trade relations. The paper reviews the main changes that have taken place in Botswana’s exchange rate arrangement, and discusses the development of the country’s external trade. Indicators of competitiveness are presented, and some conclusions are drawn about the appropriateness of Botswana’s exchange rate regime and its role in economic diversification.

Botswana’s Exchange Rate Regime and Developments in Trade and Competitiveness, 1976-97

I. Introduction

1. This note describes the evolution of Botswana’s exchange rate regime against the background of the country’s main economic developments and trade relations. Over the years, Botswana’s exchange rate policy has accorded a high priority to preserving competitiveness with a view to promoting diversification of economic activities and employment in nontraditional industries. At the same time, due attention has been given to the impact of exchange rate developments on inflation. An important consideration in the choice of the exchange rate arrangement has been Botswana’s trade relations and its membership in the Southern African Customs Union (SACU).1 After reviewing the main changes that have taken place in Botswana’s exchange rate arrangement, the paper discusses the development of the country’s external trade. Subsequently, indicators of competitiveness are presented, and some conclusions are drawn about the appropriateness of Botswana’s exchange rate regime and its role in economic diversification.

II. Evolution of Exchange Rate Arrangement2

2. Against the background of rising diamond production, in August 1976 Botswana withdrew from participation in the Rand Monetary Area (RMA)3 and introduced its own currency, the Botswana pula. Initially, the pula was pegged to the U.S. dollar; since the South African rand was also pegged to the U.S. dollar, this arrangement provided a stable relationship between the pula and the two currencies in which the majority of the country’s trade was conducted. Following an 18-month period from January 1979 when the rand floated against the U.S. dollar—which entailed a significant appreciation of the rand and thus a depreciation of the pula against the rand—the Botswana authorities decided in June 1980 to switch from a peg to the U.S. dollar to a currency basket with weights of 50 percent for both the SDR and the rand. An important reason for this switch was the inflationary impact of the depreciation of the pula vis-a-vis the rand. By mid-1980, Botswana’s inflation had risen to about 12 percent from about 8 percent in early 1979, and it peaked at over 18 percent in May 1981. In comparison, between early 1979 and mid-1981, inflation in South Africa accelerated from 11 percent to 14.5 percent.

uA01fig01

Consumer Price Indices, 1976 - 97

(Annual percentage change)

Citation: IMF Staff Country Reports 1998, 039; 10.5089/9781451806335.002.A001

3. Botswana’s decision to peg its currency to a basket of currencies, rather than to float the pula, was taken for three reasons: (i) the thinness of the market for pula; (ii) the possibility that, given the size of diamond receipts, a float could lead to an appreciation that would run counter to the economic development and diversification objectives; and (iii) the need to provide a nominal anchor for price stability. Since 1980, Botswana has continued to avail itself of an exchange rate arrangement based on a currency basket, but the authorities have occasionally changed the composition of the basket and have made discrete adjustments to the peg when circumstances required.

4. Since the introduction of the currency basket, Botswana has been faced with a series of external shocks linked to developments in the South African economy and to international mineral markets. This was particularly evident in the early 1980s. In 1981, owing to a recession in the major industrial countries, demand for diamonds fell sharply. As a consequence, Botswana’s external current account deteriorated markedly, and, by December 1981, its foreign exchange reserves had fallen from a peak of US$357 million at end-October 1980 to US$250 million, equivalent to four months of import cover. This development prompted the authorities, in May 1982, to devalue the pula by 10 percent against the basket as part of a package of adjustment measures. While the diamond market recovered and Botswana’s external current account position improved (since 1981, the current account has been in continuous surplus), in the early 1980s the Botswana authorities continued to face problems caused by the instability of the rand against the U.S. dollar. In order to protect the competitiveness of Botswana’s economy, the authorities devalued the pula against the basket in both 1984 and 1985, by 5 percent and 15 percent, respectively. As a consequence, during the 1980-85 period, the pula depreciated by more than 60 percent against the U.S. dollar (Table 1).

Table 1.

Botswana: Exchange Rates and Consumer Prices and Exchange Rate Indices, 1976-97

(Period average)

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Sources: Botswana authorities; and Fund staff calculations.

Weighted by trade and currency denominations (average 1990-95): South Africa (47 percent); United Kingdom (9 percent); United States (39 percent); and Zimbabwe (5 percent).

uA01fig02

Pula per U.S. Dollar, 1976 - 1997

(average rate)

Citation: IMF Staff Country Reports 1998, 039; 10.5089/9781451806335.002.A001

5. In 1986, as the rand appreciated rapidly against the U.S. dollar, the authorities introduced a new basket of currencies, with undisclosed weights, and, in 1987, implemented a policy to maintain a broadly stable real exchange rate against the rand, requiring discretionary adjustments in the rate of the pula relative to the currency basket. Since 1987, the real pula-rand exchange rate has remained virtually unchanged, but there have been periods in which the pula has appreciated in real effective terms against the currency of its major trading partner. In the late 1980s, the authorities allowed a significant real appreciation of the pula to reduce imported inflation and absorb some of the rising demand pressures through increased imports. The real appreciation had a negative impact on the competitiveness of the nontraditional sectors. Accordingly, the pula was devalued by 5 percent against the basket in both 1990 and 1991, but rising inflation, which peaked at 17.7 percent in June 1992, eroded any gains in competitiveness.

