Botswana
Staff Report for the 2012 Article IV Consultation
Author:
International Monetary Fund
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Publication Date:
10 Aug 2012
eISBN:
9781475504880
Language:
English
Keywords:
ISCR; CR; debt; real GDP; fiscal policy; balance; balance of payments; open economy; market index; per capita income; Non-price competitiveness indicator; Income; Non-renewable resources
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The major trends in terms of GDP growth rates, conditions of market forces, and the core inflation crisis in Botswana are analyzed in detail in the report. It has been suggested that although the recovery from the financial crisis of Botswana is the strongest compared with other middle-income countries, the overall results do not point toward a positive development in the economy. The need for authorities to take up certain measures and modify their methods of functioning is pivotal to Botswana's survival in the existing fragile economic environment.

Abstract

The major trends in terms of GDP growth rates, conditions of market forces, and the core inflation crisis in Botswana are analyzed in detail in the report. It has been suggested that although the recovery from the financial crisis of Botswana is the strongest compared with other middle-income countries, the overall results do not point toward a positive development in the economy. The need for authorities to take up certain measures and modify their methods of functioning is pivotal to Botswana's survival in the existing fragile economic environment.

Recent Developments, Outlook, and Risks

A. Recent Developments

1. Botswana’s economic recovery after the 2008–09 financial crisis was one of the strongest among middle-income countries (MICs), but its growth weakened in the second half of 2011. Real GDP grew by 5.1 percent in 2011 (just below the average for its peer MIC group) compared with 7 percent growth in 2010 (Chart and Table 1). The growth deceleration was driven by a significant slowdown in diamond exports during the second half of the year. However, the nonmineral sector registered brisk growth during the year, despite a significant fiscal withdrawal. Diamond sales for the first quarter of 2012 showed only a very modest recovery.

Table 1.

Botswana: Selected Economic and Social Indicators, 2008–2017

article image
Sources: Botswana authorities and IMF staff estimates and projections.

Calendar year.

Refers to the growth of value added of sectors other than mining, excluding statistical adjustments. The latter includes financial intermediation services indirectly measured (FISIM), taxes on products, and subsidies.

Year beginning April 1.

The nonmineral primary balance is computed as the difference between nonmineral revenue and expenditure (excluding interest receipts and interest payments), divided by non-mineral GDP.

Includes publicly guaranteed debt.

Based on imports of goods and services for the following year.

2. At the same time, while receding, inflation remains relatively high. Consumer price inflation (year-on-year) declined from 9.2 percent in December 2011 to 7.7 percent in May 2012, which is higher than the upper end of the Bank of Botswana’s (BoB) medium-term objective range of 3–6 percent. Core inflation (excluding food, fuel, and administered prices) has declined slightly in the last few months. Alternative measures, including the trimmed mean, also suggest a downward trend in core inflation.

uA01fig03

Real GDP Growth

(Annual percent change)

Citation: IMF Staff Country Reports 2012, 234; 10.5089/9781475504880.002.A001

Source: IMF World Economic Outlook.
uA01fig04

CPI Inflation

(Annual percent change)

Citation: IMF Staff Country Reports 2012, 234; 10.5089/9781475504880.002.A001

Sources: INS and IMF World Economic Outlook.

3. Notwithstanding the moderation in growth, conditions in financial markets have improved. Private sector credit growth is now approaching the precrisis level, supported by a strong growth in credit to businesses. Banks’ nonperforming loans (NPLs) fell notably in the second half of 2011 because of a significant improvement in the quality of loans to households. Increased interest and non-interest income, combined with lower provisions for nonperforming loans, contributed to the rebound in banks’ profitability.

4. The fiscal outcome was better than planned. The estimated fiscal deficit in FY2011/12 was about 2 percent of GDP, compared with the budget target of about 6 percent. The non-mineral primary deficit also declined from about 24 percent of non-mineral GDP in FY2010/11 to 17 percent in FY2011/12 (Table 2d). The adjustment reflects a sharp decline in government spending, mainly owing to savings generated in the education budget, because of the increase in the number of students admitted to local tertiary institutions, rationalization of student allowances and improved administration, as well as better prioritization of development spending. Higher-than-expected customs revenue from the Southern Africa Customs Union (SACU) Common Revenue Pool also contributed to the lower deficit.

Table 2a.

Central Government Operations, 2008/09–2016/171

article image
Sources: Ministry of Finance and Development Planning; and IMF staff estimates and projections.

Fiscal year begins on April 1.

Refers to sales tax and VAT.

SACU receipts consist of external trade and excises on imported goods as well as a development component derived from excises.

These transactions reflect Botswana’s SDR allocation and contribution to the Fund’s General Resource Account (GRA).

The non-mineral primary balance is computed as the difference between nonmineral revenue and expenditure. (excluding interest payments and receipts, which are roughly proxied by BoB transfers and interest).

Table 2b.

Central Government Operations, 2008/09–2016/17 (GFSM 2001 Classification)1

article image
Source: Ministry of Finance and Development Planning and Fund staff estimates.

Fiscal year begins on April 1.

SACU receipts consist of taxes on international trade and excise on imported goods as well as the impact of a development component derived from excises.

Includes transfers received from the Bank of Botswna (BoB) on account of interest income on government investments made by the BoB on behalf of the government.

The non-mineral primary balance is computed as the difference between nonmineral revenue and expenditure (excluding interest payments and receipts, which are roughly proxied by BoB transfers and interest).

Table 2c.

Central Government Operations, 2008/09–2016/171

article image
Sources: Ministry of Finance and Development Planning; and IMF staff estimates and projections.

Fiscal year begins on April 1.

Refers to sales tax and VAT.

SACU receipts consist of external trade and excises on imported goods as well as a development component derived from excises.

The non-mineral primary balance is computed as the difference between nonmineral revenue and expenditure (excluding interest payments and receipts, which are roughly proxied by BoB transfers and interest).

Table 2d.

Central Government Operations, 2008/09–2016/171

article image
Sources: Ministry of Finance and Development Planning; and IMF staff estimates and projections.

Fiscal year begins on April 1.

Refers to sales tax and VAT.

SACU receipts consist of external trade and excises on imported goods as well as a development component derived from excises.

The non-mineral primary balance is computed as the difference between non-mineral revenue and expenditure (excluding interest payments and receipts, which are roughly proxied by BoB transfers and interest).

Table 2e.

Central Government Partial Balance Sheet, 2005–2012

article image
Source: Botswana authorities and Fund staff estimates.

Information is not available on existing government investments.

Using market value of the government debt.

Using nominal value of existing foreign loans.

5. The overall external position also strengthened in 2011. Annual export growth (in dollar terms) rebounded to about 66 percent in the first half of 2011 but declined sharply in the second half of the year to 20 percent. Exports grew faster than imports, turning the current account deficit into a surplus for the first time in the last three years (Table 3). Diamond exports benefited from higher diamond prices in the first half of 2011, which more than offset the poor performance of copper and nickel exports. Besides mining, plastic products and textile exports surged in 2011. However, exports of meat and meat products fell compared with 2010 because of the restriction on meat exports to the European Union related to the noncompliance with the EU’s export requirements. The real effective exchange rate lost ground slightly during the last 12 months (Figure 1).

Table 3.

Balance of Payments, 2008–2017

article image
Source: Bank of Botswana; and IMF staff estimates.

Months of prospective imports.

Figure 1.
Figure 1.
Figure 1.

