Botswana: 2019 Article IV Consultation—Press Release; Staff Report; and Statement by the Executive Director for Botswana
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International Monetary Fund. African Dept.
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Publication Date:
27 Mar 2020
eISBN:
9781513537375
Language:
English
Keywords:
ISCR; CR; building resilience; mission chief; resilience to shock; Botswana; resilience; expenditure measure; crawling band exchange regime; AFS Pima; Fiscal consolidation; Fiscal stance; Global; SACU proceeds; monetary policy; potential GDP; fiscal policy; return on assets; Non-renewable resources
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2019 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Botswana

Abstract

2019 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Botswana

Background

1. A challenging environment has exposed the limits of Botswana’s current growth model (Figure 1). Since the global financial crisis, diamond proceeds have remained significantly below pre-crisis levels as global demand weakened. These pressures intensified in 2014 reflecting increased competition from synthetic diamonds and higher production costs as the diamond mines become deeper. The government’s continued support to growth and employment through fiscal expansion (increases in public sector wages, employment and social spending, continued investments) lead to large fiscal deficits, a persistent drawdown in buffers, weakening the external position and, with the BoB seeking to maintain a stable REER to counter inflation, resulting in a moderate overvaluation of the exchange rate. At the same time, with limited progress on structural reform, growth potential has slowed, diversification has remained elusive, and non-mining exports market shares have fallen. Progress in reducing poverty and inequality has been modest and, unemployment increased to 20.7 percent, especially for youth and educated workforce.

Figure 1.
Figure 1.

Botswana: Improved Living Standards, but High Inequality and Persistent Unemployment

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Sources: Statistics Botswana, Worldwide Governance Indicators – D. Kaufmann (Natural Resource Governance Institute and Brookings Institution) and A. Kraay (World Bank) 2019, World Bank World Development Indicators, United Nation Human Development Index, and IMF staff calcualtions.
1

A Persistent Decline in Revenue

(Percent of GDP)

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Sources: Authorities and IMF staff calculations.

Fiscal and External Buffers

(Percent of GDP)

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Sources: Authorities and IMF staff calculations

2. Implementation of past staff advice has been mixed. The pace of reforms has regained momentum recently, especially in relation to the business environment, but several recommendations of the last article IV, including on fiscal policy have been delayed (Annex I).

3. The ruling Botswana Democratic Party (BDP) won a large majority in the parliament in the October 2019. The BDP secured 67 percent of the vote (38 seats out 57 seats in the parliament). Mr. Masisi, the leader of the BDP, was sworn in as the 5th President of the Republic of Botswana.

Macrofinancial Developments

4. GDP growth decelerated in 2019, while inflation remained subdued. Growth slowed to an estimated 3.4 percent in 2019 (3.5 percent over the first three quarters), down from 4.5 percent in 2018. The slowdown reflects a temporary contraction in diamond activity and a severe drought. Accommodative fiscal policy, in particular through higher public wages and employment, helped maintain non-mining GDP growth close to its potential. Inflation remained subdued at 2.8 percent on average in 2019, as low imported inflation and stable administered prices outweighed higher food prices (Table 1, Figure 2).

Table 1.

Botswana: Selected Economic and Social Indicators, 2014–2025

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

Calendar year, unless otherwise indicated.

Projections are based on diamond production due to lack of information on the breakdown of mining value added by mineral.

Year beginning April 1.

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

Includes central government-guaranteed debt.

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

Figure 2.
Figure 2.

Botswana: Macroeconomic Developments

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Sources: Bank of Botswana, Statistics Botswana, and IMF staff calculations.

Non-Mining Output-Gap

(Percent of potential GDP)

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Sources: Authorities and IMF staff estimations

5. The fiscal position also deteriorated significantly. After widening to 4.6 percent of GDP in FY2018 (up from 1.1 percent of GDP), the overall deficit is projected to increase further in FY2019 (5.8 percent of GDP). The deterioration reflects lower mining revenue and SACU transfers (-3.5 percent of GDP), continued underperformance of VAT, a larger-than-expected increase in the wage bill (both salaries` and employment), and other one-off expenditures (e.g. drought relief package), which were partially offset by an under execution of capital sending. Despite this deterioration, gross public debt is expected to remain broadly stable at about 19 percent of GDP as the deficit will be mostly financed by exceptional capital gains from the Bank of Botswana (BoB) and a drawdown in buffers (Tables 3a-3b).2

Table 2.

Botswana: Balance of Payments, 2014–2025

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

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

BOP data have been revised starting in 2012. A change in the information sytem may explain the large drop in import prices in 2017.

Table 3a.

Botswana: Central Government Operations, 2014/15–2025/261

(Billions of pula)

article image
Sources: Ministry of Finance and Economic Development; 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 excise taxes.

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

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 3b.

Botswana: Central Government Operations, 2014/15–2025/261

(Percent of GDP)

article image
Sources: Ministry of Finance and Economic Development; 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 excise taxes.

The 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 3c.

Botswana: Central Government Operations, 2014/15–2025/261

(Percent of non-mineral GDP)

article image
Sources: Ministry of Finance and Economic Development; 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).

6. The expansionary fiscal stance and weak diamond proceeds weighed on the external position. In 2019, diamond exports fell by 25 percent (JVi percent of 2018 GDP), mostly reflecting excess inventories in midstream industries and lower demand from Hong Kong SAR. As non-diamond imports remained broadly stable in relation to GDP, the current account surplus turned into a deficit, estimated at -4.3 percent of GDP (Table 2). Foreign exchange reserves dropped for a third consecutive year to about 10 months of imports (35 percent of GDP) at end-September, despite large positive valuation effects (about 3.6 percent of GDP). Overall, the external position is moderately weaker than the level consistent with fundamentals and desired policies (Annex II).

7. Bank lending grew broadly in line with GDP amid improving liquidity and strong banks’ balance sheets (Tables 5–6, Figure 3). Credit grew by about 6.9 percent year on year at end-October 2019, but remained skewed toward households. This is mainly because higher public wages supported households’ borrowing capacities, while uncertainty related to the general election delayed corporates’ investment and associated demand for credit. Meanwhile, the NPL ratio stabilized at 5.2 percent in Q3, while capital adequacy ratios stood well above the statutory minimum capital of 15 percent. In addition, the health of the financial system has not been impacted so far by the FATF decision in October 2018 to grey list Botswana because of strategic deficiencies in its AML/CFT framework.

Table 4.

Botswana: Monetary Survey, 2014–2025

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

Botswana: Financial Soundness Indicators, 2014–2019

article image
Sources: Bank of Botswana and IMF staff calculations.
Figure 3.
Figure 3.

Botswana: Macro-financial Linkages

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Sources: Bank of Botswana and IMF staff calculations.

Outlook and Risks

8. Growth is forecast to pick up in the near term and remain over the medium term below levels needed to achieve the authorities’ development objectives. GDP growth is projected to rebound to 4.4 percent in 2020 as diamond inventories and demand normalizes, the effects of the drought dissipate and increases in real wages kick in, and monetary policy remains accommodative, more than offsetting the drag from fiscal consolidation.3,4 Growth is expected to pick up further in 2021, with the start of the Khoemacau copper mine, and to moderate to around 4 percent over the medium term. This growth level would be insufficient for Botswana to absorb the 30,000 new entrants into the job market every year (compared to approximately 22,000 jobs created annually over 2014–18). Inflation is expected to edge up slightly due to revisions of some administered prices but will remain in the bottom half of the BoB target band.