uA01fig03

External Terms of Trade, 1985 - 96

(Index 1990=100)

Citation: IMF Staff Country Reports 1998, 039; 10.5089/9781451806335.002.A001

1/ Ratio of export to import prices

6. In the recent period, the pula has closely followed the rand, with the authorities making discretionary adjustments in the rate of the pula against the basket. When in 1996 the rand depreciated by 22 percent against the U.S. dollar, Botswana allowed the pula to follow a similar path. As the majority of nondiamond trade is transacted in rand, while diamonds are priced in U.S. dollars, movements in the U.S. dollar-rand rate can have a significant impact on Botswana’s terms of trade (Table 2). For instance, significant depreciations in the rand-U.S. dollar rate, as have occurred in the 1990s, have had a considerable, positive impact on the current account position and on government revenue, which is sourced primarily from external sector activity. The favorable effect of the depreciation was reflected in a further strengthening of the external current account surplus and a sizable increase in official reserves. In addition, the government’s diamond-related revenue and its earnings on foreign currency assets surged in 1996/97 (April/March), and the fiscal surplus increased to 7.6 percent of GDP. Overall, since the beginning of the 1990s, the pula rate has depreciated by about 50 percent against the U.S. dollar. Over the period, inflation averaged 11.7 percent annually, marginally higher than in the 1980s, although by end-1997 the annual inflation rate was at its lowest level for almost a decade. By comparison, inflation in South Africa since the beginning of the 1990s has averaged 9.7 percent annually.

Table 2.

Botswana: External Trade Indices (in U.S. Dollar Terms), 1985-96

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Source: Botswana authorities; and Fund staff estimates.
uA01fig04

Pula per Rand, 1976 - 97

(average rate)

Citation: IMF Staff Country Reports 1998, 039; 10.5089/9781451806335.002.A001

uA01fig05

Nominal and Real Pula/Rand Exchange Rate Index, 1976-97

Citation: IMF Staff Country Reports 1998, 039; 10.5089/9781451806335.002.A001

III. Trade Developments

7. Botswana has characteristics that are common to many developing countries: (i) reliance on primary commodity production and exports; (ii) limited substitutability of domestically produced goods for imports; and (iii) dependence on the external sector for essential imports, particularly intermediate goods and capital equipment. Apart from diamond exports—and, to some extent, beef, copper nickel, and textile exports—Botswana’s trade is concentrated in the S ACU region. Close to three-fourths of Botswana’s imports and about 60 percent of nondiamond exports are traded within the SACU region, principally South Africa. There are also close commercial links between South Africa and Botswana in the form of inward direct investment. In addition, because of its geographic proximity and the size of its market, South Africa is Botswana’s natural export market. This tendency is reinforced by the tariff policy of SACU members which, in essence, provides a tariff-free market for companies located within it. Overall, Botswana runs a large trade deficit with the SACU region—about P 3 billion in 1996 (20 percent of GDP)—which is more than offset by a large trade surplus with non-SACU countries, owing to diamond exports. In these circumstances, Botswana has recorded a considerable surplus on its overall external current account, and official reserves have risen to the equivalent of about 32 months of imports of goods and services.

uA01fig06

Trade with SACU Region, 1980-96

(In percent of Total Trade)

Citation: IMF Staff Country Reports 1998, 039; 10.5089/9781451806335.002.A001

8. Botswana’s geographical trade pattern has remained remarkably stable over the years (Table 3). The share of SACU countries, primarily South Africa, in Botswana’s trade has remained at about 45 percent of total trade for the past decade. Its major export commodity, diamonds, is sold outside the SACU region. While the data indicate that Europe is the main market for diamonds, the final destinations of diamonds are more widely dispersed than suggested by these statistics. For instance, it is estimated that one-third of global diamond sales in recent years have been to Asia.

Table 3.

Botswana: Direction of Trade, 1980-96

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Source: Botswana authorities.
uA01fig07

Diamond and Other Exports, 1980 - 96

(In millions of U.S. dollars)

Citation: IMF Staff Country Reports 1998, 039; 10.5089/9781451806335.002.A001

9. The composition of Botswana’s exports and imports since 1980 is set out in Tables 4 and 5. The share of diamonds within total exports has remained broadly at the 70–75 percent range since the mid-1980s, having risen from about 50 percent in the years of depressed demand in the early 1980s.4 Other traditional exports, such as meat and copper nickel, have decreased in importance, while the share of textile exports has remained small, at less than 5 percent. In recent years, vehicle exports have become significant, accounting for just over 10 percent in the 1995–97 period. With respect to imports, the composition has been generally stable since the early 1980s, with a strong emphasis on essential items, including food, intermediate goods, and capital equipment. More recently, imports of vehicle and transport equipment have increased their share significantly, associated with the establishment of the motor vehicle assembly plant.

