This Selected Issues paper and Statistical Appendix provides medium-term estimates of the cost of the government’s current anti-HTV/AIDS policies and programs in Botswana. The paper throws light on the policy challenges that Botswana authorities face in combating the crisis. The findings suggest that the cost of treating HIV/AIDS patients is likely to be high, about 10 percent of GDP, by 2010 (using the baseline estimates). The paper also analyzes Botswana’s approach to medium-term fiscal management.

Abstract

This Selected Issues paper and Statistical Appendix provides medium-term estimates of the cost of the government’s current anti-HTV/AIDS policies and programs in Botswana. The paper throws light on the policy challenges that Botswana authorities face in combating the crisis. The findings suggest that the cost of treating HIV/AIDS patients is likely to be high, about 10 percent of GDP, by 2010 (using the baseline estimates). The paper also analyzes Botswana’s approach to medium-term fiscal management.

III. Botswana’s Exchange Rate Competitiveness12

A. Introduction

42. The exchange rate of the Botswana pula is determined with reference to a weighted basket of currencies comprising the SDR and the South African rand. The exchange rate policy aims to keep the nominal effective exchange rate (NEER) of the pula constant. The Bank of Botswana seeks specifically to achieve a rate of inflation that, at a minimum, will maintain relative stability in the real effective exchange rate (REER) in support of the broader national objectives of economic diversification and export competitiveness.13 This objective, however, has been complicated by the recent developments in the rand. This section briefly reviews the evolution of Botswana’s exchange rate arrangement and then discusses the impact of recent exchange rate developments on its external competitiveness. It appears that the significant appreciation of the pula in real effective terms since mid-2000, mainly as a result of sharp depreciation of the rand against the SDR, has adversely affected the country’s competitiveness.

B. Evolution of Exchange Rate Arrangement, 1976-200014

43. Botswana attained monetary independence in 1976 by introducing its own currency—the pula.15 The pula, like the rand at the time, was initially pegged to the U.S. dollar, resulting in a stable relationship between the pula and the currencies of Botswana’s two major trading partners. However, the pula and the rand started to diverge following the introduction of a floating exchange rate regime in South Africa in 1979. As the pula depreciated against the rand, concerns about imported inflation prompted the authorities to adopt a peg to a currency basket in June 1980, with weights of 50 percent for both the SDR (as a convenient proxy for the major world currencies) and the rand. Botswana has maintained the basket peg since then, although the authorities have occasionally changed the composition of the basket and made discretionary adjustments to the peg when circumstances required.

44. The pula was devalued against the basket in 1982, 1984, and 1985, either in response to external shocks or in order to maintain external competitiveness. In 1986, the authorities introduced a new basket of currencies—including the rand and the SDR—with undisclosed weights.16 In 1987, the authorities implemented a policy to maintain a broadly stable real exchange rate against the rand that in practice entailed discretionary adjustments in the rate of the pula relative to the currency basket. Since then, changes in the nominal exchange rate have been consistent with a policy of maintaining a stable real exchange rate for the pula against the currencies of Botswana’s major trading partners (Figure III.1).17

Figure III.1.
Figure III.1.

Botswana: Effective Exchange Rate of Pula, January 1987-May 2002

(Index, 1990-100)

Citation: IMF Staff Country Reports 2002, 243; 10.5089/9781451806373.002.A003

Source: International Monetary Fund, EER Facilitiy

45. The pula has followed a depreciating path of the rand relative to the U.S. dollar since early 1980s, reflecting the large weight of the rand in the basket and apparent periodic interventions to keep Botswana’s nonmineral exports competitive in the rand area (Figure III.2). The exchange rate rarely moved out of the range of 1.25-1.35 rand per pula from 1994 to August 2000, feeding market speculation that the pula was effectively linked to the rand (Figure III.3).

Figure III.2.
Figure III.2.

Botswana: Exchange Rate Index, January 1990-May 2002

(U.S. dollars per national currency, 1990=100)

Citation: IMF Staff Country Reports 2002, 243; 10.5089/9781451806373.002.A003

Source: International Monetary Fund, Economic Data Sharing System.
Figure III.3.
Figure III.3.

Botswana: Bilateral Exchange Rate, January 1990-May 2002

(South African rand per pula)

Citation: IMF Staff Country Reports 2002, 243; 10.5089/9781451806373.002.A003

Source: International Monetary Fund, Economic Data Sharing System.