Botswana: Recent Economic Developments

Citation: IMF Staff Country Reports 2012, 234; 10.5089/9781475504880.002.A001

uA01fig05

Exports in US$, 2011

(Annual percent change)

Citation: IMF Staff Country Reports 2012, 234; 10.5089/9781475504880.002.A001

Sources: Botswana authorities and IMF staff estimates.
uA01fig06

Contributions to Export Growth, 2011

Citation: IMF Staff Country Reports 2012, 234; 10.5089/9781475504880.002.A001

Sources: Botswana authorities and IMF staff estimates.

B. Outlook and Risks

6. Outlook

Output: Overall output growth is likely to moderate in 2012, reflecting subdued diamond exports. Staff projects that real GDP growth will decline to 4 percent in 2012 with nonmineral GDP decelerating to about 4 percent (Table 1). Medium-term GDP growth is forecast to average around 4.5 percent through 2017. The planned relocation of De Beers’ diamond-sorting and sales activity from London to Botswana by end-2013 is expected to boost economic activity.

Inflation: While projected inflation remains slightly above the BoB’s medium-term objective range, it is expected to converge to the upper end of the range in 2013. At the same time, a negative output gap is projected through 2013; and fiscal consolidation, underpinned by wage restraint, should help to constrain domestic demand.

External position: With projected fiscal surpluses in FY2012/13 and beyond, the current account surplus is forecast to stabilize at about 2 percent of GDP (Table 1). Staff’s assessment, which incorporates features appropriate for natural resource–rich economies, show that the current level of the real effective exchange rate (REER) is broadly in line with macroeconomic fundamentals from a medium-term perspective. However, these estimates have large confidence bands, suggesting a significant degree of uncertainty regarding the long-run equilibrium level of the REER (Appendix I). This said, overall the analysis suggests a medium-term balance of payments position that does not and is not likely to give rise to disruptive exchange rate movements under the crawling peg arrangement. Beyond this, Botswana’s conduct of prudent domestic economic and financial policies will continue to promote external stability.

7. Risks. The main near-term risks relate to the highly uncertain external environment, which remains fragile and poses significant downside risks to mineral export demand. The associated outward spillovers could also be transmitted through Botswana’s linkages with South Africa. Botswana also faces medium-term risks: most notably the sustainability of growth, as trend growth has slowed in the last decades (chart), highlighting the need to find new non-diamond growth engines. Another medium-term risk is that, like other countries in SACU, Botswana faces a possible decline in SACU revenue (which represents about 20 percent of total revenue) in the long-run, either owing to low global growth or changes in the SACU revenue-sharing formula currently under negotiation.

uA01fig07

Real GDP Growth Rates, 1966–2011

(Percent)

Citation: IMF Staff Country Reports 2012, 234; 10.5089/9781475504880.002.A001

Source: IMF World Economic Outlook.

Policy Discussions

The authorities agreed with the mission’s assessment of recent economic developments, outlook, and prospects. Given the uncertain and fragile external environment, they shared staff’s view that the period ahead requires a delicate balancing act in the implementation of macroeconomic policies.

With risk-based surveillance as the backdrop to the consultation, tailored to the policy challenges facing a small middle–income country (MIC) in sub-Saharan Africa (SSA), this year’s consultation with Botswana used an issues-oriented surveillance framework. Thus, the policy discussions focused on four main themes: (i) Managing near-term macroeconomic policy mix and spillovers from the global economy; (ii) rebuilding policy buffers through high-quality medium-term fiscal consolidation to buttress external stability; (iii) strengthening monetary operations, financial intermediation and stability; and (iv) enhancing inclusive growth, reducing structural unemployment (relevant macro critical social issues), and fostering institutional and capacity development in support of long-term growth. The authorities’ Vision 2016 and NDP10 also place emphasis on these policy challenges, which bodes well for gaining traction. They acknowledged that while mineral wealth has propelled Botswana to a high middle-income status, long-standing structural challenges which no longer exist in some of the other high middle-income countries and are often found in economies with much lower level of per capita income, remain. With some of these policy themes also relevant for other MICs in SSA, cross-country analysis and best practice policy advice underpinned by analytic work in a MIC clustered group featured prominently in the consultations (Figure 2).

Figure 2.
Figure 2.

Middle-Income Countries in Sub-Saharan Africa: Regional Comparison

(Average 2002–2011, unless otherwise indicated)

Citation: IMF Staff Country Reports 2012, 234; 10.5089/9781475504880.002.A001

A. Policy Theme 1: Managing the Near-Term Macroeconomic Policy Mix and Spillovers from the Global Economy

Background

8. Botswana’s mineral-based and highly open economy makes it vulnerable to global shocks. A renewed escalation of the euro area crisis may lead to a more prolonged global slowdown than envisaged in staff’s baseline scenario. Staff’s analysis shows that the direct, immediate impact of a financial stress in Europe on Botswana’s banking system will likely be small given its limited reliance on external funding, with bank funding being largely domestic, and low cross-border financial linkages. Indirect “real economy” channels through a collapse in diamond exports will thus be the main transmission channel. Staff simulations using the IMF’s Global Integrated Monetary and Fiscal (GIMF) model, which explores both trade and financial channels, show that financial stress in the euro area through further deleveraging would have limited and short-lived impact on real GDP growth in Botswana. However, the estimated impact on diamond prices is significant which could lead to a loss in fiscal revenues (Appendix II). A key focus of the consultation was to identify systemic risks and vulnerabilities and to discuss with the authorities the appropriate policy responses.

Staff recommendations

9. Near-term policy mix: Staff advised that a tight fiscal policy combined with an accommodative monetary policy stance is an appropriate macroeconomic policy mix that preserves external stability. Fiscal policy should be centered on further expenditure restraint, as laid out in the FY2012/13 Budget, while an accommodative monetary policy should be maintained as long as generalized price pressures are contained.

10. Managing global spillovers: Staff noted that if global financial markets become severely disrupted again or if world growth falters beyond what is envisaged in staff’s baseline forecast, Botswana’s policy framework is well positioned to respond to such shocks. In that scenario, staff advised that the authorities allow the automatic stabilizers to operate on the revenue side.1

Authorities’ views

11. In response, the authorities noted that their macroeconomic policy responses would need to be flexible, measured, and proportional to pressures coming from the global economic environment. They emphasized the need for continued fiscal restraint without jeopardizing the sustainability of the recovery. The BoB will continue to remain vigilant and stand ready to take preemptive action on monetary policy if needed.

B. Policy Theme 2: Rebuilding Policy Buffers through High-Quality Medium-Term Fiscal Consolidation

Background

12. The overriding fiscal policy challenge for Botswana is to reduce the size of the government (as a share of GDP). The government remains the main employer in the economy. The government’s expenditure envelope (above 30 percent GDP), including the wage bill, is high by international standards, thus warranting a thorough assessment of pockets of unproductive spending and ways to increase efficiencies. Both FY2011/12 and FY2012/13 Budgets have focused on addressing this key challenge.

uA01fig08

Government Spending and Wage Bill, Average 2007–2011

(Percent of GDP)

Citation: IMF Staff Country Reports 2012, 234; 10.5089/9781475504880.002.A001

Source: IMF World Economic Outlook and Government Finance Statistics.

13. The Pula Fund served as a smoothing mechanism to support the government’s countercyclical policy response to the 2008–09 global financial crisis. It is a bedrock for the crawling peg mechanism and a tool for transferring mineral wealth across generations.