9. Staff’s baseline scenario assumes a gradual fiscal consolidation starting in 2020. The fiscal deficit is expected to narrow to about 3 percent of GDP in 2020 helped by higher SACU transfers and gradually return to 0.5 percent of GDP by FY2024, amid increased efficiency gains and reprioritization of capital projects.5 This, together with increased mining production over the medium term—as new copper mines come on stream and diamond output rises—will help strengthen the current account balance and rebuild external buffers.

10. The outlook is subject to several downside risks, most of which would impact Botswana through lower mineral revenue or SACU transfers. There are significant downside risks relating to trade policy uncertainty and global growth, especially a faster-than-anticipated slowdown in China, the United states and South Africa. In the near term, widespread and prolonged disruptions from the coronavirus could lower growth and mining revenue through slower tourism activity and demand for diamonds. Higher mining production could provide some upside, but this could be offset by climate shocks, which would also weigh on agricultural output and tourism. These climate shocks will continue to threaten the outlook over the medium to longer term (Box 1). In addition, shifts in consumer preferences toward synthetic diamonds could force a sharp adjustment in domestic spending with attendant effects on macroeconomic and social stability.

Growth-at-Risk: Projected GDP Growth Distribution, Bostwana, 2020

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Source: IMF staff calculations.

Policy Discussions

Discussions centered on i) calibrating macroeconomic policies to adjust to the persistent shock to mineral and SACU revenues, and navigate the uncertain outlook, ii) revamping the policy frameworks to increase resilience and efficiency, and iii) designing and implementing supply-side reforms to promote private sector activity and diversify the sources of growth.

A. Calibrating Macroeconomic Policies

Fiscal Policy Stance and Quality of the Fiscal Adjustment

11. The authorities envisage to balance the fiscal position by FY2023 and reach a small surplus beyond that date. The fiscal consolidation aims to gradually rebuild fiscal buffers and guard against future economic shocks. In the FY2020 budget, the adjustment would be achieved mostly through reprioritization of capital outlays, cuts in non-priority spending and increase in public service fees, and is expected to be supported by improvements in diamond and SACU revenue. Higher mining and SACU revenue, which account for 60 percent of Botswana’s revenue, will help reduce the fiscal deficit in FY2020 by 2¾ percent of GDP. The envisaged reduction in the deficit is consistent with past performance as the fiscal effort will be about ½ percent of GDP. Over the medium term, more savings would be achieved through efficiency gains and control of the wage bill (mostly though partial attrition).

12. The size and pace of the authorities’ planned adjustment are broadly appropriate. Botswana has low debt and gross financing needs, and reserves at 35 percent of GDP (250 percent of the ARA metric) but needs to rebuild buffers for intergenerational equity purposes. This means that Botswana has some fiscal space that allows a gradual consolidation in order to minimize the impact on competitiveness, growth, and the most vulnerable. However, it is critical that the planned consolidation be implemented starting in FY2020 as it would help address external imbalances and contribute to a gradual rebuilding of buffers over the medium term, consistent with intergenerational equity. Achieving the authorities’ objective of a surplus by FY2024 would also allow Botswana to guard against cyclical shocks.6

13. Additional revenue and expenditure measures beyond those currently planned by the authorities are needed and the composition of the planned fiscal adjustment should protect efficient capital and social spending. Achieving the authorities’ planned fiscal consolidation while maintaining the wage bill in relation to GDP at the current level would likely entail significant cuts in capital expenditure and social spending, which could be inconsistent with the authorities’ transformation strategy. And while there is room for prioritizing quality public investment and enhancing spending efficiency, large and abrupt cuts would not be desirable given adverse effects on long-term growth. Moreover, enhancing spending efficiency typically requires public management reform, the benefits of which take time to materialize. Thus, additional revenue and expenditure measures beyond those currently planned by the authorities (and included in staff’s baseline) are needed. Specific measures that could help achieve the consolidation plans while minimizing the impact on growth (by protecting efficient public investment and competitiveness) and the most vulnerable include:

  • On the expenditure side: i) introducing means testing of scholarships in tertiary education, ii) gradually eliminating the electricity and fuel subsidies, while minimizing the impact on the poor (for example through targeted cash transfers), and iii) freezing hiring by the public sector and better aligning wage increases with productivity.

  • On the revenue side, the planned increase in public services fees should be progressive. Other measures should focus on broadening the tax base, including streamlining exemptions. Aligning the VAT rate to the regional average (14–15 percent, compared with 12 percent in Botswana), and increasing the progressivity of the personal income tax by adding brackets for higher income earners would provide immediate revenue. This could be supported over the medium term by increases in the level and coverage of property rates.7

Authorities’ Views

14. The authorities reiterated their commitment to achieving a small surplus over the medium term but are still working out how best to achieve it. They agreed that social and capital spending should be preserved but saw significant scope to reduce public sector waste and enhance efficiency, including in special funds and parastatals. They saw also scope for greater prioritization of productive and soft infrastructure, especially given their objective to transform Botswana in a knowledge-based economy. In addition, the authorities pointed to improvements in planning and budgeting as potential sources of saving.

Monetary Policy Stance

15. The accommodative monetary policy stance is appropriate. After over a year of constant rates, the cut in the BoB policy rate in August was in line with changes in global rates and consistent with the BoB’s objective of maintaining a stable REER. It was made possible by the low core inflation and inflation expectations anchored within the CB target band. The lower policy rate will pass through to lending rates, providing a stimulus to economic activity. However, in lowering interest rates, the BoB’s continued attention to the vulnerabilities in households’ balance sheets (high share of unsecured loans) is critical. Macroprudential policies could be tightened, if necessary, by introducing regulatory limits on Debt-To-Income or introducing a limit on unsecured lending.

Authorities’ Views

16. The BoB considers that the risks related to households’ balances sheets are manageable. While acknowledging the high household indebtedness and the high exposure of banks to households, the BoB sees several mitigating factors. These include the fact that banks generally collect payments for unsecured loans directly from borrowers’ paychecks; the concentration of unsecured loans is low; and Botswana still has room to deepen credit markets given its macroeconomic fundamentals and when compared with other countries at similar levels of development.

Macroeconomic Policy Mix if Downside Risks Materialize

17. Botswana has room to adjust macroeconomic policies to deal with shocks, but greater flexibility in the exchange rate would permit a more rapid adjustment to persistent shocks. In the event downside risks to growth materialize, the size and pace of fiscal adjustment could be recalibrated as part of a credible medium-term consolidation plan. On the monetary side, the BoB stable REER objective will limit its ability to provide further support to growth and constrain the economy’s response to the shock. In fact, the BoB may well need to maintain interest rates higher than they would otherwise, which would further weaken growth (as during the 2015 shock). Thus, the BoB needs to use the flexibility afforded by the current exchange rate framework to allow the Pula REER to respond to persistent shocks.8

B. Fostering Economic Transformation

There is an urgent need to advance structural reforms to lift medium-term growth and create the jobs to lower unemployment and absorb the new entrants into the labor market. Doing so will require enhancing macroeconomic policy frameworks and accelerating supply-side reforms.

Enhancing Macroeconomic Policy Frameworks

Fiscal Policy Framework

18. The current framework lacks operational guidance for fiscal policy and did not prevent a large and persistent decline in buffers. Limits are specified on gross debt (40 percent of GDP), and the shares of FX and local currency debt (20 percent of GDP for each). At the same time, the Pula Fund is not governed by strict deposit or withdrawal rules. Instead, deposits are determined by the size of foreign exchange inflows and the fiscal surplus, while withdrawals finance fiscal deficits.9 This framework likely encouraged an overreliance on buffers to finance fiscal deficits, delaying the needed fiscal adjustment.