46. Botswana’s choice of a pegged exchange rate regime can be justified because it is a small, open economy that is attempting to avoid the “Dutch disease.” In this case, a mineral-led appreciation would erode the competitiveness of nonmineral exports and run counter to the objective of economic and export diversification.18 In addition, the basket peg—rather than a peg to the rand—can minimize imported inflation and currency fluctuations associated with tracking the rand. However, it appears that the basket peg had not been strictly implemented before mid-2000, as evidenced by the stable relationship between the pula and the rand. Nevertheless, by changing either the nominal exchange rate against the basket or the currency weights in the basket, Botswana appears to have achieved over time a relatively stable REER that has helped its nonmineral goods compete in the rand area.

C. Exchange Rate Regime, Rand Volatility, and Competitiveness, 2000-02

47. Botswana appears to have moved away from its apparent de facto rand targeting in the second half of 2000, as the rand depreciated sharply against major currencies. In September 2000, the pula appreciated outside the band of 1.25-1.35 against the rand, and kept appreciating against the rand throughout 2001. It appears that the authorities began to allow the basket mechanism to function without intervention and no longer devalued the pula to ensure a stable bilateral exchange rate with the rand. In consequence, the pula appreciated to 1.74 rand per pula at end-2001, before easing to 1.68 rand per pula at the beginning of September 2002.

48. As the basket mechanism was allowed to operate through end-December 2001, the effective value of the pula rose. This follows from the fact that the basket is calculated based on the arithmetic average method, so that currency weights in the basket are variable and decreasing weight is given to a depreciating currency. 19 As a result of the depreciation of the rand in 2001, its effective weight in the basket fell significantly and the rand and SDR became almost evenly weighted in the basket. This caused an almost symmetric movement of pula’s exchange rates relative to the rand and the U.S. dollar (Figure III.4). The pula, therefore, appreciated in effective terms because the effective index is a geometric weighted average of exchange rate indices in Botswana’s major trading partners, with a weight of roughly three-fourth assigned to South Africa.

Figure III.4.
Figure III.4.

Botswana: Bilaternal Exchange Rates, January 2000-May 2002

(Index, January 2000=100)

Citation: IMF Staff Country Reports 2002, 243; 10.5089/9781451806373.002.A003

Source: International Monetary Fund, Economic Data Sharing System.

49. It is clear that Botswana lost competitiveness over the period from September 2000 to December 2001. Owing to the nominal appreciation of the pula against the rand, the REER of the pula appreciated by 11 percent over this period, indicating a significant loss of competitiveness.20 In addition, the internal terms of trade, as measured by the ratio of the price index of tradables to the price index of nontradables, fell during the same period, also pointing to a weakening of the external competitive position (Figure III.5).21,22 Output growth in the manufacturing sector also slowed, perhaps reflecting the over 20 percent appreciation of the pula against the rand, as South Africa is Botswana’s major competitor in manufactures.

Figure III.5.
Figure III.5.

Botswana: Internal Terms of Trade, 1996:Q1-2002:Q1 1/

(Index, November 1996=100)

Citation: IMF Staff Country Reports 2002, 243; 10.5089/9781451806373.002.A003

Source: Central Statistics Office; and Fund staff estimates.1/ The ratio of the price index of tradables to the price index of nontradables.

50. There is anecdotal evidence that the sharp depreciation of the rand through mid-2002 has not brought about a commensurate fall in prices of imports from South Africa, owing in part to the market expectation that the authorities would intervene again to bring the exchange rate back to the historical range of 1.25-1.35 rand per pula. It has also been suggested that retailers have a tendency to not pass the benefit of lower prices on to their customers. Taken together, the exchange rate pass-through is unlikely to be complete, and a substantial appreciation against the rand would hurt Botswana’s external competitiveness, as the lower domestic inflation rate relative to South Africa would be insufficient to compensate for the nominal appreciation against the rand.

51. The loss of competitiveness is aggravated by Botswana’s trade structure. As shown in Figure III.6, more than 80 percent of Botswana’s exports—mainly diamonds—go to Europe, while imports from the rand area—dominated by food, intermediate goods, and capital equipment—account for about three fourths of its total imports. Because diamond production in Botswana is leveling off due to technical factors, the pula’s depreciation against advanced economy currencies is not expected to substantially boost production of diamonds and export earnings (in foreign currency terms). However, Botswana’s nonmineral exports are competing with those from the rand area, both in local and third markets.23 As a result of the pula’s real appreciation against the rand, Botswana is most likely to lose competitive ground to the rand area, thus dampening the authorities’ plan to broaden the export base and diversify the economy in general.

Figure III.6.
Figure III.6.