14. The FY2012/13 budget targets a small fiscal surplus, which will help to rebuild the Pula Fund. The budget is centered on further expenditure restraint, most notably of the wage bill, while improving the quality of spending consistent with past staff advice.2 Staff’s estimates of the implied fiscal impulse is more than minus 3 percentage points of GDP, and the budget will also reduce the nonmineral primary balance (NMPB) by more than 6 percentage points of nonmineral GDP, bringing it closer to its sustainable level. The budget targets an annual 5 percent reduction in the wage bill over the next three years. Staff’s assessment, based on wage data provided by the authorities, show that the savings generated from the current measures such as outsourcing of low-skilled activities to the private sector, hiring and vacancy freeze and natural attrition will likely deliver at most one-fifth of the 5 percent targeted reduction in the wage bill.

15. The FY2012/13 Budget is hesitant on tax reform. Staff welcomed the abolition of the two-tier corporate tax system and replacing it with a unified corporate tax rate of 22 percent and a withholding tax of 7.5 percent, as it should help to simplify the tax system. At the same time, the effective tax rates of the VAT and corporate income taxes continue to be significantly lower than the statutory rates on account of a number of tax exemptions. Beyond that, pressures remain in granting preferential tax regimes for businesses, particularly for the hubs.

16. Further fiscal consolidation is required to achieve medium-term fiscal sustainability. Staff’s analysis, based on the permanent income hypothesis, suggests that in order to fully preserve mineral wealth for future generations, the non-mineral primary balance (NMPB) should be reduced to about 5 percent of non-mineral GDP from the current level of about 17 percent (Appendix III).3 Staff’s updated Debt Sustainability Analysis shows that Botswana’s debt burden continues to be very low although sensitive to diamond revenue fluctuations that are crucial for overall economic growth and the primary deficit calculations (Informational Annex).

Central Government Operations, 2011/12–2015/16

article image
Source: Botswana authorities and IMF staff estimates and projections.

The kink in the overall balance in FY2013/14 represents the large windfall revenue from SACU in FY2012/13.

In percent of non-mineral GDP.

Staff recommendations

17. Staff supports the authorities’ FY2012/13 Budget given the emphasis to buttress medium-term fiscal consolidation and rebuild the fiscal buffers. Staff called for greater clarity on the linkage between the Pula Fund and fiscal policy, in particular the Fund’s withdrawal and inflow rules and how they relate to fiscal developments.

18. Staff noted that the targeted reduction in the wage bill should be supported by a credible civil service and wage scale reform. In the short term, the current measures in the budget should be augmented with a streamlined system of non-wage payments, including tighter eligibility criteria for allowances. However, to achieve high-quality reforms of public sector employment and wages, short-term measures should be complemented with medium-term measures such as (i) Using economy-wide productivity gain as an additional indicator for public sector wage adjustment after a careful assessment of the various inputs from stakeholders; (ii) rationalizing the size and structure of government; (iii) tightening the link between pay and performance; and (iv) strengthening payroll systems. The revision of the wage scale, which pays a premium to low and middle pay grades relative to the private sector and where the concentration of large number of employees is in the civil service, would support fiscal sustainability. In addition, it would also contribute to reducing distortions in the labor market given that reservation wages are perceived to be high and unemployment remains a major challenge.

19. Staff reiterated the need to broaden the tax base to provide a stronger foundation to the authorities’ fiscal consolidation objectives. This will also prepare the economy for a potential decline in SACU revenue over the medium term. The measures needed to attain this objective include a judicious rationalization of tax incentives to reduce the gap between the effective tax rate and the statutory rates on both the VAT and corporate income tax. The authorities should also avoid granting unwarranted preferential tax regimes for businesses. More broadly, staff noted that a comprehensive study on tax expenditure would inform policymakers about the magnitude of tax revenue that is lost through tax incentives and provide a solid foundation to streamline tax incentives to specific activities that absolutely need the incentives.

20. Staff also advocated for delinking the fiscal policy stance from volatile diamond and SACU revenue. Thus, the authorities should adopt either the NMPB or the structural fiscal balance (à la Chile) as an anchor in the formulation of fiscal policy. This should be supported by a medium-term fiscal framework (MTFF). Consistent with past staff advice, the government committed to put in place an MTFF by 2016 as part of its public financial management reform agenda.

Authorities’ views

21. The authorities affirmed their medium-term fiscal consolidation goals, centered on reducing the size of the government. The main strategy behind the FY2012/13 Budget is for the government to focus spending on high priority and high return activities, including development expenditure, scale down spending on low return programs, and increase quality in the delivery of government services.

22. On the linkage between the Pula Fund and fiscal policy, the authorities noted that the Pula Fund inflows and outflows are guided by their macroeconomic policy framework. In particular, any resources the government is not able to invest in productive domestic investment are transferred to the Pula Fund thus treating the Fund as a residual. By the same token, current spending is generally financed by non-mineral revenue. They also clarified that in the event of external shocks, the first line of defense is through macroeconomic policy adjustments. If such measures prove to be insufficient to stabilize the reserve level, the Pula Fund is used to bridge the residual gap. They emphasized that while these overarching principles that govern the Pula Fund lack specific linkage to fiscal developments, they do provide the needed flexibility that has served Botswana well over the years.

23. The authorities will consider the mission’s advice on measures to support the targeted reduction of the wage bill. They agreed with the staff’s analysis that measures included in the current budget for reducing the wage bill will likely not deliver the intended results. While in broad terms their focus continues to be to reduce the head count in the civil service, the government will consider augmenting its wage reduction measures with additional measures suggested by staff.

24. The authorities concurred that the negative externalities of tax incentives outweigh their marginal benefits. They expressed strong interest in conducting a full-fledged study on tax expenditure noting that doing such an analysis is timely because there are pressures to grant new tax incentives. To support the government’s revenue-raising objective, a working group has been established to identify the areas of the tax system that require reforms. Consistent with staff’s past advice, the Botswana Unified Revenue Service has just established a Large Taxpayer Unit and is also working to enhance tax administration through multitasking tax officers and scaling up tax auditors.

25. The authorities emphasized that they recognize the need for a fiscal anchor that deals with volatile revenue, although care needs to be taken in transitioning from the current fiscal objectives, which include mineral revenue, to a more constrained rule that excludes mineral revenue. They noted that thus far they have been able to deal with revenue volatilities through accumulating foreign exchange reserves during boom years and using them to compensate revenue shortfalls during economic downturns. The new fiscal anchor should take a long-term view of revenue, especially mining revenue that are likely to decline in the decades following the NDP10. Their Sustainable Budget Index rule in the NDP10 reserves mineral revenue for capital spending, leaving only non-mineral revenue to finance recurrent spending. The authorities also noted that they are reviewing the legal and regulatory framework for accommodating the MTFF and program based budgeting, developing a debt management strategy, and enhancing ministries’ capacity in cash flow monitoring and forecasting to support the MTFF implementation by 2016.

C. Policy Theme 3: Strengthening Monetary Operations, Financial Intermediation, and Stability

Background

26. During the last six months, the BoB has enacted reforms in its liquidity management operations. The key goal was to reduce sterilization costs that have severely affected the BoB’s balance sheet in recent years, a challenge that many other central banks around the world have faced. The reforms should reduce the amount of liquidity absorbed through the issuance of the Bank of Botswana Certificates (BoBCs), the main instrument used to mop up excess bank liquidity. This resulted in a significant reduction in the quantity of BoBCs offered for auction. The reforms also included an increase in the reserve requirement for banks and more frequent use of reverse repo operations.

uA01fig09

Botswana: Selected Nominal Interest Rates, Jan 09–Feb 12

(Percent)

Citation: IMF Staff Country Reports 2012, 234; 10.5089/9781475504880.002.A001

Sources: International Financial Statistics.*Deposit rate refers to the 88-day notice deposit.