19. The authorities have proposed a new fiscal rule, but the proposal could inadvertently generate undesirable outcomes. The rule, to be achieved by the end of the NDP 11, envisages that the recurrent budget be financed from non-mineral revenues (Sustainable Budget Index-like), and mineral revenues be used for investment in physical and human capital (60 percent) and be saved for future generations (40 percent). Achieving this target would be difficult given the current level of mineral and SACU revenue and would likely lead to high volatility in spending on physical and human capital, and therefore on GDP.

20. Amendments to the proposed rule would better ensure intergenerational equity while allowing for countercyclical policy. These would include:

  • Setting an explicit long-run target for the return on assets, including both financial and non-financial (e.g. infrastructure or human capital). This target should be consistent with intergenerational equity, defined as providing future generations (once mineral resources are exhausted) with a return comparable to what current generations enjoy (equivalent to an annuity of 11 percent of GDP).

  • In the short and medium term, complementing the existing ceiling on gross debt with a period-by-period floor on assets, based on the ARA metric and the size of buffers needed for smoothing cyclical fluctuations (about 18 percent of GDP).

  • Defining an operational target (e.g. a ceiling on recurrent expenditure growth) that ensures consistency between short- and long-run objectives.

Illustrative simulations (see Appendix I) show that under such a rule, continuation of the fiscal consolidation envisioned in staff’s baseline, which achieves a surplus of 0.8 percent of GDP starting in 2026, would leave the economy with sufficient financial assets to guard against shocks (cyclical fluctuations in mineral and SACU proceeds) and achieve intergenerational equity (Figure 4). The simulations also indicate that the long-run target could be achieved through different investment strategies (e.g. higher investment in infrastructure or human capital and less financial assets) with attendant effects on the ability to smooth shocks.

Figure 4.
Figure 4.

Botswana: Fiscal Rules for Intergenerational Equity and Smoothing Fluctuations

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Sources: Bank of Botswana and IMF staff calculations.

21. Improving spending efficiency would facilitate fiscal adjustment and buy-in for tax reform. Enhancing the efficiency of spending, including for parastatals, will in the short term reduce the impact of fiscal consolidation on growth. Over the long term, it will maximize the returns on capital and social spending, especially if combined with structural reforms to boost private sector development and exports. Priorities include further strengthening public investment management, better targeting of social spending, and moving to performance-based budgeting to enhance accountability in the medium term.

22. Rationalizing and enhancing the governance of parastatals would help improve the efficiency and effectiveness of the public sector and contain contingent liabilities.10 The lack of a regulatory governance framework for parastatals could result in a misalignment between parastatals’ strategies and their line ministries’ objectives. Furthermore, persistent delays in the timely publication of audited financial statements complicates financial oversight. Thus, it is critical to empower the Public Enterprises Evaluation and Privatization Agency (e.g. legal authority to enforce compliance), merge parastatals with overlapping mandates, enhance financial transparency, and strengthen the governance framework. In particular, there is a need for greater accountability, professionalization of the boards of parastatals, and appointing CEOs and board members based on competencies and expertise. The staff also encourage the authorities to set clear timelines for the restructuring of key loss-making enterprises, notably Air Botswana, the Botswana Meat Commission, and the National Development Bank, and proceed with their privatization plans.

Domestic Revenue Mobilization

23. Mobilizing additional domestic revenue would help Botswana reduce its dependence on mineral revenue and SACU transfers and preserve capital and social spending. These two revenue sources account for more than 60 percent of total fiscal revenue, making the fiscal position highly vulnerable to external shocks. At the same time, tax revenues are significantly below their potential as the domestic tax base has been eroded by multiple tax exemptions.11 Moreover, the authorities’ efforts to strengthen tax administration have stalled with several tax bills intended to simplify regulation and enhance compliance still being drafted. Thus, there is a need to broaden the tax base (e.g. streamlining VAT exemptions, increasing the level and coverage of property rates) and strengthen tax administration. The potential effects of revenue measures on vulnerable groups should be offset by expanding targeted cash transfers or other social protection programs. Finally, tax reform should avoid discouraging foreign investment (e.g. the recent large increase in transfer duties for foreigners).12

Debt Management

24. There is a need to revamp the medium-term debt management strategy (MTDMS). The overreliance on buffers to finance the deficit and the reduction in the share of external borrowing came at a cost of a rapid decline in buffers. The authorities should use the opportunity provided by the preparation of a new MTDMS to base their financing decisions on the levels of external and fiscal buffers, the financial opportunity cost of issuing debt against drawing down buffers (e.g. comparing returns on assets against the cost of issuing debt, including in domestic and foreign markets), a dynamic forward-looking strategy based on budget forecast, and on-lending and redemptions. Furthermore, the debt management strategy should be part of a broader strategy to deepen Botswana’s financial markets. Doing so would help accelerate structural transformation by providing domestic investment instruments to institutional and retail investors and enhance liquidity in the bond market.

Authorities’ Views

25. The authorities welcomed staff’s suggestions of alternative fiscal frameworks. They underscored the difficult trade-off not only between financial and non-financial assets but also within non-financial assets between human and physical capital and requested technical assistance for the calibration of the fiscal rule. They agreed on the scope for greater revenue mobilization and stressed the need for analyzing the reasons behind the decline in tax efficiency rates. Finally, they saw merit in revamping their assets and liability management framework, in particular through greater domestic borrowing on medium-to-long-term maturities to finance the deficit.

The Exchange Rate

26. The current monetary policy objective of maintaining a stable real exchange rate against the currencies in the basket has been successful in achieving price stability but slowed economic adjustment. While this policy has helped stem short-term appreciation pressures and accumulate buffers during episodes of temporarily high diamonds proceeds, the absence of an adjustment of the REER in the face of persistent decline in mineral revenue and SACU receipts has slowed economic adjustment.

27. Going forward, the exchange rate will need to facilitate Botswana’s economic transformation. This is because of several reasons. First, the exchange rate is moderately overvalued relative to levels consistent with fundamentals and desired policies (Annex II). And while the planned fiscal adjustment would help bring it broadly in line, the ensuing real depreciation should be allowed to play out. Second, the current external environment is fraught with downside risks (e.g. elevated trade tensions and faster-than-anticipated slowdown in China), which would likely entail depreciation pressure if they were to materialize. Keeping the real exchange rate constant in the event downside risks materialize would require maintaining real interest rates higher than they would otherwise, limiting the countercyclical role of monetary policy. And finally, over the medium to longer term, broad-based structural reforms to increase productivity in the economy will require changes to relative prices as capital and labor are reallocated from one sector to another, that will entail changes in the equilibrium exchange rate.

Authorities’ Views

28. The authorities broadly concurred with staff’s assessment that the exchange rate is moderately overvalued relative to medium-term fundamentals and desired policies. They saw scope to allow for greater flexibility within the BoB’s existing exchange rate framework in order to correct the misalignment and help the economy adjust to shocks. They agreed on the need to assess the role of the exchange rate in facilitating structural transformation, nurturing competitiveness, and fostering an export-led economy.

The Monetary Transmission Mechanism

29. The staff supports the BoB’s efforts to revamp its monetary operations framework in order to enhance policy transmission and deepen domestic financial markets. The BoB recently introduced the 7-day BoBC as the main instrument for conducting monetary operations to replace the 14-day BoBC and removed the ceiling on the issuance of BoBCs. These, together with the adoption of reserves averaging, will help enhance liquidity management. The desired effect could be strengthened by consolidating banks’ current accounts and reserve requirement accounts into a single account and introducing standing facilities. Staff support the ongoing discussions on replacing the Bank rate to enhance the signaling effects of policy actions on market rates (Box 2).

