This Selected Issues paper for Botswana highlights the macroeconomic impact of an effectively implemented National Strategic Framework (NSF) program. The NSF is anchored on the goals of prevention, care, and support; management of the national response; economic impact mitigation; and provision of a strengthened legal and ethical environment. The treatment of the pandemic focuses on the administration of antiretroviral drugs to the infected, the effect of which would be to prolong their lifespan, as well as increase the average level of productivity.

Abstract

This Selected Issues paper for Botswana highlights the macroeconomic impact of an effectively implemented National Strategic Framework (NSF) program. The NSF is anchored on the goals of prevention, care, and support; management of the national response; economic impact mitigation; and provision of a strengthened legal and ethical environment. The treatment of the pandemic focuses on the administration of antiretroviral drugs to the infected, the effect of which would be to prolong their lifespan, as well as increase the average level of productivity.

II. Fiscal Policy Challenges Under the Ninth National Development Plan, 2003/04–2008/0910

A. Introduction

32. Botswana’s long record of fiscal prudence is a key feature of the country’s strong overall economic performance over the last three decades. Despite implementing public investment programs that have vastly transformed the country’s physical and social infrastructures and improved the provision of current public services, the government’s budget has been kept in overall surplus during most of the last 20 years. These surpluses averaged about 9 percent of GDP between mid-1980 and 2000, and accumulated government savings in the form of deposits at the central bank remain high (29 percent of GDP at the end of 2003), despite recent declines associated with the partial privatization of the public service pension scheme.

33. In the last three years, deficits have emerged in the government’s fiscal operations, owing mainly to temporary factors, but increasingly to developments in both revenue and expenditure that are more structural in nature. First, HIV/AIDS-related expenditures have risen sharply since 2001/02 and are expected to be a growing source of pressure on the budget over the medium term and beyond. Second, education spending has been growing rapidly, and the trend could continue under existing policies aimed at expanding ongoing programs at all levels of the educational system. Third, recurrent expenditures have increased rapidly for some time in most areas, including transfers to local governments. Fourth, there has been a broadly downward revenue trend, mainly reflecting the sluggish performance of nonmineral revenue. Against this backdrop, and in the absence of structural revenue and expenditure reforms, the fiscal outlook is likely to pose a challenge for the implementation of the Ninth National Development Plan (NDP 9), 2003/04–2008/09 (April–March), which Botswana launched in April 2003.

34. This paper reviews recent fiscal developments against the background of the broad macroeconomic framework of the NDP 9 (See Box II.1) and considers the challenges entailed in its successful implementation. Its broad conclusion underscores the importance of the reforms that the authorities have embarked upon to enhance revenue mobilization, achieve savings in public expenditures, and continually reexamine spending priorities.

Macroeconomic Targets of the NDP 9

The NDP 9 targets an average real GDP growth of 5.5 percent a year, which is about the same average rate of growth (5.6 percent) achieved during the previous plan period, the Eight National Development Plan (NDP 8) 1997/98–2002/03 (April–March) (left chart). The nonmining sectors are projected to continue growing at a relatively fast pace, averaging about 7 percent a year, in response to the policies and reforms envisaged under the plan. Growth of the mining sector on the other hand, is projected to average less than ½ of 1 percent per year, compared with an average 5.3 percent rate of growth during the NDP 8, mainly because diamond production is assumed to be close to full capacity. However, recent productivity gains from the application of improved mining technology suggest that this assumption is likely to be unduly pessimistic. Employment is targeted to grow by 5.6 percent per year, a stronger performance than under the NDP 8 (3.4 percent) but consistent with progress in diversifying the economy and the proposed investment in human capital. Private sector employment is projected to grow by an average of 7.7 percent a year, while growth in the public sector will be held to no more than 2.4 percent a year.

Investment is projected to increase from 26 percent of GDP in 2002/03 to an average of 30 percent over the plan period, with foreign direct investment rising steadily to over 5½ percent of GDP in 2008/09 from about 4 percent of GDP in 2002/03. While this target is recognized as ambitious, the planned privatization program and ongoing promotional efforts, including through the encouragement of joint ventures are expected to provide the necessary boost.

The government’s investment program over the six-year period is estimated at P 35.7 billion (US$7.4 billion), compared with actual development expenditure of P 20.4 billion (US$4.3 billion) under the previous plan.

