IMF Concludes 2005 Article IV Consultation with Botswana

The staff report for the 2005 Article IV Consultation on Botswana highlights key issues, recent developments, and policy discussions. The authorities are strengthening their structural reform agenda and moving ahead with sector-specific development programs with a view to sustaining annual growth in the 5–6 percent range as targeted in their current medium-term development plan. The authorities recognized the importance of fiscal adjustment to maintaining macroeconomic stability. They have no plans to move away from the exchange rate peg in the near term, but are exploring their options with regard to the monetary policy framework.

Abstract

The staff report for the 2005 Article IV Consultation on Botswana highlights key issues, recent developments, and policy discussions. The authorities are strengthening their structural reform agenda and moving ahead with sector-specific development programs with a view to sustaining annual growth in the 5–6 percent range as targeted in their current medium-term development plan. The authorities recognized the importance of fiscal adjustment to maintaining macroeconomic stability. They have no plans to move away from the exchange rate peg in the near term, but are exploring their options with regard to the monetary policy framework.

On June 22, 2005 the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Botswana.19 The Botswana authorities’ view is published in a bundle together with this notice.

Background

Botswana has been among the world’s best performing economies over the past three decades. Real GDP growth averaged over 8 percent per year, facilitating Botswana’s evolution from one of the poorest countries in the world to middle income status and the highest sovereign credit rating in Africa. This success can be attributed to sound economic policies, particularly in the management of its vast diamond resources, as well as a stable political environment and strong commitment to good governance. However, the leveling off of diamond production and the spread of HIV/AIDS—which has resulted in the erosion of key social indicators, such as life expectancy and mortality rates—threaten to undermine past achievements. The diamond sector—which presently contributes about one third of GDP and 75 percent of exports—continues to dominate macroeconomic activity. At the same time, the prevalence of HIV/AIDS has risen over the past decade, intensifying pressures on expenditures at a time when budgetary resources are becoming more constrained.

Economic activity has slowed over the past year. Real GDP growth decelerated to 5.7 percent in 2003/04 (July–June), from 7.8 percent in 2002/03, and is expected to slow further to 4–5 percent in 2004/05 as the productivity improvements from enhancements in the diamond-sorting process continue to level off. Growth in key nonmining sectors—including manufacturing, trade, and tourism—has also slowed over the past year, reflecting a slowdown in public investment and the effects of the weak U.S. dollar. Inflationary pressures picked up in late 2004, reflecting the impact of higher world oil prices, increased public utility charges, and the pass through from the 7.5 percent devaluation of the pula in February 2004. Inflation has declined in recent months, falling to 6.2 percent in April, from a peak of 8.0 percent in January.

The budget deficit is estimated by staff to have narrowed from about 2½ percent of GDP in 2003/04 (April–March) to about 1 percent in 2004/05. In 2003/04, revenue shortfalls—reflecting problems in VAT administration—were partly offset by scaling back capital expenditure, but not sufficiently to achieve the budget target of a small deficit. The improved outturn in 2004/05 stems primarily from lower-than-projected current and capital spending. The lower spending results in part from transitory factors, including a mandated 5 percent across-the-board reduction in recurrent expenditure, as well as slower-than-expected implementation of investment projects. The expenditure savings were partially offset by lower mineral revenues resulting from the weak U.S. dollar and shortfalls in domestic tax collections.

The Bank of Botswana lowered its inflation target to 3–6 percent in February 2005 in anticipation of an improved inflation outlook. The Bank rate was maintained at 14.25 percent from late 2003 until late April 2005, when it was lowered to 14 percent. Private sector credit growth has remained broadly within the BoB’s target range—which was lowered to 10–13 percent in February 2005, from 12–15 percent—over the past year, despite rapid growth in credit to households. The BoB also continued to mop up excess liquidity from the ongoing privatization of the public pension system through issuance of Bank of Botswana Certificates.

External performance has remained very strong. The current account surplus widened to about 9½ percent of GDP in 2004, up from 6½ percent of GDP in 2003, underpinned by continued growth in diamond exports in U.S. dollar terms (partly reflecting higher world prices) and tourism revenues as well as a large increase in Southern African Customs Union receipts and increased regional trade. Foreign reserves were US$5.7 billion at end-2004 (about 18½ months of imports).

On May 29, the government of Botswana announced that the pula would be devalued by 12 percent against the currency basket effective the following business day, citing the need to maintain a “stable and competitive real exchange rate” and to “achieve sustained and diversified growth.” The authorities at the same time announced that the exchange rate of the pula would be adjusted continuously rather than in discrete steps against the basket in a “crawling peg” type of arrangement. The rate of crawl will be forward looking and aligned with the differential between the inflation objective in Botswana and expected inflation in trading partner countries. The spread between the buy and sell rates of the pula was also widened from 0.125 percent to 0.5 percent in order to encourage further development of the interbank market for foreign exchange.