27. At the same time, the reforms have posed transitional challenges for the BoB. It severed the traditional link between the BoB’s policy rate and other short-term interest rates in the economy, thus weakening the monetary transmission channel. The large reduction in the stock of BoBCs has, however, not translated into an outflow from the banking system through the balance of payments because increased reserve requirements and more active use of reserve repo instrument by the BoB partially absorbed the excess liquidity. In addition, commercial banks have increased lending to businesses. The fiscal withdrawal has also contributed to the sterilization of excess liquidity.

28. While the banking system remains sound, the high level of exposure of banks to households is a potential source of vulnerability. Although the recent entry of new domestic banks is expected to spur competition, the latest financial sector indicators show no discernible change. Commercial banks, the largest of which are subsidiaries of South African and British banks, appear to be well capitalized and profitable, and have little direct exposure to the current financial stress in the euro area. However, banks are still heavily exposed to households, which now account for 53 percent of bank lending and whose balance sheet is beginning to show signs of stress. Households’ real incomes have declined in recent years given three years of public sector wage freeze, and they are now increasingly running down their savings. The excessive leveraged nature of households and the related financial stability issues are now becoming even more relevant in light of the authorities’ reform agenda on financial sector development.

29. Broadening the population’s access to financial services and improving financial intermediation are key priorities for the authorities. The 2009 Finscope study found that a significant proportion of adults (about 60 percent) do not have a bank account—a feature that is reminiscent of economies with a much lower level of income per capita. Ongoing initiatives to broaden access include e-money, e-wallet, microfinance, and other innovative financial products. Botswana’s financial system had grown and diversified considerably over the last decade. However, financial intermediation, while improving, remains low compared with other high middle-income countries.

uA01fig9

Private Sector Credit, 2011

(Percent of GDP)

Citation: IMF Staff Country Reports 2012, 234; 10.5089/9781475504880.002.A001

Sources: IMF International Financial Statistics and World Economic Outlook.
uA01fig10

Sectoral Composition of Commercial Bank Loans

(Percent of total loans)

Citation: IMF Staff Country Reports 2012, 234; 10.5089/9781475504880.002.A001

Sources: BoB and IMF staff calculations.

30. Non-bank financial institutions (NBFIs)—if overlooked—could increase vulnerabilities in the financial system. The current environment of low external and domestic interest rates may give rise to an aggressive search for yields. The asset size of NBFIs, which mainly include the pension funds, insurance institutions, and asset management companies, has experienced rapid expansion in recent years. Amidst paucity of reliable property market data, discussions with a broad section of market participants point to a significant price buildup in the real estate market. The acceleration of lending by NBFIs to households and for property market development, especially in the commercial segment of the real estate market in Gaborone, pose emerging risks to financial stability and require close monitoring. The Non-Bank Financial Institutions Regulatory Authority (NBFIRA), however, is not yet equipped to fully discharge its mandate because of delays in building a full complement of skilled and experienced staff. Moreover, a legal and regulatory infrastructure is not fully in place.

Botswana: Structure and Performance of the Financial Sector

Botswana’s financial sector has evolved over the years, and featured new entrants, mergers and acquisitions, and orderly exits. The banking sector has expanded from two to eight banks serving the domestic market and two banks operating as offshore banks. The banking system is profitable, liquid, and well capitalized with capital adequacy ratios well above prudential norms (Table 5). In addition to institutional movements, there has been a progressive widening of services, coverage and innovation, in the context of the authorities’ financial sector development strategy and regulatory oversight, as well as global developments regarding the banking business model and information and communications technology. While financial exclusion decreased by 13 percentage points in 2009 compared with 2004, access to financial services remains low with estimates of financial exclusion at about 33 percent (number of adults without access to financial services).

Botswana’s financial sector features three broad categories: depository corporations (commercial banks and other deposit taking institutions), other financial corporations (OFCs), and the offshore banking sector. OFCs, which are supervised by the Non-Bank Financial Institutions Regulatory Authority (NBFIRA), include insurance companies, pension funds, and other institutions such as the Botswana Stock Exchange and stock brokerage firms, asset managers, micro finance institutions and collective investment undertakings. In addition, there are statutory development finance institutions, and the Motor Vehicle Accident Fund. The depository corporation segment of the financial sector (excluding BoB) is historically dominated by commercial banks, which on average held 98 percent of total deposits and 92 percent of total advances from 2001 to 2010. In the non-banking sector, life insurance companies and pension funds provide a wide range of savings and protection products and collectively constitute one of the largest and deepest non-bank financial sectors in sub-Saharan Africa.

uA01fig11

Botswana: Total Assets by Financial Institutions, 2001–2010

Citation: IMF Staff Country Reports 2012, 234; 10.5089/9781475504880.002.A001

Source: Bank of Botswana.
uA01fig12
Source: Bank of Botswana
Table 4.

Monetary Survey, 2008–2017

article image
Sources: Bank of Botswana and IMF staff estimates and projections.
Table 5.

Botswana: Banking System Prudential Indicators, 2005–20121

article image
Source: Bank of Botswana and FSAP estimates.

The compilation methodology has changed somewhat since 2006; the number of banks has increased since 2007.

Regulatory capital refers to the total of Tier 1 and Tier 2 capital, less investments in subsidiaries and associates.

The minimum capital requirement is 15 percent of risk weighted assets.

The minimum capital requirement is 7.5 percent of risk weighted assets.

NPLs are defined as credits with interest past due of 182 days or more; compromised assets are defined as credits with interest past due of 91 days or more.

Foreign currency liabilities less foreign currency assets as a percent of regulatory capital.

Staff recommendations

31. Staff supports the main thrust of the BoB’s recent reforms in its liquidity management operations. The reforms will likely promote more financial intermediation and put the BoB’s balance sheet on a sustainable footing. Staff discussed with the BoB various options to re-establish the traditional link between its policy rate and short-term interest rates, including the use of the reverse repo to credibly set the overnight rate corridor supported by a standing facility. This would enable market participants to respond appropriately to changes in the monetary policy stance, and anchor inflation expectations better. Increased issuance of treasury paper should facilitate the burden-sharing of sterilization costs and provide investment opportunities for nonbanks.

32. Although efforts to broaden financial inclusion and deepen intermediation are consistent with both Vision 2016 and NDP10, these need to be accompanied by adequate safeguards to preserve the stability of the financial system. The introduction of innovative products to broaden the population’s access to financial services would require measures to contain possible risks, including money laundering. Staff called for efforts to develop a reliable property market index to help monitor price developments and take appropriate regulatory steps where needed. More broadly, staff recommended that the BoB use its newly established financial stability unit to put in place a macro-prudential framework and strengthen information sharing with foreign supervisors on cross-border flows.

33. Staff underscored the need to strengthen the regulatory and supervisory framework for NBFIs. The emphasis here is on the potential risks NBFIs pose to the domestic financial stability, including through regulatory arbitrage. The cross-linkages between the bank and non-bank parts of the financial system are significant. Thus, any large shock to the non-banking system could reverberate through the banking system and pose systemic stress across the financial system and thus to the broader macroeconomy.

Authorities’ views

34. The BoB acknowledged the ongoing transitional challenges posed by their liquidity management reform. Thus, the central bank is exploring various options to re-establish the traditional link between its policy rate and short-term interest rates. To facilitate the implementation of the government’s domestic bond program, two working groups have been established to look into the issues of coordination between monetary and debt management policies and more frequent issuance of government securities.