The external current account is projected to remain in surplus throughout the plan period. However, with diamond exports projected to remain unchanged in volume terms, the surpluses would decline sharply compared with the past (right chart). Diamond exports would grow by an average of 5.1 percent in pula terms, (18 percent during NDP 8) reflecting U.S. dollar price increases and a depreciation of the pula against the U.S. dollar with no increases in volume. Nontraditional exports (excluding diamond, other minerals and meat) are expected to expand by an average of nearly 17 percent per year in response to diversification policies. International reserves are expected to rise slowly from US$6.8 billion in 2003/04 to US$7.1 billion in 2008/09.

B. Background

35. The overarching objectives of the NDP 9 are to diversify the economy away from mining, create employment, and reduce poverty.11 Integral to these objectives is the goal of effectively combating HIV/AIDS, to which the government attaches the highest priority in view of the danger that the pandemic poses to economic gains of the past and the attainment of the economic and social objectives of the plan. The broad strategies of the NDP 9 include maintaining macroeconomic stability and financial discipline, implementing public sector reforms, including the privatization of public enterprises, and developing Botswana’s human resources.12

36. The key objective of fiscal policy under the NDP 9 is to support macroeconomic stability. To this end, government will restrain expenditure as necessary to avoid crowding out the private sector, which is expected to emerge as the main engine of growth. Consistent with this broad objective, a balanced budget is envisaged over the NDP 9 period. In addition, in formulating the budget, the government will continue to be guided by a fiscal rule that seeks to channel mineral revenue into an expansion of the productive base to support future growth, as opposed to consumption. This rule requires that the ratio of noninvestment current expenditure to nonmineral revenue, referred to as the “sustainability,” ratio be kept at or below 1.13 It is envisaged that the sustainability ratio will be reduced to well below 1 by end-2008/09.

C. Recent Budgetary Developments

37. The government’s operations moved into deficit in 2001/02 for only the second time in nearly 20 years, owing mainly to an unanticipated fall in diamond revenue (of about 10 percent of GDP) and an increase in current expenditure (of 2 percent of GDP) (see table below). In 2002/03, a modest recovery in revenue was more than matched by an increase in expenditure, and, as a result, the budget deficit increased to about 4 percent of GDP from 3 percent of GDP in the previous year. Staff estimates indicate a movement close to an overall budget balance in 2003/04, largely based on an expected improvement in revenue of about 4 percent of GDP from the value-added tax (VAT), personal and company income taxes, and increase in Southern African Customs Union (SACU) receipts owing mainly to the pula depreciation against the South African rand.14 The VAT revenue, however, significantly underperformed the 2003/04 budget estimates (1.5 percent of GDP), owing to problems of administration. Thus, while the downward trend in revenue since the mid-1990s accounts for some of the recent deterioration in the overall budget position, the increase in expenditure (5 percent of GDP since 2000/01) has been an important contributory factor.

Table II. 1.

Botswana: Central Government Operations, 1982/83-2003/04 1/

(In percent of GDP)

article image
Sources: Botswana authorities; and Fund staff estimates and projections.

Fiscal year begins April 1.

Authorities’ and staff estimates and projections.

38. On the revenue side, market-related factors have contributed to sharp fluctuation in mineral revenue, while nonmining revenue has remained well below its peak (30 percent of GDP) reached in 1993/94 (see figure). The main nonmineral sources of revenue are SACU receipts, income from the Bank of Botswana (BoB) profits, personal income and company taxes, and the VAT, which replaced the sales tax in 2002. Of these, SACU and BoB profits, which were much larger sources of revenue in the first half of the 1990s, have witnessed significant declines (see Figure II.1). Revenues from the other two sources, by contrast, have been growing in the last few years, but not nearly enough to fully offset the declines from SACU and BoB receipts. Moreover, problems of tax administration—mainly ineffective audits and follow-up—have been hampering the collection of personal and company income taxes, and of the VAT.

Figure II.1.
Figure II.1.

Botswana: Nonmineral Revenue, 1990/91–2002/03

Citation: IMF Staff Country Reports 2004, 212; 10.5089/9781451806380.002.A002

Source: Botswana authorities.1/ Fiscal year begins April 1.
uA01fig03

Mineral Revenue, 1990/91-2002/03 1/

(In percent of GDP)

Citation: IMF Staff Country Reports 2004, 212; 10.5089/9781451806380.002.A002

uA01fig04

Nonmineral Revnue, 1990/91-2002/03 1/

(In percent of GDP)

Citation: IMF Staff Country Reports 2004, 212; 10.5089/9781451806380.002.A002

1/ Fiscal year begins April 1.