Financial Stability

30. While financial stability risks appear low in the short term, there are vulnerabilities related to over-reliance on wholesale funding and concentration in banks’ lending portfolio. These vulnerabilities could exacerbate the potential adverse effects of higher government debt issuance (to finance fiscal deficits) on overall liquidity. Thus, it is important to continue to closely monitor the liquidity situation in the financial system, strengthen the liquidity framework, including by introducing Emergency Liquidity Assistance, and finalize the banking act to enhance the crisis resolution framework. Furthermore, while not constituting an immediate risk to financial stability, the high household indebtedness and share of unsecured lending could reduce private consumption and growth over the medium term. These effects could amplify the adverse effects of fiscal consolidation on growth. Introducing macroprudential limits to contain household indebtedness and expediting credit reporting reform would reduce this risk. This should be supported by land reform (especially communal lands and land registry) and encouraging banks to implement programs to gradually reduce the share of unsecured loans.

Supply Side Reforms

31. Increased competition would boost productivity and promote private sector activity. Past policies that aimed to support private sector activity (e.g. subsidies and taxes, tariff and non-tariff barriers, such as local content requirements, cluster programs, spatial development programs) were not as effective as envisaged because they were mainly designed to shield local producers from international competition with no clear link to any performance criteria and targeted low sophistication products with weak export potential. This, together with the government’s large economic footprint, reduced domestic firms’ ability to compete on global markets and shift to higher productivity activity (Box 3). At the same time, the combination of low productivity and high labor costs weigh on the country’s competitiveness. Lastly, the weakening business environment, skills mismatches, and lack of technological readiness have impeded the development of a modern export sector.

32. Substantial gains could come from investment and productivity-enhancing policies. The authorities have recently passed several regulations to ease doing business (e.g. e-registration) and facilitated the granting of visas and work permits.13 These efforts could be complemented by:

  • Streamlining the regulatory framework and reducing the cost of doing business, including by advancing the e-Government agenda.

  • Reducing the government footprint by rightsizing the wage bill and better aligning wages to productivity, reforming parastatals, and increasing the contestability of markets, especially in network services to improve connectivity and affordability.

  • Further enhancing human capital and reducing skills mismatches by improving the efficiency and quality of basic education through reallocation/prioritization of spending, addressing the fragmented education budget between ministries, implementing pre-primary and Early Childhood Care and Education, expanding the training of teachers and increasing the role and quality of vocational training.14 Furthermore, it would be important to develop capabilities and skills for the future, especially promoting digital literacy, adaptability, and life-long learning as well as attracting FDIs and high-skilled foreign workers to fast-track technology transfer. This, together with greater affordability and availability of ICT infrastructure, would contribute to transforming Botswana into a knowledge-based economy (Box 4).

  • Integrating into regional and global value chains, including in the context of the AfCFTA. This requires: strengthening export and investment promotion institutions (including by clarifying their mandates, Box 5), upgrading trade-supporting infrastructure, promoting cross-border investments (including domestic firms’ investment abroad), better coordinating investment and trade policies at the regional level, and targeting products with complementarities with other countries in the region. Public R&D could help build capacities and improve productivity along the value chain (as is done for vaccines).

Growth Effects of Structural Reforms Through TFP

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Sources: WEF Global Competitiveness Index 2017/18, Worldwide Governance Indicators – D. Kaufmann (Natural Resource Governance Institute and Brookings Institution) and A. Kraay (World Bank) 2019, and IMF staff estimates.

33. Deepening the domestic financial sector would support Botswana’s development goals. Despite sizable savings, the financial sector’s contribution to Botswana’s development remains below its peers. While this may be partly due to low demand for credit, supply may also be constrained by gaps in the availability of collateral, information asymmetry, and the high share of volatile deposits (corporate and institutional). At the same time, Botswana’s financial markets are very shallow relative to emerging markets and advanced economies, which hampers an efficient allocation of savings in the economy. Priority should be given to reforming the land registry and establishing a collateral registry for movable assets, enhancing credit information, and assessing the efficiency of public development banks. In addition, Fintech offers significant opportunities for Botswana to make strides in deepening its domestic financial market. Capitalizing on these opportunities will require significant investment in digital networks and skills upgrading.

Authorities’ Views

34. The authorities lamented the lack of progress in advancing diversification. They shared staff concerns about delays in reforms implementation as well as the need to strengthen coordination, governance and accountability to achieve better outcomes.15

Other Issues

35. Statistics. Data provision is broadly adequate for surveillance. The authorities have continued to improve statistics, with support from AFRITAC South and IMF (Annex V). The staff welcomes recent improvements in external statistics and urges the authorities to move to GFSM 2014, to improve the classification of current and capital expenditures, and to accelerate the collection of financial accounts of extra-budgetary entities, including SOEs.

36. AML/CFT. The grey listing has not led to a loss of correspondent banking relationships for domestic banks. However, it has reportedly contributed to delays in outward investment by asset managers and shifts in the management strategy of assets abroad with attendant effects on costs. Thus, efforts to address the remaining deficiencies identified in the 2017 AML/CFT Mutual Evaluation Report, including implementing a sound and effective risk-based approach to supervision for offsite surveillance and on-site activities for the BoB and NBFIRA, should continue.16 This may require more dedicated human resources.

37. Governance. Botswana’s economic success hinged in part on strong governance. In this context, the staff supports recent initiatives related to asset declaration by public officials and customer due diligence (Freedom of Information), which should allow better tracking of illicit transactions and asset recovery and help stem corruption. However, while governance standards remain high overall, further improvements could be made in the areas of fiscal governance (revenue mobilization and spending efficiency, timely publication of budget documents, increased financial transparency and monitoring of parastatals), the regulatory framework (ease of doing business, trade facilitation), and rule of law (contract enforcement). Better governance could help raise the efficiency of public investment, with significant growth payoffs.

Staff Appraisal

38. The economy faces significant challenges and uncertainty. Persistently lower mineral revenues and SACU proceeds, and delays in the needed fiscal adjustment, including the large increase in the wage bill, have contributed to a moderately overvalued exchange rate and eroded buffers and savings for future generations with reserves falling from $8.3 billion in 2014 to $6.6 billion in 2019. Growth is expected to pick up in 2020–21 (4.4 percent and 5.6 percent respectively) but remain around 4 percent over the medium term, a level that is insufficient to reduce unemployment and reach high-income status. In addition, the outlook is subject to significant downside risks, most of which will affect Botswana through diamond and SACU revenue. Several sectors could also be affected by climate change.

39. The staff supports the authorities’ objective to return to a fiscal surplus over the medium term in line with their track record of fiscal discipline. Botswana still has some fiscal space that allows a gradual adjustment to the persistent drop in mineral and SACU revenue, but it is critical that fiscal consolidation starts in FY2020 in order to rebuild buffers. While acknowledging the scope for efficiency gains, such reforms might only bear fruits over the medium term. Thus, achieving the authorities’ objective requires additional revenue and expenditure measures beyond those currently being considered by the Government. Recent changes in the composition of expenditure (e.g. increases in the wage bill at the expense of capital investment) emphasize the need to carefully calibrate priorities going forward, to minimize the impact on competitiveness and growth, while preserving efficient capital investment and protecting the most vulnerable.

40. The accommodative monetary policy stance is appropriate. The recent policy rate cut is consistent with the objective of maintaining a stable REER. In lowering interest rates however, the BoB’s continued attention to the vulnerabilities in households’ balance sheets will be critical. In the event downside risks materialize, the monetary policy stance could be loosened further if greater exchange rate flexibility is allowed within the existing framework.