35. The authorities also recognize the stability challenges involved in broadening financial access and deepening financial intermediation. Steps are being considered to monitor the associated risks posed by new innovative products in the banking system. They noted that while households’ portion of total bank lending has declined from about 61 percent to 53 percent, they are now beginning to borrow outside the banking system including through microfinance institutions. To monitor price developments in the real estate sector and take appropriate regulatory steps where warranted, the BoB has stepped up efforts to collect more information on the property market and develop a reliable property market index.

36. As highlighted in the FY2012/13 Budget speech, the government has placed emphasis on enhancing the capacity of the non-bank regulator. To start with, the government has put the appropriate regulation in place to allow the NBFIRA to collect supervisory levies from NBFIs to address some aspects of its funding problems. In addition, efforts by the government are ongoing to strengthen the supporting and enabling legislation for pension fund and insurance institutions. Moreover, progress toward signing a memorandum of understanding (MOU) between the BoB and NBFIRA is well advanced. This will facilitate the effective information sharing between the two supervisory agencies of the financial system, consistent with staff’s past advice.

D. Policy Theme 4: Promoting Inclusive Growth, Addressing Unemployment, and Fostering Institutional and Capacity Development

Background

37. The poverty headcount rate declined sharply in recent years driven mostly by poverty reduction in rural areas. Preliminary estimates based on the Botswana Core Welfare Indicators Survey (BCWIS) 2009/10 show a significant decline in the poverty headcount rate, from 30.6 percent in 2002/03 to 20.7 percent in 2009/10 (Selected Issues Paper-Chapter 1 ). The expansion of social programs, as well as continuing growth and urbanization, could be responsible for this marked reduction in the poverty rate.

38. Despite many years of robust economic growth, the distribution of income remains highly unequal in Botswana. Botswana has one of the highest income inequalities in the world especially when compared with other middle-income countries, with a Gini Index in excess of 0.5. Staff’s estimates based on preliminary data from the 2009/10 Botswana Core Welfare Indicators Survey (BCWIS) compared with data from the 2002/03 Household Income and Expenditure Survey (HIES), suggest there was a decrease in inequality in the intervening period, as measured by a decline in the Gini coefficient. Staff analysis also shows that decreasing income inequality has the potential to extend growth spells in SACU countries (Selected Issues Paper-Chapter 1).

uA01fig13

International Comparison: GINI Coefficient and Real Output Growth

Citation: IMF Staff Country Reports 2012, 234; 10.5089/9781475504880.002.A001

Sources: IMF, World Economic Outlook; and World Bank, World Development Indicators.

39. Nevertheless, middle-income households experienced more rapid growth than those in the lowest or in the highest percentiles of income distribution. The shape of the estimated growth incidence curve, which shows the growth rate of real consumption per capita for each percentile of the distribution, suggests that households between percentiles 15 and 75 of the distribution experienced more rapid growth than those in the lowest 15 percentile or in the highest 25 percentile. The results suggest that despite the expansion of the welfare programs in Botswana, they have been relatively less effective in terms of targeting the very poor when compared with other middle-income countries like Brazil, Chile, Mauritius and Indonesia. Staff analysis suggest that part of the significant decline in the preliminary poverty estimates by Statistics Botswana may be because the increase in the cost of the consumption basket (around 43 percent), during 2002/03-2009/10 on which the poverty line data is based, is smaller than the accumulated consumer price index inflation (around 58 percent).4 It is important to underscore that these estimates are provisional and will be updated once the final official data are made available (Selected Issues Paper Chapter 1).

40. The unemployment rate has been persistently high driven by structural factors. Public sector wage and employment policies, their demonstration effect on the private sector and on reservation wages, and the interplay with skill mismatch in the labor market have all contributed to persistently high structural unemployment in Botswana and other SACU member countries (Selected Issues Paper Chapter 2).

uA01fig14

Unemployment Rate

Citation: IMF Staff Country Reports 2012, 234; 10.5089/9781475504880.002.A001

Source: World Bank World Development Indicators.

41. While Botswana’s per capita income is well in the high middle-income category, capacity is unevenly distributed across the government and weaknesses are found in areas that crucially need to be addressed before the economy can move to a higher level of development. Government effectiveness indices prepared by the World Bank suggest that, for Botswana, the private sector’s perceptions of the quality of public services and civil service bureaucracy are more positive than, for example, those for Cape Verde, Namibia, and Seychelles, but have remained broadly unchanged over the last decade. Botswana’s relative weaknesses are in institutional effectiveness, excessive red tape, and poor allocation of public resources for rural development (Appendix IV).

42. Data quality is broadly adequate for surveillance, however, there is room for improvement. Staff’s assessment shows weaknesses in the compilation of the national accounts data, including the expenditure side of GDP. There is also room for improvement in the compilation of the balance of payments statistics, including the services data.

Staff recommendations

43. Policies to enhance inclusive growth should target inequalities at their sources. Measures should include fostering effective investment in health and education and enhancing the population’s access to financial services to support greater financial inclusion. This would complement the current redistributive aspects of fiscal policy including targeting a direct redistribution of income.

44. Tackling the high level of unemployment in Botswana will require faster economic growth and well–designed structural reforms. The structural measures should focus on changing public employment and wage policies (see Policy Theme 2) and aligning the curricula for university and tertiary education and vocational training to meet the demand for skilled labor in the broader economy. The government’s Economic Diversification Drive (EDD), which will demand sizeable foreign direct investment in the non-diamond sector and measures to improve the business environment, should also enhance job creation. Like Botswana, Chile—a middle-income and mineral-based economy—has achieved relatively better employment outcomes and the lessons from this country’s experience could be a useful case study for the authorities’ job creation efforts, including measures on labor-intensive non-tradable sectors.

45. Reforming Botswana’s public expenditure framework is warranted. The Public Expenditure and Financial Accountability (PEFA) report of 2009 provides some practical sequences of reforms to Botswana’s public expenditure, procurement, and financial accountability systems (Appendix IV). Prompt action across the board is needed given the numerous low-ranking areas identified in the PEFA report, especially when compared with ratings of other high middle-income countries.

46. The authorities need to take steps to improve the quality of macroeconomic statistics. Staff looks forward to the forthcoming IMF technical assistance missions on national accounts and balance of payments. The development of new high-frequency time series on inflation expectations, housing prices, and industrial production indicators would allow the BoB to act in a timely fashion in the event of second-round impacts on domestic inflation of commodity price increases or in the formation of asset price bubbles. These efforts should be accelerated to help propel Botswana toward subscribing to the IMF’s Special Data Dissemination Standard (SDDS) and joining its middle-income peer countries such as Mauritius, which has recently subscribed to the SDDS.

Authorities’ views

47. The authorities recognize the need to pursue policies to enhance inclusive growth, reduce unemployment, and deepen economic diversification including through an improvement of the business environment. They noted that considerable strides have been made toward reducing absolute poverty as reflected in the Botswana Core Welfare Indicators survey of 2009/10. The government’s tertiary education reform program and the Human Resource Development Council are expected to become operational in 2012. This combined with the graduates’ internship program would provide skills and on-the-job training needed to address the skill mismatch in the labor market. Under the EDD initiative, the authorities are pursuing a two-pronged diversification strategy: (i) diversifying within the mining sector beyond diamonds; and (ii) exploring the potential in cost-effective service sectors including financial and information technology sectors. The government has established the National Committee on Doing Business with the overall objective of improving the business climate.

48. The authorities acknowledged the need for fostering institutional and capacity development. The government is pursuing its public financial management reform agenda assisted by IMF and World Bank experts. The recent initiative to develop the e-government program would also contribute to improving the quality of publicly provided services. To enhance the government’s capacity to collect and compile high quality statistics, Statistics Botswana has been transformed recently into a fully autonomous agency.