39. Government expenditure, in contrast, has risen sharply in recent years after remaining broadly stable at about 40 percent of GDP for about a decade (see figure below). Total expenditure and net lending reached a new peak (47 percent of GDP) in 2002/03, largely reflecting current spending on education, health, and general public services. Expenditure on current services increased from an average of about 26 percent of GDP in the five-year period ended 2000/01 to about 34 percent of GDP in 2002/03, with education and health spending accounting for about half of the increase. Capital expenditure was reduced sharply in 2001/01, partly reflecting capacity constraints in implementing public sector projects, and has since been kept at about 11 percent of GDP.

uA01fig05

Central Government Expenditure, 1990/91-2002/03 1/

(In percent of GDP)

Citation: IMF Staff Country Reports 2004, 212; 10.5089/9781451806380.002.A002

uA01fig06

Expenditure on Education and Health, 1990/91-2002/03 1/

Citation: IMF Staff Country Reports 2004, 212; 10.5089/9781451806380.002.A002

40. The fiscal rule has been observed consistently for more then 20 years, most of the time by wide margins. However, in the last few years, a combination of weak nonmineral revenue performance, especially since 1994/95, and strong growth in noninvestment expenditure has contributed to a steep rise in the sustainability ratio and a shrinking of the surpluses in the balance between nonmineral revenue and noninvestment expenditure (see figures below).

uA01fig07

Noninvestment Expenditure/Nonmineral Revenue Ratio, 1982/85-2002/03 1/

Citation: IMF Staff Country Reports 2004, 212; 10.5089/9781451806380.002.A002

1/Fiscal year begins April 1.
uA01fig08

Nonmineral Revenue, Noninvestment Expenditure and Balance, 1982/83-2002/03 1/

(In percent of GDP)

Citation: IMF Staff Country Reports 2004, 212; 10.5089/9781451806380.002.A002

41. Both the increasing difficulty in adhering to the fiscal rule and the emergence of fiscal deficits since 2001/02 are a reflection of the divergence in the long-term nonmineral revenue and total current expenditure trends. Until 1993/94, nonmineral revenue in each year was sufficient to cover all current outlays and leave a balance for other purposes, including capital expenditure. However, since 1994/95, the balance between nonmineral revenue and current expenditure has moved into deficit, and this deficit has been growing steadily (see figure above). In 2003/04, this gap, which has had to be covered by mineral revenue, will reach 14 percent of GDP. With mineral revenue at 22 percent of GDP in recent years and capital expenditure maintained at about 11 percent of GDP, the government not surprisingly, found it difficult to avoid running into overall budget deficits in the last few years.

uA01fig09

Nonmineral Revenue and Current Expenditure, 1982/83-2002/03 1/

(In percent of GDP)

Citation: IMF Staff Country Reports 2004, 212; 10.5089/9781451806380.002.A002

1/ Fiscal year begins April 1.

D. Meeting the Fiscal Challenges

42. To return to the strong fiscal path of the past, or a balanced budget over the NDP 9 period as intended by the government, efforts are needed on both the revenue and expenditure fronts. On the revenue side, SACU receipts face considerable uncertainty arising from the tariff reductions that, in the context of the trade agreements between South Africa and the European Union, have yet to be phased in, the ongoing negotiations between SACU and the United States, and the new revenue-sharing formula due to go into effect in 2006.15 Income from the BoB profits has been squeezed in recent years by relatively low equity prices and interest earnings on financial investment in the world financial centers, as well as by recent drawings on the BoB’s reserves, as the government used its deposits at the bank to fund the privatized government employees’ pension fund.16 A recovery of revenue from this source to levels comparable to the past is unlikely. Revenue from personal and company taxes increased in 2002/03 by about 1.4 percent of GDP after several years of stagnation, mainly in response to a streamlining of tax legislation aimed at closing loopholes and supporting better enforcement. However, compliance remains a problem, and continued strong performance of revenue from both these taxes depends on the success of planned reforms aimed at strengthening tax administration. Moreover, the government has indicated that rates on both these taxes will be kept at the existing levels to serve as an incentive to attract foreign investment.17 Similarly, while revenue from the VAT in six months of 2002/03 (3.6 percent of GDP) substantially exceeded sales tax revenue in the previous year (1.7 percent of GDP), earlier expectations about the full-year outturn have proved overly optimistic. Problems of administration have contributed to a significant downward revision in the original 2003/04 revenue estimates to be under 5 percent of GDP. Mineral revenue is likely to strengthen modestly over the medium term in light of the recent increase in diamond production. However, with the existing diamond mining industry reaching full production capacity, the prospects for strengthening revenue depends increasingly on the success of efforts to improve revenue from nonmineral sources.