Botswana: Direction of Trade, 1996-2000

(In percent of total)

Citation: IMF Staff Country Reports 2002, 243; 10.5089/9781451806373.002.A003

Source: Customs and Excuse Department; and Fund staff estimates.

52. More recently, since the beginning of 2002, both the rand and the pula have generally been appreciating against the U.S. dollar. As of end June 2002, the rand and the pula had risen by 18 percent and 12 percent relative to the U.S. dollar, respectively. As a result, the pula depreciated by more than 5 percent against the rand. Taking into account the slightly higher inflation rate in South Africa, the real depreciation of the pula relative to the rand should be somewhat larger than nominal but insufficient to recoup the loss of competitiveness in 2001.

D. Conclusions

53. Policymakers in Botswana are constantly confronted with decisions on the trade-off between price stabilization and competitiveness of exports. The authorities have tried to strike a balance by pegging the pula to a basket of the rand and SDR, while assigning a dominant weight to the rand and following the rand movement closely through discretionary adjustment. For most of the period since 1990, this arrangement has served Botswana well, and the authorities had been quite successful in achieving a stable REER before mid-2001.

54. It appears that sometime in 2000, the authorities decided to give up an effective targeting of the rand and follow the basket mechanism more closely. However, given the way currency weights are designed and the dramatic movement of cross exchange rates, the basket peg can no longer guarantee a stable NEER, and the REER appreciated quickly during the second half of 2001. The movements of both the REER and the bilateral real exchange rate relative to the rand indicate loss of external competitiveness, especially in view of the trade structure of Botswana.

55. A reversion to the rand-biased intervention to restore competitiveness could undermine the hard-won credibility of the government’s determination to implement strictly the basket peg arrangement.

12

Prepared by Shuang Ding.

13

See Bank of Botswana, Monetary Policy Statement-2002, Gaborone, Botswana: Bank of Botswana, 2002.

14

For details of evolution of exchange rate arrangement before 1998, see Hassanali Mehran and others, Botswana - Selected Issues and Statistical Appendix, IMF Staff Memorandum No. 98/59, Washington, International Monetary Fund.

15

Botswana continued to use the South African rand even after it gained political independence in 1966.

16

The Zimbabwe dollar was introduced into the basket in September 1991; it was subsequently withdrawn in June 1994.

17

The consumer price index-based REER is calculated using the IMF Effective Exchange Rate Facility, based on weights that are broadly consistent with Botswana’s nondiamond trade.

18

See Jacob K. Atta and others, “Exchange Rate Policy and Price Determination in Botswana,” African Economic Research Consortium Research Paper No. RP93, Nairobi, Kenya: African Economic Research Consortium, 1999.

19

The basket comprises specified units of the rand and the SDR. The composition of the basket will remain the same regardless of subsequent exchange rate changes, until the authorities decide to change it deliberately. Since the currency units are fixed under this method, an increase in the value of a component currency means an increase in the share of that currency in the basket. For a detailed description of the valuation of the currency basket based on arithmetic average and geometric average methods, see Shinji Takagi, “Pegging to a Currency Basket”, Finance & Development, Vol. 23, September 1986, pp. 41-44.

20

The rand has a weight of 75.7 percent in the IMF’s calculation of the effective exchange rate. The NEER during the same period rose by nearly 9 percent.

21

A fall in the ratio of the price index of tradables to the price index of nontradables (PT/PN) reduces the incentive to produce of tradables. It would also increase the domestic consumption of tradables relative to nontradables.

22

Real exchange rate based on normalized unit labor costs in manufacturing is widely regarded as the preferred indicator of external competitiveness. No such data can be constructed owing to a lack of data on labor costs.

23

For example, the textile industry of Botswana faces competition from the rand area.

Botswana: Selected Issues and Statistical Appendix
Author: International Monetary Fund
  • View in gallery

    Botswana: Effective Exchange Rate of Pula, January 1987-May 2002

    (Index, 1990-100)

  • View in gallery

    Botswana: Exchange Rate Index, January 1990-May 2002

    (U.S. dollars per national currency, 1990=100)

  • View in gallery

    Botswana: Bilateral Exchange Rate, January 1990-May 2002

    (South African rand per pula)

  • View in gallery

    Botswana: Bilaternal Exchange Rates, January 2000-May 2002

    (Index, January 2000=100)

  • View in gallery

    Botswana: Internal Terms of Trade, 1996:Q1-2002:Q1 1/

    (Index, November 1996=100)

  • View in gallery

    Botswana: Direction of Trade, 1996-2000

    (In percent of total)