41. Achieving a sustained acceleration in growth and job creation will require a fundamental change in the growth model. Within a more constrained fiscal environment, the growth model will need to move from a mining and government-led model to a private sector and export-driven one. In turn, this entails revamping the macroeconomic policy frameworks to increase the resilience of the economy and its capacity to deal with external shocks and accelerating the implementation of supply-side reforms.

42. The fiscal framework should be strengthened. Fiscal reforms include i) defining a medium-term anchor and modifying the fiscal rule (by setting a long-run target for returns on assets and imposing a floor on assets, and defining an operational target such as a ceiling on recurrent expenditure growth) to allow Botswana to achieve its intergenerational equity objective and shelter the economy from the commodity cycle and revenue volatility; ii) greater revenue mobilization through broadening the tax base and advancing tax reform; iii) public financial management reforms to enhance the efficiency of spending; iv) reforming parastatals and other extra-budgetary entities including by enforcing compliance to best governance practices and strengthening their monitoring and accountability, and v) revamping the debt management framework.

43. Greater flexibility within the current exchange rate regime will help the economy adjust to the persistent decline in mineral and trade resources and foster structural transformation. Moreover, recent reforms to strengthen the monetary transmission mechanism and deepen the domestic financial market should continue, including by further developing the secondary market for government securities, leveraging Fintech, facilitating the attachment of collateral, and improving credit information.

44. Supply-side policies should focus on further improving the business environment, redesigning industrial policies with a view to fostering competition and competitiveness, and reducing the government footprint in the economy. Furthermore, transitioning to a knowledge-based economy and high-income status will require prioritizing investment in human capital, upgrading digital skills and deepening information and communications technology penetration, as well as promoting integration in regional and global value chains. Strategic deficiencies in the AML/CFT framework should also be addressed.

45. Staff recommends that the next Article IV consultation with Botswana be held on the standard 12-month cycle.

Climate Change in Botswana

In recent years, more prevalent droughts have challenged economic development. Botswana declared 2018/19 a “severe drought year”. The unevenly distributed rains, heat waves, and dry spells have led to lower hectarage planted, crop failure, and falling livestock population. The limited water availability has impacted mining activity and exacerbated tensions between human and wildlife.

Rainfall and Livestock Population

(Thousands for liverstock and millimiters for rainfall)

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Source: Statistics Botswana.Note: Livestock statistics in 2001, 2014 and 2017 include traditional sector only.

Proj. Average Temperature Change by 2100, RCP 4.5

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Source: The World Bank Climate Change Knowledge Portal.

Long-term projections suggest that Botswana will be one of the most exposed sub-Saharan countries to climate change. Botswana ranks in the top-3 countries in sub-Saharan Africa in terms of expected average temperature increase, ranging over 2.9–3.8 degrees Celsius by 2100. In three out of the four IPCC emissions scenarios (RCP 4.5, 6.0 and 8.5), Botswana also ranks in the top 2 countries in sub-Saharan Africa in terms of expected average decrease in annual rainfall (4.7–9.5 millimeters). The extreme climate is expected to reduce domestic water available, with Botswana’s Limpopo catchment expected to decline by 26 percent (36 percent) and cause maize yield to decline by over 20 percent (35 percent) by 2100, under stringent GHG emission mitigation scenarios of global warming contained to 1.5 degrees (2.0 degrees) Celsius, according to analysis from the Adaptation at Scale in Semi-Arid Regions (ASSAR) project. While deeply affected by the extreme weather, Botswana produces only 1 percent of the region’s emissions that account for 2 percent of global total.

The authorities are adapting to climate change. Botswana has developed an automatic mechanism to support the agriculture sector which delivers subsidized animal feeds, vaccines, and drugs. Additional measures and initiatives by the government include a Climate Change Policy, Climate Change Strategy and Action Plan, Climate Smart Agriculture (CSA) program, and Global Environmental Facility (GEF). Going forward, advancing economic diversification, making infrastructure more resilient to climate shocks, increasing access to financing and cost-effective insurance, and enhancing social safety nets and policy buffers will help reduce Botswana’s vulnerability to climate shocks.

Botswana: Average Annual Precipitation Projections

(Percent deviation)

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Source: The World Bank Climate Change Knowledge Portal.

Monetary Policy and Monetary Transmission in Botswana

Botswana’s monetary policy is currently implemented in the context of a crawling peg. The rate of the crawl is determined based on estimated inflation differentials. Given the lack of substitutability of domestic and foreign assets, the BoB has room to target domestic objectives through short-term interest rates.

The policy rate pass-through to lending rates is high. Using an auto-regressive distributed lag model, a 1 percent increase in the policy rate increases lending rates by 0.87 percent in the long term. The lending rates are also found to be significantly driven by asset quality; a 1 percent increase in the NPL ratio increases lending rates by 0.39 percent. The speed of adjustment to equilibrium is relatively fast (2 quarters). In the absence of a developed yield curve, the high pass-through to lending is most likely due to the direct signaling effect of the prime rate which serves as a reference for loan pricing.1 The pass-through to deposit rates is lower (within 0.6–0.7 percent depending on the category of deposits), which is most likely hindered by the excess liquidity that prevailed in the system and the increased concentration of funding on wholesale deposits, which also depend on foreign yields.

Response of the Credit Gap to one S.D of the Real Lending rate

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Sources: Staff estimations

An increase in real lending rates reduces credit to the private sector. Based on a VAR model including real lending rates, credit gap and the NPL ratio, the impulse response function shows that higher lending rates adversely affect asset quality and reduce credit to the economy. It takes 3 quarters for the effects to materialize and they become significant in the second year. The effects also vary across borrowers; they are more immediate and stronger for the corporate sector than for households. This may suggest that banks prefer to continue lending to households either because they perceive them as less risky or because lending rates are higher for households.

Response to one S.D of the Real Lending rate

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Sources: Staff estimations

Efforts to strengthen liquidity management and deepen financial markets could strengthen further monetary transmission. In particular, it is important to further develop the interbank market, enhancing liquidity forecasts for a better liquidity management, increasing bonds issuance especially for medium-term maturities and simplifying the interest rate structure in line with past technical recommendations could enhance price discovery and the signaling effect of monetary policy.

1 In Practice, banks are free to determine the rate they propose to customers, as long as the rate is interpreted as spread to the prime rate.

Illustrative Effects of Delayed Fiscal Adjustment to a Persistent Terms of Trade Shock

The box illustrates the effects of expansionary fiscal policy and maintaining a stable real exchange rate in the face of a persistent negative terms of trade shock. This has been accompanied by a substantial reduction in buffers and, more recently, a moderately overvalued exchange rate. To assess the dynamic effects on income distribution and the macroeconomy of these policies, a multi-sector general equilibrium, heterogenous agent model, calibrated to Botswana, was deployed (technical details are in Appendix II). The experiment consists of simulating the effects of a permanent decline in government diamond proceeds of 4 percent of GDP and analyzing the medium-term impact under different fiscal policies:

  • Scenario 1. Tax rates and government expenditure policies remain at the pre-shock levels.

  • Scenario 2. The government increases non-tradable spending while maintaining tax rates. The added expenditure is financed through a reduction in buffers.

  • Scenario 3. The government expands both non-tradable spending and the wage bill (employment and wages) and finances it through buffers.

A sustained fiscal expansion in response to the permanent shock to diamond revenue could delay structural transformation and lower potential GDP.

  • Sustained increases in public spending on non tradables and the wage bill cause the real exchange rate to appreciate relative to the case without intervention. Since productivity growth potential of manufacturing is larger than that of services, the shift towards more services driven by the real appreciation, results in a misallocation of resources and lower growth potential.