Executive Board Assessment

Directors commended the Botswana authorities for their sound economic policies, continued prudent management of Botswana’s vast diamond resources, and commitment to good governance, which have underpinned the country’s remarkable growth performance over the past three decades. They also welcomed the authorities’ recent efforts to increase resource commitments in the fight against HIV/AIDS. At the same time, however, diamond production is leveling off, while the spread of HIV/AIDS has steadily eroded social indicators and intensified expenditure pressures at a time when budgetary resources are becoming more constrained.

Against this background, Directors underscored the importance of strengthened efforts to diversify the economic base and to build on Botswana’s sound macroeconomic fundamentals and positive economic prospects to achieve broad-based social improvements and poverty reduction. They therefore welcomed the ongoing assessment of Botswana’s economic policies and reform agenda in the context of the mid-term review of the National Development Plan (NDP 9). In particular, Directors called for structural reforms aimed at developing the domestic private sector and attracting foreign direct investment, coupled with broad-based efforts to prevent and combat HIV/AIDS. They noted that fiscal policy would also have to be adapted as revenues decline and spending pressures increase.

Directors commended the authorities’ continued commitment to a prudent fiscal policy aimed at achieving balanced budgets over the medium term. While the net asset position of the government is set to remain comfortable, they agreed that a move toward overall balance would be desirable in anticipation that small deficits may be inevitable over the longer term, given the uncertain impact of HIV/AIDS on future generations.

Directors stressed that significant additional fiscal adjustment will be needed to maintain budget balance over the medium term. They urged the authorities to set out clearer road maps for expenditure reprioritization and public sector reform, including a reduction in the public sector wage bill. Efforts will also need to be accelerated to strengthen budget systems and improve capacity to track expenditure in priority areas, particularly on HIV/AIDS. In this regard, Directors welcomed steps to integrate a comprehensive strategy for HIV/AIDS into the medium-term budgetary framework. On the revenue side, Directors stressed the need to strengthen tax administration, improve tax compliance, and broaden the tax base. The institutional structure of the Botswana Unified Revenue Service should be further developed, and stronger legal sanctions should be taken against tax evaders. Consideration should also be given to the establishment of a large taxpayers unit and an increase in the value-added tax rate.

Directors noted that the recent devaluation of the pula and move to a “crawling peg” arrangement would need to be accompanied by appropriate supportive measures to minimize the near-term costs and enhance the longer-term benefits for sustained economic growth and poverty reduction. With Botswana’s inflation rate still above the authorities’ target range and in light of the interest rate cut in April, they urged decisive policy action to contain inflationary pressures from the devaluation. In particular, monetary policy should be tightened expeditiously, including through higher interest rates, and efforts should be stepped up to achieve fiscal balance in 2005/06, through cuts in nonessential expenditure, in order to minimize any upward pressures on aggregate demand and the real exchange rate.

Directors also urged the authorities to move quickly to put in place a supportive policy and operational framework that would establish a clear nominal anchor and lend credibility to the new exchange rate regime. They encouraged the authorities to pre-announce the rate of crawl—set at a pace consistent with maintaining low inflation—and to ensure that fiscal and monetary policies are closely coordinated and kept consistent with the rate of crawl. Going forward, a move toward greater exchange rate flexibility will require the development of tools and institutions for effective monetary policy management.

Directors agreed that Botswana’s banking sector is generally sound and prudential supervision broadly adequate. They welcomed the initial progress made under the Financial Sector Reform and Strengthening Initiative, and commended the authorities for their vigilance in overseeing the activities of the offshore financial center. Directors noted, however, that the high exposure of the banking sector to households warrants close monitoring. They urged the authorities to expedite action on establishing a financial supervisory agency for nonbank financial institutions, given their rapid growth in recent years. They also looked forward to continued efforts to bring the AML/CFT regime more in line with international standards. Directors encouraged the authorities to participate in the Financial Sector Assessment Program at an early opportunity.

Directors highlighted the importance of faster and deeper structural reforms to promote an enabling environment for private business activity and facilitate economic diversification, by increasing productivity and addressing competitiveness concerns in the nondiamond sector. Directors welcomed efforts to remove labor market rigidities and encouraged the authorities to deepen labor market reforms to enhance flexibility and skills. Comprehensive reform of the legal and regulatory framework will also be crucial to the successful development of public/private partnerships and implementation of the Privatization Master Plan.

Directors commended the authorities’ continued commitment to trade liberalization, and the progress made in negotiating free trade agreements and lowering tariffs, while calling for faster progress with the removal of nontariff barriers. They also welcomed the authorities’ intention to eliminate the multiple currency practice arising from the Foreign Exchange Risk-Sharing Scheme in 2006.

Public Information Notices (PINs) form part of the IMF’s efforts to promote transparency of the IMF’s views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

Botswana: Selected Economic and Financial Indicators, 2000–2004

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Sources: Data provided by the Botswana authorities; and IMF estimates.

National accounts year beginning July 1; figures for 2004 are estimates.

Calendar year.

Fiscal year beginning April 1.

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Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. This PIN summarizes the views of the Executive Board as expressed during the June 22 Executive Board discussion based on the staff report.