Staff Appraisal

49. The current fragile global economic environment is likely to delay the pace of recovery in Botswana. Trend growth will likely moderate over the medium term as the historical success over diamond wealth continues to fade.

50. Against this backdrop, the authorities’ current policy mix of fiscal restraint and an accommodative monetary policy stance is appropriate. In a more adverse global economic scenario, the authorities should allow the automatic stabilizers to operate on the revenue side.

51. Bolder measures are required to achieve the targeted reduction in the wage bill. Such measures include streamlining the system of non-wage payments, rationalizing the size and structure of government, tightening the link between pay and performance, strengthening payroll systems, and revising the wage scale.

52. Broadening the tax base should be an integral part of the authorities’ fiscal consolidation strategy. Staff strongly recommends conducting a full-fledged study on tax expenditure to provide a solid foundation for streamlining tax incentives to specific activities that absolutely need it.

53. The authorities should adopt a fiscal anchor that delinks the fiscal stance from volatile mineral revenue and SACU receipts. Thus, staff reiterates the need to adopt either the non-mineral primary balance or the structural fiscal balance (à la Chile) in the formulation of fiscal policy.

54. Staff supports the main thrust of the Bank of Botswana’s recent reform in its liquidity management framework. Greater coordination between monetary operations and debt management through enhanced issuance of treasury securities should help to support the needed burden-sharing of sterilization costs.

55. The authorities should pay close attention to macro-financial linkages. The high level of exposure of the banking system to household debt is a significant source of vulnerability and warrants close monitoring.

56. There is an urgent need to strengthen the capacity of the non-bank financial institutions’ regulator. The rapid expansion of these institutions has propelled them into a systemically important component of the financial system, while the capacity of the non-bank regulator to supervise these large institutions lags behind. The cross-linkages between the bank and non-bank parts of the financial system constitute potentially an additional risk to the financial system.

57. Botswana faces long-term development and structural challenges that it needs to address to move the country to a higher level of development. Current redistributive aspects of fiscal policy should be complemented with policies that tackle inequality through fostering effective investment in education and health and enhancing financial inclusion. As one of the largest employers in the economy, the government has an important effect on economy-wide wage settlements and job creation. Thus the reform of the public sector employment policies is critical to enhancing job creation in the broader economy. Fostering deeper institutional and capacity development should be an important part of the government’s reform agenda to support long-term growth.

58. Staff judges the level of the real effective exchange rate as broadly in line with fundamentals from a medium-term perspective.

59. Staff recommends that the next Article IV consultation with Botswana take place on the standard 12-month cycle.

Table 6.

Millennium Development Goals, 1990–2011

article image
Source: World Bank.

Poverty headcount ratio at national poverty line updated from the Botswana 2002-2003 HIES.

Appendix I. Botswana: Exchange Rate and External Balance Assessment

1. This Appendix provides an assessment of Botswana’s exchange rate based on CGER methodologies adapted to country-specific circumstances.1 Botswana follows a crawling peg exchange rate regime with the objective of stabilizing the real exchange rate. The pula is pegged to a basket of currencies. The regime is implemented through continuous adjustment of the trade-weighted nominal effective exchange rate at a rate of crawl based on the differential between Botswana’s medium-term inflation objective and the forecast inflation of trading partner countries.

2. The analysis indicates that the pula is broadly in line with medium-term fundamentals. Table 1 presents the results of an analysis of exchange rate misalignments in Botswana based on four different methodologies. Taking into account the confidence bands surrounding the various estimates, staff concludes that the real effective exchange rate (REER) is broadly in line with macroeconomic fundamentals from a medium-term perspective. The estimates obtained are diverse, with one measure indicating no exchange rate misalignment, two measures suggesting that there is evidence of some degree of overvaluation, ranging from eight to ten percent and another measure pointing to a minor undervaluation.

Table 1.

Estimated Real Exchange Rate Misalignments

article image

3. The macroeconomic balance approach: This is a two-stage methodology. Firstly, the equilibrium current account norm is estimated based on panel regressions for a dataset covering 184 economies over the period 1973–2011. The current account norm is then compared to underlying current account projections and the degree of exchange rate misalignment is determined by the size of the gap between the two current account measures and the elasticity of the current account relative to the real effective exchange rate. This elasticity is assumed to be -0.5 based on country-specific estimated import and export elasticities for Botswana.2 This approach yields a current account norm for Botswana of 0.2 percent of GDP in 2017, which is close to the underlying current account balance, but indicates a small undervaluation of close to 4 percent. Nevertheless, the estimated misalignment is not statistically significant.

4. The external sustainability approach: This approach also estimates exchange rate misalignments as the exchange rate adjustment required to close the external gap. Nevertheless, this approach is tailored to the characteristics of a resource-rich economy by defining the current account norm in a forward-looking way based on a normative path for net foreign assets (NFA) consistent with a rule for the inter-temporal allocation of the revenue from nonrenewable resources. The target path of NFA (of 70% of GDP by 2017) was based on the fiscal sustainability analysis for Botswana undertaken by IMF staff in 2012. Using the same elasticities as in the macroeconomic balance approach would suggest that the real exchange rate is overvalued by close to eight percent.

5. The equilibrium real exchange rate approach: This approach estimates panel regressions of the level of the real exchange rate on macroeconomic fundamentals and then compares the fitted values to the observed real exchange rate to calculate the misalignment. It suggests that the real exchange rate is broadly in line with macroeconomic fundamentals.

6. The purchasing power parity approach (PPP): In this approach, we estimate panel regressions of the ratio of the PPP exchange rate to the market exchange rate as a function of GDP per capita at “PPP dollars” and subsequently evaluate the residuals of the regressions to determine the degree of exchange rate misalignment. The PPP approach indicates that the exchange rate is overvalued by about 10 percent in the medium-term, but the large confidence intervals around the mean estimate indicate that evidence of overvaluation should be interpreted with caution.

7. Non-price competitiveness indicators suggest that Botswana performs well relative to its peers, but important challenges persist. Botswana performs better than other middle-income countries in terms of strength of institutions, but on other metrics such as health, education as well as infrastructure, the country is lagging behind comparators (Figure 1). These indicators reinforce the need to prioritize investments in infrastructure and human capital to address constraints to improvements in competitiveness.

Figure 1
Figure 1

Botswana and Other Middle-Income Countries Competitiveness Indicators, 2011

(Scorefrom 1 [less Competitive] to 7 [more competitive])

Citation: IMF Staff Country Reports 2012, 234; 10.5089/9781475504880.002.A001

Sources: World Economic Forum.

Appendix II. Botswana: Responding to Spillovers from the Global Economy

1. This appendix assesses potential spillovers from deterioration in the global economic outlook on Botswana’s economy.1 As a mineral-based and highly open economy Botswana is potentially vulnerable to a range of global shocks. The appendix presents econometric results as well as model simulations quantifying the impact of global shocks on international diamond prices and on Botswana’s economy more generally. In particular, it focuses on shocks to output growth in advanced economies, on deterioration in financial conditions in Europe, and on an increase in international oil prices. The analysis looks at the propagation of these shocks through financial and trade channels. Also possible second-round effects of these shocks were considered, including the transmission channel through South Africa.