43. On the expenditure side, health spending is set to grow rapidly as current and new HIV/AIDS programs are implemented. While the NDP 9 provides for a number of programs for combating the pandemic, a comprehensive framework, the National Strategic Framework (NSF) for HIV/AIDS (2003–08) was launched more recently.18 An illustrative exercise by staff to integrate the estimated HIV/AIDS program expenditures in the NSF into the NDP 9 macroeconomic framework indicates that full implementation of the programs, after allowing for the expected donor assistance, could lead to budget deficits that are estimated to reach nearly 7 percent of GDP in 2008/09 (see table below). Education spending has been increasing rapidly and could continue, based on the expansion envisaged in the government’s education programs including in the area of tertiary education. Two other factors are likely to put pressure on the budget. First, current expenditures associated with new public investment projects have been substantially understated under the previous plan and are likely to continue to be significant. Second, increases in project costs, which arise in large part from capacity-related delays in completing projects, are also likely to remain significant. Such upward revisions in project costs led to a doubling of the total development program under the NDP 8.

Table II.2.

Botswana: Government Operations--Baseline and Illustrative NSF Scenarios, 2000/01-2008/09 1/

(In percent of GDP)

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Fiscal year begins April 1.

Staff projections are based on NDP 9 allocations to the Ministry of Health, and HIV/AIDS program cost estimates from the National Strategic Framework for HIV/AIDS 2003–2009.

44. The authorities recognize these challenges and have embarked on a number of reforms to address them. The VAT was introduced with a much broader base than the sales tax that it replaced, partly to shore up the government’s revenue performance against possible declines in receipts from SACU and other sources. Measures taken to improve collections from personal and company income taxes have produced some results. To consolidate these efforts, the cabinet in November 2003, approved the setting up of the Botswana Unified Revenue Service (BURS), which is planned to begin operating later this year. As regards expenditure, there is an emphasis on prioritization within the available resource envelope and stricter control of spending by line ministries and agencies. In 2004/05, for example, allocations to ministries are based on global ceilings for both current and capital spending, with no provision for inflation adjustments. Moreover, a range of user charges has been approved by the cabinet. In December 2003, water tariffs were raised by 23 percent, while others user charges are to follow in about two year’s time. Included in the latter group are user charges on education and health, which are two areas where expenditures have been growing rapidly. Against the backdrop of the broad range of freely provided services and safety nets in place, the authorities expect any regressive impact of these user charges on the poor and vulnerable groups to be fully offset.19 Ongoing civil service reforms aimed at improving productivity in the civil service are expected to generate cost savings, in addition to improved service delivery. The planned privatization program is also expected to ease the pressure on the budget, more likely beyond the medium term.

45. With the shift in the composition and balance between nonmineral revenue and total current expenditure the observance of the fiscal rule that has guided budget policy over the years may no longer guarantee an overall surplus or balanced budget as in the past. Indeed, if the rule had been observed in 2002/03, the overall budget deficit would have been only slightly lower, at 3.8 percent of GDP, as against the actual 4 percent. An overall deficit of about 0.7 percent of GDP is envisaged in 2003/04, even though the balance between noninvestment expenditure and nonmineral revenue is projected to show a surplus of 2.4 percent of GDP. Hence, while the existing rule remains relevant as a guide for the prudent use of mineral resources, it has become necessary to impose a second constraint on spending to better ensure the attainment of the government’s overall budget objectives.

46. In the medium term and beyond, the revenue and expenditure adjustment efforts the authorities are implementing should pay appropriate dividends toward fiscal stability. From the staff’s baseline scenario, Botswana’s public debt appears sustainable under all shocks considered (Table 1).20 In the near term, the authorities could achieve their twin budget objectives by adopting an approach to investment spending that is more internally consistent. In particular, current spending on education and health is regarded as “investment spending,” even though they are not classified as development or capital expenditure in the budget. Their inclusion would raise the level of capital spending to about 25 percent of GDP in recent years. It could be argued that this level of investment spending provides room to reprioritize and reduce capital expenditure, in order to allow the authorities to achieve the objective of a balanced budget over the medium term. Moreover, this approach would be consistent with the objective of dedicating mineral revenue entirely to investment spending, as intended by the fiscal rule.