  • Increasing the wage bill (scenario 3) significantly amplifies the misallocation effect (by crowding out private employment, especially for the skilled labor force). The share of manufacturing in GDP falls by almost 10 percent, while the share of services increases by 11 percent. The drop in GDP is 4 times larger than in the case without intervention (compared to 1.5 times in scenario 2).

Medium-term Sectoral Effect of Lower Diamond Prices

(Share of GDP)

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Source: IMF staff calculation.

The fiscal intervention (expansion) marginally reduces inequality but reduces aggregate welfare. Since the profitability of capital falls following the diamond shock, and relatively higher income individuals rely more heavily on capital as a source of income, the incomes of the upper ends of the distribution fall more than others, thereby reducing inequality. The expansion of the public sector wage bill and the higher wages in the non-tradable sector (labor intensive sector) lower the income of capital even further. Relative to the case without intervention, inequality falls by about 1 point (remaining close to the case prior to the shock). A better alternative would be to intervene only through targeted cash transfers (scenario 1 with cash transfers).

Medium-term Macro Effect of Lower Diamond Prices

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Source: IMF staff calculation.

Transitioning to a Knowledge-Based Economy

The transformation rests on three integral pillars are entailed to achieve the transformation: knowledge production, knowledge dissemination, and knowledge capitalization.

Tertiary Enrollment

(Distance from UMI median, percent of standard deviation)

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Sources: World Bank World Development Indicators and IMF staff calculations.

Knowledge production. The knowledge-based economy is defined as production and services based on knowledge intensive activities1. Higher education is essential to produce the knowledge base. Tertiary education in Botswana has experienced a significant improvement, from 8.2 percent in 2006/07 to 18.2 percent in 2017/182. Nonetheless, the progress does not keep up with the rapid development in upper middle-income countries. Compared to 2008, the distance of Botswana’s tertiary enrollment from upper middle-income countries has widened, leaving Botswana less competitive in creating the knowledge base necessary for the transformation.

Knowledge dissemination. Botswana also needs higher-quality digital infrastructure to facilitate the information transmission. The country has so far achieved a broad internet coverage with affordable prices. About 50 percent of the population are internet users, and 80 percent of the population are covered by at least a 3G mobile network3. However, the quality of internet may not be able to support the high data volume in a knowledge-based economy. The internet speed in Botswana has stagnated for almost a decade, which becomes a bottleneck for a widespread digital adoption, particularly in the business sector that demands high digital capacity.

Digital Adoption Index

(Distance of score from UMI median, percent of standard deviation)

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Sources: World Bank and IMF staff calculations.

Business Environment

(Scores, higher is better)

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Sources: World Bank Doing Business 2020 and IMF staff calculations.

Knowledge capitalization. Promoting a knowledge-based economy requires investment in education, financing, and strategic planning, with engagement of the private sector.

1 Powell, W. W., & Snellman, K. (2004). The knowledge economy. Annual Review of Sociology, Vol 30:1, p. 199–220. 2 Statistics Botswana: Tertiary Education Statistics 2018. 3 International Telecom munition Union 2018.

Accelerating Convergence: Lessons from Selected Countries’ Experiences

Export diversification and sophistication are key to accelerate convergence. A plethora of studies (Chang, 2007a, 2007b; Hausmann et al, 2007 and more recently Cherif et al., 2018) found that countries get richer by producing a more diverse range of technologically dynamic and sophisticated goods and services, commonly described as “productive” economic transformation.

Countries followed different approaches to export diversification. Commodity exporters have in general focused on vertical diversification (both upstream and downstream) in relation to their comparative advantage (e.g. the salmon industry in Chile), and in some cases, diversified horizontally (e.g. electronics in Malaysia). Other countries concentrated their efforts on quality upgrade, relying on FDI-driven models to fast track the development of capabilities through transfer of skills and technology (e.g. Costa Rica in semiconductors and medical devices). Finally, greater integration in regional and global value chains played a big role for many countries (e.g. European countries).

In addition to horizontal policies, many countries often used targeted industrial policies to support economic diversification, though with mixed success. While acknowledging the difficulty to draw conclusions from successes and failures (because of selection bias), Rodrick (2004), and Cherif and Hasanov (2019) tried to set principles for a “good/true” industrial policy. In particular, they emphasized the need to:

  • Start by fixing government failures and macroeconomic policies (especially exchange rate overvaluation) that hamper export competitiveness;

  • Focus on export orientation rather than import substitution and avoid raising barriers to competition;

  • Enforce accountability by setting clear performance criteria, sunset clauses, clearly defining responsibilities, and regularly monitoring and accepting failures (accepting the cost of closing firms if they fail).

Well-designed, high-skilled and sufficiently empowered dedicated public institutions could be a useful tool to overcome coordination failures. Spar (1998) shows the critical role that CINDE, the export and investment promotion agency played in the negotiation with INTEL by improving the reactivity of the government to the investor’s needs. Similarly, Fundación Chile and the Rubber Malaysian Board played a key role in R&D support and technology diffusion, quality control services, and export promotion assistance (Lebdioui, 2019).

Annex I. Track Record of Economic Policies and Reforms

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Annex II. External Stability Assessment

Botswana’s external position is moderately weaker than implied by medium-term fundamentals and desired policies in 2019. Implementing the planned fiscal consolidation, advancing structural reforms to strengthen competitiveness and promote diversification, and allowing the real exchange rate basket to reflect changes in fundamentals will help close the current account gap.

Introduction

1. Botswana’s current account balance has deteriorated since 2014. After reaching a sizeable surplus of 10.7 percent of GDP in 2014, the current account narrowed to 2.1 percent of GDP in 2018 amid lower demand for diamonds and fiscal expansion. Movements in the current account balance have historically reflected primarily changes in public savings-investment gaps. The current account balance is expected to deteriorate further in 2019 to -4.3 percent of GDP, driven in part by one-off factors, before improving to about 1 percent of GDP over the medium term as diamond production recovers and fiscal consolidation advances.

Savings and Investment

(Percent of GDP)

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Sources: BoB and IMF staff estimates.

2. The financial account has been volatile, mostly owing to swings in portfolio investment, while foreign direct investment (FDI) remained mostly stable and positive amid steady investments in the mining sector (which on average account for about 80 percent of FDI inflows). Gross external financing requirements have gradually decreased over the past five years to about 2.9 percent of GDP. Net foreign assets (NFA) have nevertheless continuously deteriorated, and stood at 32.9 percent of GDP, about half their 2009 level, reflecting the drawdown of buffers to finance the fiscal expansion. NFA are expected to recover over the medium term as the current account surplus improves and foreign investment in the diamond sector continues.

Figure A2.1.
Figure A2.1.

Botswana: Key External Sector Indicators

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Sources: Bank of Botswana, Bloomberg, and IMF staff estimates.

3. Botswana’s real effective exchange rate (REER) has remained broadly stable despite substantial variations in diamond prices. The relative stability of the REER can be attributed to the relatively low capital mobility combined with the BoB’s policy of adjusting the nominal value of the pula in line with expected inflation differentials with major trading partners and basket weights (the basket comprises the SDR and the South African rand, with a 45 percent weigh for the latter).

Real Effective Exchange Rate

(Index. 201S December=10Q)

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Sources: Bank of Botswana and staff estimates.

Gross Reserves

(Percent of GDP)

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

4. Botswana’s international reserves are expected to decline further in 2019, with improvements foreseen only over the medium term. Reserves reached US$6.6 billion by the end of 2018 (US$0.9 billion lower than the previous year), equivalent to 37 percent of GDP or 11 months of imports the following years.1,2 The worsening of the current account expected for 2019 will also result in a further reduction to 35 percent of GDP in reserves, with the losses partially contained by stock market buoyancy and the corresponding high returns on reserves investments. Under the baseline projections, the import coverage is expected to increase in the medium to long term, as diamond production increases and the government improves its fiscal balances.