Table 4.

Botswana: Value of Principal Exports, 1980-97

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Source: Botswana authorities.

The data for 1997 are for January-June.

Table 5.

Botswana: Value of Principal Imports by Category, 1980-97

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Source: Botswana authorities.

The data for 1997 are for January-June.

uA01fig08

Composition of Imports, 1980 -1996

(average)

Citation: IMF Staff Country Reports 1998, 039; 10.5089/9781451806335.002.A001

IV. Competitiveness

10. Developments in effective exchange rates since 1980 have been characterized by pronounced nominal and real depreciations during the first half of the 1980s, followed by a period of relative stability in both the nominal and real effective exchange rates.5 However, since the beginning of the 1990s, the nominal effective exchange rate has depreciated steadily by a cumulative 26 percent; meanwhile, the real effective exchange rate appreciated through 1995, as inflation in Botswana exceeded that of its trading partners. Over the last few years, the real effective exchange rate depreciated, largely on account of declining inflation in Botswana. While the real pula-rand rate has been broadly stable over the past decade, from early 1982 to mid-1992 the inflation rate of Botswana was always lower than that of South Africa. In contrast, since mid-1992, the reverse has been true: the inflation rate in Botswana has been above that of South Africa. Over the last year, however, the inflation rates in both countries have fallen and converged.

uA01fig09

Nominal and Real Effective Exchange Rates, 1979-97

(Period average, index 1990 = 100)

Citation: IMF Staff Country Reports 1998, 039; 10.5089/9781451806335.002.A001

11. Apart from effective exchange rate calculations, Botswana’s competitiveness can be assessed on the basis of developments in the traded and nontraded sectors of the economy and the internal terms of trade. Table 6 presents data on formal employment, labor productivity, and real unit labor costs in Botswana by sector, both in level and percentage change terms. Because of data limitations, these data should be regarded as only broadly indicative of trends.6 Focusing on the manufacturing sector—the main nontraditional exporting industry—its labor productivity performance has tended to be weaker than the rest of the private sector, while its unit labor costs have been lower.7 In recent years, wage increases in this sector seem to have been held close to productivity gains. In 1995, the average cash earnings in the manufacturing sector were 80 percent of the average for the whole economy. The internal terms of trade remained broadly unchanged between 1990 and 1997, as a worsening during the 1992-94 period was reversed during the 1994-97 period (Table 7).

Table 6.

Botswana: Labor Statistics, 1983/84-1995/96 1/

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Sources: Central Statistics Office; and Fund staff estimates.

All numbers in the table are derived from official data. However, there is a discontinuity in the real GDP data that are used for the calculation. While the data up to 1987/88 are based on 1985/86 prices, the data after 1988/89 are based on 1992/93 prices and rebased to 1985/86 prices.

Data for March.

Labor productivity data are calculated by dividing real GDP by the number of employees; no adjustment is made for the effect of changes in working hours as information on working hours is not available. Also, labor productivity data are calculated by using real GDP on the national accounts year (July-June) and the number of employees as at March each year.

Excludes general government

Unit labor costs in the table are calculated by dividing compensation of employees by value added. Another method is to divide nominal wage rate (per hour) by labor productivity (per hour).

uA01fig10

Internal Terms of Trade, 1990 - 97 1/

Citation: IMF Staff Country Reports 1998, 039; 10.5089/9781451806335.002.A001

1/ Ratio of prices of tradeables and nontradeables

12. In terms of employment growth, the performance of the traded-goods sectors—agriculture, mining, and manufacturing—has not been noticeably better than that of the nontraded sectors, although, in the period between 1985 and 1991, manufacturing was among the sectors with stronger employment growth rates. Subsequently, private sector employment growth has fallen, with the government sector accounting for the modest growth in overall employment in the economy.

V. Concluding Remarks

13. Given the size and openness of Botswana’s economy, the substantial level of foreign reserves, and the strong external position in the last decade, it appears that the pegged exchange rate regime has served Botswana well. The policy of maintaining a stable pula-rand rate in real terms has protected the viability of the nontraditional export sector and import-substitution activities. This achievement has been important in safeguarding employment and attaining a measure of diversification. Nonetheless, economic diversification in the face of a dominant diamond sector will remain a continual challenge. This process is unlikely to be driven substantially by exchange rate management, but more by structural policies aimed at raising skill levels in the labor force and developing the infrastructure.

Table 7.

Botswana: Price Index of Tradables and Nontradables, 1990-97

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Sources: Central Statistics Office; and Fund staff estimates.

Ratio of price index of tradables to price index of nontradables.