E. Conclusion

47. The Botswana authorities face an uphill task in implementing the public investment programs under the NDP 9, while maintaining a balanced budget over the period of the plan. While the deposits built up by the government in the era of budget surpluses remain substantial and offer some scope for financing budget deficits on the scale of the last few years, a sustained effort at budget consolidation has become necessary, if the government is to cope with the spending pressures, especially on HIV/AIDS over the medium term and beyond. The authorities have embarked on reforms to strengthen revenue mobilization and improve expenditure efficiency, including cost recovery on a variety of public services, which could make an important contribution if implemented fully. However, in order to come to a firm assessment of the effort required, priority needs to be given to the full integration of the government’s programs to address HIV/AIDS into the expenditure framework of the NDP 9. In this connection, the authorities have requested Fund technical assistance to help improve budget classification and tracking of social expenditures.

Table II. 3.

Botswana: Public Sector Debt Sustainability Framework, 1998-2008

(In percent of GDP, unless otherwise indicated)

article image

Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used.

Derived as [(r - π(1+g- g + αε1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; = growth rate of GDP deflator; g = real GDP growth rate; α = share of foreign-currency denominated debt; and ε = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π (1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as αε (1+r).

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

Derived as nominal interest expenditure divided by previous period debt stock.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

The implied change in other key variables under this scenario is discussed in the text.

Real depreciation is defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).

Assumes that key variables (real GDP growth, real interest rate, and primary balance) remain at the level in percent of GDP/growth rate of the last projection year.

10

Prepared by Patrick Akatu.

11

The diamond sector accounts for about 35 percent of GDP, 72 percent of exports of goods and services, and 50 percent of government revenue.

12

The broad goals of the government’s AIDS programs were articulated in a recent strategy document and include the following: strengthening prevention efforts; stepping up the provision of treatment, care and support for AIDS’ patients; mitigating the social and economic impact of the pandemic; and improving the management of the country-wide response.

13

Noninvestment current expenditure is defined as total current expenditure excluding outlays on health and education, which are regarded as investment in human capital.

14

The VAT was introduced in July 2002 at a single, nonzero rate of 10 percent. It has a broader coverage of goods and services than the sales tax that it replaced. Petrol, diesel, paraffin, maize meal, sorghum meal and exports are zero-rated. The SACU comprises Botswana, Lesotho, Namibia, South Africa, and Swaziland. Customs and excise duties collected are paid into South Africa’s National Revenue Fund, and the revenue is shared among members according to a revenue-sharing formula that was revised in 2002.

15

The New SACU Agreement was covered in a recent staff paper, (IMF Country Report No. 04/23). Under the new revenue- sharing formula, members’ receipts have three components: a customs component, based on intra-SACU imports; an excise component, by which 85 percent of excise collections are shared according to members’ shares of SACU GDP; and a development component for distributing the remaining 15 percent of union-wide excise collection.

16

Transfers to private pension managers in respect of the accumulated benefits under the previous pension scheme since the Government began implementing the new pension system in 2001, reached P 10 billion (27 percent of GDP) at the end of 2003. In addition to the impact of the stock reduction, net earnings have also been reduced by the interest cost of BoB certificates, which had to be issued to drain excess liquidity in the banking system caused by the transfers.

17

A top rate of 25 percent applies to personal and company income taxes, and the capital gains. Manufacturing companies are subject to a basic 5 percent rate and an additional rate of 10 percent.

18

National AIDS Coordinating Agency: National Strategic Framework for HIV/AIDS 2003–09. The NSF brings together all HIV/AIDS programs and projected expenditures, including identified donor funding, which is estimated at about 30 percent of projected total expenditure.

19

These include an old-age pension scheme introduced in 1976, an orphanage support program for all orphans, and a destitute policy introduced in 1980 and revised in 2000. The National Poverty Program approved in 2003, as well as the NSF, reinforces these programs of support for the vulnerable.

20

Botswana’s public debt has been historically low (under 10 percent of GDP in 2002). The first issue of domestic debt in 2003 in the form of bonds was only for the purpose of stimulating the development of the domestic financial market.

Botswana: Selected Issues and Statistical Appendix
Author: International Monetary Fund