Current Account and Exchange Rate Assessment

5. The assessment of Botswana’s external position employs the External Balance Assessment (EBA)-lite models for the CA and REER.3 The former approach assesses the current account relative to the position required to generate enough future returns for intergenerational equity purposes. The latter estimations assume that both the CA and REER are endogenous variables simultaneously determined as a function of domestic and external variables including fundamentals, policy variables, and cyclical conditions (these methodologies assess the CA and REER in a multilateral-consistent manner, as each country’s variables are measured relative to a weighted-average of other countries’ values).4 Improvements in BOP data have enhanced the reliability of EBA-lite methods as the size of errors and omissions has been reduced by about one half. 5

6. The EBA-lite suggests a moderate overvaluation of the Pula (see table below). The CA-EBA lite approach estimates the CA gap to be equivalent to -2.4 percent of GDP, with a CA norm of -0.3 percent of GDP in 2019.6 Since the estimated elasticity of the trade balance to changes in the REER is -0.25, this methodology suggests that the REER would need to depreciate by 9 percent for the CA surplus to be reduced to the fitted value of the regression (see table below). From the perspective of the EBA-lite REER approach, the REER would need to depreciate by almost 20 percent to reach the fitted value of the regression.7 Staff gives more weight to the CA-EBA lite approach as the one-offs driving some of the imbalances in 2019 can be more directly assessed than in the REER approach (which explains the larger overvaluation suggested by the latter approach).

Results from CA-EBA-Lite Estimation

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Sources: Bank of Botswana and staff estimates

Reserve Adequacy

7. The IMF methodology to estimate reserves adequacy provides a rigorous way to assess the appropriate level of reserves. Traditional metrics of adequacy—such as months of imports, cover of short-term debt plus debt service, or percent of broad money—though attractive for their simplicity, are rather arbitrary as they only focus on one aspect of vulnerability and may provide conflicting signals. Since a balance of payments crisis can arise from various sources, the IMF’s metric for market access countries employs a risk-weighted measure of diverse sources of risk (see table below).8

8. The IMF’s metric encompasses four specific vulnerabilities: (i) export earnings to capture potential losses from terms of trade shocks; (ii) short term debt at remaining maturity (short term debt plus debt service) to reflect rollover risk; (iii) portfolio investments plus medium and long-term debt to account for drains from non-residents’ investment; and (iv) broad money as a proxy for residents’ capital flight. The weights for the risks in the metric are computed as the financial outflows at the tenth percentile of the estimated annual distributions of percentage changes of each of the items discussed above during periods of exchange market pressures.9 Separate distributions are estimated for countries with fixed exchange rates or capital controls.10 The weights for countries with a fixed exchange rate (assumed for Botswana) are:11

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9. Botswana has a comfortable reserve position. According to the IMF’s metric, reserves of 14 to 16 percent of GDP, amounting to 100–150 percent of the ARA metric, would be adequate, compared to the estimated level for 2019 of 35 percent of GDP. However, this assessment doesn’t fully consider Botswana’s high dependence on commodity exports. Indeed, using a weight of 25 percent for exports (instead of 10 percent) to reflect the country’s dependence on volatile diamond receipts, the adequacy range would increase to 18–25 percent of GDP. Moreover, for the past twenty years the level of reserves has far exceeded the upper bound of the adequacy range.

Composition Metric

(Percent of GDP)

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Sources: BoB and IMF staff estimates.

10. Foreign reserves are under the control of the Bank of Botswana ―with about two-thirds kept in a sovereign wealth fund (the Pula Fund) and one-third in a “liquidity” portfolio (used as a short-term liquidity buffer).12 Within the Pula Fund, one-third is owned by the BoB and two-thirds by the government (kept separately in a “government investment account” held at the BoB in domestic currency).

References

  • International Monetary Fund. 2013. “The External Balance Approach.” IMF policy paper.

  • International Monetary Fund. 2011. “Assessing Reserve Adequacy.” IMF policy paper.

  • International Monetary Fund. 2013. “Assessing Reserve Adequacy-Further Considerations.” IMF policy paper.

  • International Monetary Fund. 2014. “Assessing Reserve Adequacy-Specific Proposals.” IMF policy paper.

  • International Monetary Fund. 2019. “The revised EBA-Lite Methodology.” IMF policy paper.

Annex III. Risk Assessment Matrix1

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The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. “Short term (ST)” and “medium term (MT)” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.

Annex IV. Debt Sustainability Analysis

Botswana’s public debt ratio remains low and is projected to decline over the medium-term as fiscal consolidation advances and output recovers. The large deficit in FY2019 will increase financing needs but is expected to be financed mostly through a drawdown of buffers and exceptional capital gains from the central bank, limiting the effect on public debt. Based on standard stress tests, the country’s level of risk of debt distress remains low.

Public Debt Sustainability

1. Public debt remains low despite high deficits in the past few years. Preliminary estimates indicate that following a slight increase in debt in FY2018, Botswana’s gross public debt (including domestic and external guarantees) is likely to stabilize in FY2019 at around 19 percent of GDP, despite a large deficit expected at 5.8 percent of GDP (Table A4.1).1 In recent years, the widening of the deficit had little impact on public debt it was mainly financed through a drawdown of buffers (as well as exceptional gains from the BoB in FY 2019). As a result, the Pula Fund assets have narrowed to 25 percent of GDP in 2018, down from 31 percent of GDP in 2017. The composition of public debt remained unchanged and dominated by external debt, mostly multilateral. Vulnerabilities associated to the high share of external debt (about two-third of total debt) are mitigated by the fact that most of the external borrowing is multilateral with long maturities and that 60 percent of fiscal revenue are in foreign currency, offering a natural hedge against currency depreciation.

2. The medium-term baseline macroeconomic scenario envisages a gradual fiscal consolidation starting in 2020/21, consistent with the authorities track record of fiscal discipline. Given available fiscal space and to smooth the impact on growth, we expect the primary deficit to decline gradually to -0.5 percent of GDP in FY2024. The deficit is assumed to continue to be financed mostly by withdrawal of deposits and medium and long-term domestic debt, in line with the authorities’ past debt management strategy. As a result, public debt and gross financing needs are projected to follow a downward path, reaching 14.6 percent of GDP and 2.8 percent of GDP respectively in FY2024. Should the deficit be financed entirely through debt (including FY2019), the debt level would reach about 23 percent of GDP in FY2024, well below the 40 percent of GDP statutory limit.

3. Figure A4.1 shows three alternative scenarios which yield sustainable debt levels:

  • Historical values. The first scenario shows the behavior of public debt if the main macro variables are assumed to remain at their historical 10-year averages. Dynamic simulations show that under such a scenario the debt-to-GDP ratio would remain broadly in line with staff’s baseline scenario with public debt reaching 16.6 percent of GDP over the medium term.

  • Constant primary balance. The second scenario assumes no change in fiscal policy stance, holding the primary fiscal balance constant at its FY2018 level. In such a scenario, gross financing needs would exceed 9 percent of GDP and public debt would follow a rapid upward trend, reaching 33.8 percent of GDP in FY2024—a level still low compared with other countries at similar levels of development or with crisis levels. Thus, while on both the debt levels and gross financing needs, Botswana would continue to be classified as a lower scrutiny country, proceeding with fiscal consolidation is required for fiscal sustainability and intergenerational equity.