2. Outward spillovers from South Africa to other members of the Southern Africa Customs Union (SACU) could, in principle, be particularly strong. Customs revenue heavily depends on South African imports and account for a substantial amount of fiscal revenue in most SACU countries. In addition, most SACU members, except Botswana, peg their currencies to the South African rand, in practice, adopting monetary policy decisions from the South African Reserve Bank. Anecdotal evidence suggests that remittances from South Africa to some SACU members may also be significant. Moreover, South African financial groups are the dominant players in the financial markets of the region, spanning banking, pension, insurance, and wealth management services, whose treasury and risk management decisions tend to be centralized in Johannesburg. These institutions may help channel foreign direct investment from South Africa into the rest of the region.

3. Results from econometric models indicate that diamond prices are sensitive to shocks to growth rates in advanced economies. Staff estimated Vector Autoregressive models to quantify the impact of shocks to growth in advanced economies on international diamond prices (impulse response functions are depicted in Figure 1). Overall, the results indicate that, a one standard deviation (positive) shock to output growth in advanced economies increases diamond prices by about 2 percent on impact. Nevertheless, the effects of shocks are not very persistent. A variance decomposition analysis suggests that shocks to US growth rates are particularly important in explaining the variation in diamond prices.

Figure 1.
Figure 1.

Generalized Impulse Response Functions

Response to Generalized One S.D. Innovations ± 2 S.E.

Citation: IMF Staff Country Reports 2012, 234; 10.5089/9781475504880.002.A001

Source: WEO, Bloomberg; and IMF staff estimates.

4. The Global Integrated Monetary and Fiscal (GIMF) model was used to simulate the impact of financial distress in Europe and increases in international oil prices. Staff constructed a four region version of the IMF’s GIMF model comprising Botswana, Europe, the United States, and the rest of the world. The analysis simulated a deterioration of financing conditions in Europe, namely a temporary, but persistent increase in corporate credit spreads (surpassing 2 percentage points) combined with a one percentage point increase in the sovereign risk premium for this region. The simulated financial distress in Europe would spillover to other regions included in the model both through trade and financial channels. These shocks were combined with an increase in international oil prices over two years, thus negatively affecting all oil-importing regions.

5. Results of the model simulation indicate that the impact on real GDP growth in Botswana would be limited and rather short lived (Figure 2). This result is mainly due to limited direct exposure to Europe through trade channels. Real GDP growth is projected to decline by close to 1 percentage point before recovering the following year. Exports would decline in real terms relative to the baseline (by about 1 percent) due to lower global demand. The real exchange rate would also appreciate following the shock.2

Figure 2.
Figure 2.

Spillovers to Botswana

Citation: IMF Staff Country Reports 2012, 234; 10.5089/9781475504880.002.A001

6. In this context, monetary and fiscal policies would only play a limited role in addressing spillovers. Core inflation is projected to decline marginally relative to baseline, as economic activity decelerates, leaving space for some reduction in policy interest rates (which is incorporated in the simulations). Nevertheless, due to the need to buttress medium-term consolidation and the small fiscal multipliers in a highly open economy, staff believes that the appropriate fiscal response would be to let automatic stabilizers work rather than pursuing more active fiscal stimulus measures. While this might delay the fiscal consolidation path envisaged under the FY2012/13 budget, it should not undermine medium-term fiscal sustainability.

7. In conclusion, the analysis suggests that spillovers from the global economy are mostly transmitted through trade channels. The impact of global developments on diamond demand and prices seems particularly important. In general, the results do not indicate that the impact of global shocks on Botswana’s economy is likely to be persistent.

Appendix III. Botswana: Long-Term Fiscal Sustainability Benchmarks

1. This appendix derives numerical benchmarks to guide Botswana’s medium-term fiscal policy based on the Permanent Income Hypothesis (PIH) framework.1, 2 A key long-term fiscal challenge facing producers of exhaustible natural resources is to decide how to allocate government wealth (including mineral wealth) across generations. This challenge is met by targeting a fiscal policy that preserves the government wealth. The standard permanent income hypothesis argues that the preservation of wealth would require that spending in each period be limited to the permanent income or the implicit return on government wealth. To compute this “permanent” income, the projected stream of mineral revenue is transformed into a hypothetical annuity with the same net present value as the revenue. The annuity reflects the permanent portion of the country’s mineral wealth. The benchmark amount of spending that the government can then permanently sustain is equal to the sum of the annuity and non-mineral revenue. The benchmark fiscal balance is then calculated by setting annual expenditure equal to this level and saving the difference between actual and the hypothetical annuitized mineral revenue.

2. The judgment on the sustainability of current fiscal position is made based on the comparison of the staff’s medium-term fiscal projections (which are consistent with the government’s fiscal framework) against the fiscal benchmarks derived from the PIH approach. The staff projections assumed the attainment of a small surplus in FY2012/13 consistent with the Budget, along a steady, but gradual, diamond market recovery.

A01app03fig01

Fiscal Balance, FY 06/07—FY 16/17

Citation: IMF Staff Country Reports 2012, 234; 10.5089/9781475504880.002.A001

3. The benchmarks derived from the PIH suggest that further fiscal adjustment is required to achieve sustainability. Under the baseline scenario (scenario (a) in Table 1 below) in which the annuity is held constant as a share of non-mineral GDP, the sustainable non-mineral primary deficit is 4.9 percent of non-mineral GDP. This deficit is consistent with a spending level of 26 percent of GDP on average from FY2012/13 to FY2016/17, which is lower than the staff’s medium-term expenditure projections of 29 percent of GDP for the same period. The benchmarks nonmineral primary deficits average about 6.7 percent of GDP between FY2011/12 and FY2015/16, when we assume a more optimistic rate of return on mineral wealth (scenario (b)) or higher non-mineral revenue (scenario (c)). When the annuity is held constant in real per capita terms (scenario (d)), or simply in real terms (scenario (e)), the sustainable nonmineral primary deficits are wider initially, but narrow gradually to a range of 7 to 9 percent of nonmineral GDP by 2016–17. The assumptions used to calculate the benchmarks are summarized in Box 1.

Table 1.

Medium-Term Fiscal Outlook and Sustainability Benchmarks

article image
Source: IMF staff calculations.

4. The robustness of the PIH benchmarks was confirmed against structural budget deficit estimates prepared using Chile’s structural fiscal balance approach. Staff estimates suggest that the sustainable structural balance (SB) path for Botswana is closely correlated with the path for the non-mineral primary deficit derived using the PIH framework (Table 2). The structural balance is defined as the difference between the expected structural mining revenue and the expected structural expenditures. Expected structural mining revenue is derived by assuming that the economy is operating at its potential and diamond prices are at their long-term levels.

Table 2.

Structural Balance Estimates, 2009/10–2015/16

article image
Sources: Staff estimates and projections. Potential output is estimated using both HP and Kalman filters. SBt = E(SRt) – E(SEt).

Assumptions used to calculate benchmarks

  • ➢ Production of diamonds reaches a pick of 30.5 million carats in 2020 and begins sharp decline from 2024.

  • ➢ Nominal US dollar price of diamond is adjusted annually by the rate of change in the CPI of the advanced economies, so that stays constant in real terms. The dollar price is converted to pula using period average nominal exchange rate.

  • ➢ The initial stock of wealth accumulated into the pula fund is 50.6 percent of GDP at end-December 2011. This is added to the value of mineral wealth still in the ground in calculating the total value of mineral wealth.

  • ➢ The real return on mineral wealth is 4.2 percent, based on the average real return of the Norwegian Pension Fund over the last ten years.

  • ➢ The income from annuitized diamond revenue is spread until 2050.

  • ➢ The annuity is assumed to stay constant in terms of real non-mining GDP.

  • ➢ Non-mineral real GDP growth averages about 5 percent from 2012/13 to 2016/17 before declining gradually and to a steady state rate of 3 percent.

