Our authorities appreciate the continued engagement with the Fund and thank staff for the constructive discussions during the Article IV mission in Gaborone. They broadly agree with the assessment and conclusions of the staff report. The authorities also concur with the analysis of the challenges facing the country, especially the need to diversify the economy, reduce high unemployment, and manage the size of the public sector.

Prudent macroeconomic management has been key to Botswana’s macroeconomic stability and strong economic performance over the years. In addition, economic activity benefited from robust growth in the diamond mining sector. However, the continued weak recovery of the global economy and prolonged depression of commodity prices, especially contraction of the diamond market in 2015, have weakened the domestic economic prospects. The shortage of water and electricity, which are key inputs in driving economic activities, has also undermined domestic growth prospects.

At the same time, the authorities are mindful that reliance on a growth model driven by diamond mining and the public sector has rendered the country vulnerable to adverse shocks. That said, the country has accumulated reasonable buffers which will allow the authorities to cushion the impact of shocks and pursue their development agenda encompassed in their National Development Plan.

Recent Economic Developments

Economic activity was much weaker in 2015 due to a slowdown in mining output. Based on the third quarter GDP estimates of a 3.5 percent contraction, the GDP estimate for 2015 was revised downward from 2.6 percent to 1.0 percent. A modest recovery is expected, with GDP growth projected at 4.2 percent and 4.3 percent in 2016 and 2017, respectively, underpinned by a rebound in both the mining and non-mining sectors.

Inflationary pressures remained subdued in 2015 benefiting largely from modest demand and lower fuel prices. Fuel prices were adjusted downwards in February, August and December 2015, following a decrease in global crude oil prices. Consequently, the annual inflation rate fell from 3.8 percent at the end of 2014 to 3.1 percent at the end of 2015. Given the positive inflation outlook, the Bank Rate was reduced by a cumulative 150 basis points to 6.0 percent in 2015. Fuel prices are expected to remain low in 2016, thus exerting downward pressure on domestic prices.

The current account has improved significantly since the contraction in 2009. However, the surplus is estimated to decrease to P11.3 billion in 2015 from P22.2 billion in 2014 mainly due to lower diamond exports. Gross official reserves increased by 7.3 percent to P84.9 billion in December 2015, equivalent to 19 months of imports cover.

The outlook remains positive, supported by a projected moderate global economic recovery and expected improvements in diamond prices as well as expectations of a positive impact of the authorities’ Economic Stimulus Program. However, there are significant downside risks to the outlook, including the uncertain external environment and the sluggish growth projected for South Africa which will have an adverse impact on the Southern African Customs Union (SACU) revenues.

Fiscal policy

The authorities have pursued sound fiscal policy that has contributed to macroeconomic stability. The current fiscal framework has served Botswana well and the authorities remain committed to their guiding principles, which include expenditure ceiling of 40 percent of GDP. In the aftermath of the global financial crisis, the ratio of expenditure to GDP exceeded the 40 percent limit in 2008/09 and 2009/10. However, the authorities adopted appropriate consolidation measures in the subsequent years, reducing the ratios to be more consistent with the guiding principles of keeping expenditure in line with long-term expected revenue. In turn, Botswana’s debt has remained significantly below the target stipulated in legislation.

The fiscal framework has provided the authorities much needed flexibility to implement counter cyclical fiscal policy, to cushion the economy from adverse effects of external shocks. In line with the authorities’ objective and given the challenging domestic and external environment, the 2016/17 National Budget envisages continued government investment to address infrastructure challenges, especially for water and electricity, and support growth. The budget deficit is projected at 4 percent of GDP and will be financed by drawing down on government deposits and, foreign and domestic debt issuance. However, efforts will be made to contain expenditure; including reducing the public sector wage bill and improving the efficiency of State-owned Enterprises (SOEs). The authorities will also introduce stricter project appraisal criteria for selection of public investment projects and minimize delays in implementation.

Monetary Policy

The main objective of monetary policy is price stability. This has contributed to overall macroeconomic stability and supported sustainable economic growth. Restrained inflationary pressures allowed for an accommodative monetary policy stance and monetary policy will remain accommodative in the near term to support growth. The authorities will remain prudent and stand ready to tighten monetary policy should inflationary pressures arise.

Exchange Rate Policy

Botswana maintains a crawling peg. The authorities aim to ensure that the domestic currency is valued appropriately and the country remains competitive by maintaining a stable real effective exchange rate (REER). In this context, the annual review of the Pula exchange rate mechanism, which took place in December 2015, maintained the current basket weights of 50 percent South African rand and 50 percent IMF’s Special Drawing Rights (SDR). With domestic inflation expected to be on the lower end of the 3-6 percent inflation target range, the rate of crawl was changed from zero in 2015 to an upward rate of 0.38 percent per annum for 2016.

Structural Reforms

The main challenge for Botswana, as a land-locked country with a very small population and market base, is to reduce the cost of doing business and shift exports from goods to labor intensive services. The current water and electricity shortages have exacerbated the situation by increasing business costs. This has amplified the urgency for the authorities to address the infrastructure bottlenecks and improve efficiencies. In this context, the 2016/17 budget identifies major energy and water infrastructure projects to be implemented over the medium term.

To address unemployment and support a more inclusive growth path, the authorities have prioritized for 2016/2017 fiscal year economic activities with the potential to create employment opportunities. These include improvement and maintenance of the country’s road networks, wildlife and tourism initiatives, establishment of special economic zones and continued implementation of the Economic Diversification Drive (EDD) initiatives.

Although the authorities have invested substantial resources in the development of skills for the country’s workforce, education outcomes have been declining. To tackle this challenge, in 2015 the authorities adopted the Education and Training Sector Strategic Plan (ETSSP). It is expected that the implementation of the ETSSP will help improve the quality of existing vocational education and training programs and also equip the youth with appropriate skills. In addition, the authorities will continue investing in education and training with emphasis on ensuring that the skills and qualifications offered and acquired are more responsive to the needs of the labor market.

Conclusion

My authorities will continue to pursue sound macroeconomic policies which have supported economic growth and stability. The prudent management of diamond wealth has placed the authorities in a position to undertake structural reforms to ensure a more inclusive and sustainable economic growth. To do this, bold reforms are needed on infrastructure and human resource development, while minimizing inefficiencies and making certain that the projects commenced deliver the intended impact. My authorities believe that saving for the future generation is not just about financial resources; it is also about investing in tangible development and improving efficiency to secure the future generation. Finally, my authorities appreciate the ongoing Fund advice and Technical Assistance.