Appendix IV. Botswana: Strengthening Government Institutions

1. Strong government institutions are critical for supporting high economic growth.1 The importance of effective governmental institutions lies in their capacity to raise the return to private sector investment and, thus, overall economic growth. While the principal public-sector investments that are needed to support growth are education and infrastructure, the international evidence suggests the complementary role of regulations and the effectiveness of public institutions in supporting the materialization of potential private sector outlays for increasing the tangible and intangible asset base of the economy.2

2. Information on the World Bank’s Government Effectiveness indices point to a number of challenges for Botswana (Figures 1 and 2). While the country ranks significantly higher than other middle-income countries in SSA (i.e., Cape Verde, Namibia and Seychelles) in terms of the quality of government institutions, its absolute level of performance has remained broadly stagnant for about a decade (2000–2010). This average performance contrasts with that of Mauritius, which is an outstanding example of government institution-building throughout the same period. A detailed analysis points at Botswana’s relative weaknesses in terms of institutional effectiveness (due to a perceived low quality of its public sector bureaucracy), excessive red tape, and poor allocation of public resources for rural development according to the survey data compiled by the World Bank for computing the government effectiveness indices. Moreover, in terms of quality of public institutions, Botswana ranks somewhat below comparators with similar gross national income (GNI) per capita.

Figure 1.
Figure 1.

Botswana and Sub-Saharan African Comparators: Government Effectiveness Index

Citation: IMF Staff Country Reports 2012, 234; 10.5089/9781475504880.002.A001

Source: World Bank Worldwide Governance Indicators,http://info.worldbank.org/governance/wgi/.
Figure 2.
Figure 2.

Government Effectiveness and GNI Per Capita

Citation: IMF Staff Country Reports 2012, 234; 10.5089/9781475504880.002.A001

Source: World Bank Worldwide Governance Indicators and World Bank World Development Indicators.

3. Building efficient and accountable public financial management (PFM) systems could be a useful way to address challenges and strengthening government institutions. In this regard, Botswana’s Public Expenditure and Financial Accountability (PEFA) report of February 2009 provides some practical sequence of reforms to budgetary practices, procurement, and financial accountability systems. Low-cost reforms that could trigger an overall improvement in Botswana’s PEFA ratings include, in particular, aspects regarding: a comprehensive monitoring of debt levels of sub-national governments; the development of a multi-year perspective in fiscal planning and execution; more frequent reconciliation of tax assessments and collections; strong compliance of competitive bidding procurement processes, and enhanced quality and timeliness of the production and dissemination of central government annual financial statements and internal audit reports.

4. The government’s support in strengthening the local financial sector is yet another venue to support domestic savings and high economic growth. In general, Botswana’s overall macroeconomic stability and the resilience that has been attained in financial systems during the 2008/09 global financial crisis offer a favorable setting for further developing the depth, efficiency and competitiveness of the financial sector. This is one on the main messages of assessments under the 2007 Financial Sector Assessment Program (FSAP) and the Botswana Financial Sector Development Strategy of 2011. The latter, in particular, stresses the large size of the unbanked population, and the need for the authorities to search for measures to fill the financial access gap through the development of microfinance and e-money, for example, while taking appropriate steps to limit regulatory risks. A deepening of the government bond market would be yet another venue for the government to support domestic savings to finance investment.

5. Finally, it is important to underscore that assessing the quality of institutional effectiveness is a complex undertaking and the analysis above only addresses a limited number of issues for Botswana. That said, they do highlight that while mineral wealth has propelled Botswana to high middle-income status, there are spots of institutional weaknesses, which do not exist in some of the other high middle-income countries and are often found in economies with much lower level of per capita income.

1

Botswana does not have the traditional Keynesian automatic stabilizers on the expenditure side such as unemployment insurance.

2

The main expenditure measures in the budget include (i) a 3 percent annual salary increase for public officers (compared to a projected average inflation rate of 7.5 percent in 2012), (ii) a reduction of the wage bill by five percent each year for the next three years, and (iii) a 11 percent reduction in the budget appropriations for post-secondary education to ensure value for money in line with the last World Bank Public Expenditure Review (PER).

3

Staff’s intergenerational consumption smoothing baseline framework does not incorporate an investment function to determine the sustainable NMPB as Botswana’s infrastructure gap is largely closed and the country is not the typical LIC/LMIC case in SSA with large development needs. Moreover, Botswana has capital market access, the only country in the region with an investment-grade rating across all rating agencies. Staff’s analysis using Chile’s structural balance approach yielded broadly similar conclusions on fiscal sustainability (Appendix III).

4

However, the burden of inflation tax falls disproportionately on the very poor relative to the other quartile groups.

1

Prepared by Antonio David.

2

Deléchat, C. and M. Gaertner, 2008, “Exchange Rate Assessment in a Resource - Dependent Economy: The Case of Botswana”, IMF Working Paper No. 08/83.

1

Prepared by Antonio C. David (AFR) based on joint work with Dirk Muir (RES) and Manuk Ghazanchyan (AFR).

2

In terms of transmission of shocks through South Africa, outward growth spillovers, however, are not very evident. Preliminary results suggest that the external environment and domestic fiscal policies explain output fluctuations in the other four SACU countries, and that controlling for these, output developments in South Africa do not seem to amplify or cushion those effects on the region as a whole (using a panel data approach).

1

Prepared by Lamin Leigh and Ara Stepanyan.

2

This follows the same methodology used by Clausen (2008) and applied to Botswana in the Article IV staff reports since 2007.

1

Prepared by Gonzalo Pastor.

2

A number of studies have suggested the centrality of governance to economic development. See, for example, Gupta, S., Powell R., and Yang Y. (2005) “Macroeconomic Challenges of Scaling Up Aid to Africa,” IMF Working Paper, No. WP/05/179.

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Cover IMF Staff Country Reports
Botswana: Staff Report for the 2012 Article IV Consultation
Author:
International Monetary Fund
Volume/Issue:
Volume 2012: Issue 234
Publisher:
International Monetary Fund
ISBN:
9781475504880
ISSN:
1934-7685
Pages:
66
DOI:
https://doi.org/10.5089/9781475504880.002

Real GDP Growth

(Annual percent change)

CPI Inflation

(Annual percent change)
Figure 1.

Botswana: Recent Economic Developments
Figure 1.

Botswana: Recent Economic Developments

Exports in US$, 2011

(Annual percent change)

Contributions to Export Growth, 2011

Real GDP Growth Rates, 1966–2011

(Percent)
Figure 2.

Middle-Income Countries in Sub-Saharan Africa: Regional Comparison

(Average 2002–2011, unless otherwise indicated)

Government Spending and Wage Bill, Average 2007–2011

(Percent of GDP)

Botswana: Selected Nominal Interest Rates, Jan 09–Feb 12

(Percent)

Private Sector Credit, 2011

(Percent of GDP)

Sectoral Composition of Commercial Bank Loans

(Percent of total loans)

Botswana: Total Assets by Financial Institutions, 2001–2010

International Comparison: GINI Coefficient and Real Output Growth

Unemployment Rate
Figure 1

Botswana and Other Middle-Income Countries Competitiveness Indicators, 2011

(Scorefrom 1 [less Competitive] to 7 [more competitive])
Figure 1.

Generalized Impulse Response Functions

Response to Generalized One S.D. Innovations ± 2 S.E.
Figure 2.

Spillovers to Botswana

Fiscal Balance, FY 06/07—FY 16/17
Figure 1.

Botswana and Sub-Saharan African Comparators: Government Effectiveness Index
Figure 2.

Government Effectiveness and GNI Per Capita