  • Contingent liabilities shock. Finally, the third scenario envisages that a large share of contingent liabilities related to SOEs’ debt are called. In particular, the scenario assumes that SOEs would default on 50 percent of their total debt with banks (or about 2.2 percent of GDP) in FY2018. The scenario also assumes a one standard-deviation shock to growth, with associated deterioration of the primary balance (as in the standard contingent liability shock scenario in the MAC DSA template), and a slight increase in interest rates. The simulations indicate that under such a scenario the debt-to-GDP ratio would rise to about 19.3 percent of GDP in FY2021 and decline thereafter. Gross financing needs would reach 7.1 percent of GDP in FY2020 but will be manageable given the large buffers.

External Debt Sustainability

4. Botswana’s external debt is low. It has hovered around 4 billion dollars (25 percent of GDP) during the last decade; it decreased as a ratio to GDP in recent years, driven in part by lower public sector debt (Table A4.2). During 2013–2018, the stock of public external debt decreased from 18 to 12 percent of GDP. Private sector external debt accounted for about one-third of total external debt in 2013 and increased its share reaching 50 percent of GDP in 2018. Private sector external debt is mostly loans between fellow enterprises. More than 80 percent of total external debt has long and medium-term maturities.

5. Botswana’s external debt is projected to gradually decrease over time. The external debt-to-GDP ratio is foreseen to start decreasing after 2020, driven by continued decreases in pubic external debt, and stable private debt to GDP ratios. Gross external financing needs (GEFN) are projected to remain below 8 percent of GDP.

6. Sensitivity tests suggest the external debt is vulnerable to current account shocks, but would remain below 38 percent of GDP under standard shock scenarios. If the non-interest current account deficit widened by a (½ standard deviation shock) during 2019–23, the external debt would increase to about 38 percent of GDP by 2024. The impact of real interest rate shocks is small due to the sizeable share of fixed-rate debt. The impact of exchange rate depreciation on external debt is manageable with a 30 percent exchange rate depreciation increasing external debt to about 31 percent of GDP.

Table A4.1.

Botswana: Public Sector Debt Sustainability Analysis (DSA) – Baseline Scenario

(In percent of GDP, unless otherwise indicated)

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Source: IMF staff.

Public sector is defined as general government.

Based on available data.

Long-term bond spread over U.S. bonds.

Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.

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

The real interest rate contribution is derived from the numerator in footnote 5 as r – π (1 +g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 5 as ae(1 +r).

Includes asset changes and interest revenues (if any). For projections, includes exchange rate changes during the projection period.

Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Figure A4.1.
Figure A4.1.

Botswana: Public DSA – Composition of Public Debt and Alternative Scenarios

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Source: International Monetary Fund, country desk data, and staff estimates.
Table A4.2.

Botswana: External Debt Sustainability Framework, 2014–2024

(In percent of GDP, unless otherwise indicated)

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Derived as [r – g – r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation, and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock.

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Source: International Monetary Fund, country desk data, and staff estimates.
Figure A4.2.
Figure A4.2.

Botswana: External Debt Sustainability: Bound Tests 1/ 2/

Citation: IMF Staff Country Reports 2020, 078; 10.5089/9781513537375.002.A001

Sources: International Monetary Fund, Country desk data, and staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.4/ One-time real depreciation of 30 percent occurs in 2019.

Annex V. Summary of Capacity Development Strategy (FY2020–22)

Background

1. In recent years, Botswana has maintained relatively robust economic growth, thanks to prudent macroeconomic policies, strong institutions, and good governance. However, given the volatility and exhaustibility of diamond proceeds (in addition to volatile SACU revenues), and the government’s objective to transition to a high-income country by 2036, there is a pressing need to enhance resilience and raise growth potential. Doing so will require diversifying fiscal revenues, increasing spending efficiency, revamping the macroeconomic policy frameworks, fostering economic diversification, and promoting private sector activity, including through further financial deepening.

Capacity Development Assessment

2. Cooperation between the Fund and Botswana on technical assistance (TA) and training has been strong, spanning a wide range of areas.These include monetary policy and operations, financial supervision and regulation, central bank operations, public financial management, domestic revenue mobilization, expenditure management, debt management, legal frameworks (financial and fiscal law reform), AML/CFT financial sector supervision, and macroeconomic statistics. The authorities attach significant value to Fund TA, have showed ownership of the reform process in many areas, and have followed up on TA recommendations, albeit with delays. Implementation of recommendations has in general improved, especially on financial sector, liquidity management and BOP statistics. Progress in the areas of taxation, public financial management, and national accounts and fiscal statistics has been more mixed, with a slow pace owing to limited resources (staffing shortages and limited absorption capacity), and insufficient coordination among key agencies.

Capacity Development Priorities

3. The TA priorities listed below are consistent with the country’s macroeconomic priorities. The Fund has already delivered some assistance on the items below and further assistance is expected to be forthcoming. The authorities have made additional TA requests in FY2019 in the areas of tax administration, international taxation, PFM, and financial law (AML/CFT, drafting/updating the Bank of Botswana Act, Banking Act, national payments law, currency legislation, and deposit protection scheme). The Article IV discussions identified other areas where TA is needed, in particular the design and calibration of a new fiscal rule as well as the reassessment of the monetary policy and exchange rate policy frameworks. At the same time, there is a need for strong involvement and prioritization of human and financial resources by the authorities in the areas of TA provisioning.

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Appendix I. Revamping Botswana’s Fiscal Rule Framework-Methodology

Background

1. Botswana’s current fiscal rule framework consists of a gross debt ceiling of 40 percent of GDP (with equal 20–20 shares on external and domestic debt). In recent years, in particular since the global financial crisis, Botswana has seen a structural decline in fiscal (mineral and SACU) revenues, deteriorating fiscal balances (due, in part, also to a growing expenditure bill), and a resulting sharp decline in reserve buffers, while public debt has remained stable. Moreover, volatile revenues associated with commodity cycles and SACU proceeds, pose additional challenges for fiscal policy. Together, these challenges call for revamping Botswana’s fiscal rule framework.

2. A well-designed fiscal rule should enable Botswana to sustain buffers for intergenerational equity purposes and smooth commodity cycles. NDP 11 proposes a new operational fiscal rule whereby the recurrent budget is to be financed from non-mineral revenues, while mineral revenues shall be used in-part to finance investment in physical and human capital (60 percent) and the remaining 40 percent saved for future generations. Primary concerns with this rule are that it prescribes procyclical investment expenditure and an ad-hoc allocation between savings and investment with levels that seem difficult to achieve given the data.

Designing a Fiscal Rule for Botswana

3. Fiscal rule frameworks generally comprise an anchor (long-term target) and medium-term operational rule consistent with this anchor. One standard framework for commodity exporters is the permanent income hypothesis (PIH) model, which sets an anchor on net wealth, defined as net financial assets plus resource wealth, and sets an operational rule for the non-resource primary balance (NRPB). The framework allows to compute the NRPB target consistent with intergenerational equity, i.e. that which would stabilize net wealth at its current level. However, caveats to the PIH framework include, among others, its reliance on accurate estimates of long-term commodity prices, its compatibility with very low net financial assets (high net debt) which can carry risks, and its exclusion of both physical assets from the definition of net wealth and feedback effects of public investment on growth.

4. An alternative fiscal rule framework comprises an anchor on net debt, or a ceiling on gross debt combined with a floor on financial assets, with a target path for the (structural) overall or primary balance as an operational rule. This type of rule would require Botswana to establish an explicit anchor for financial assets and a target annuity for intergenerational equity objectives, in addition to its current ceiling on gross debt. The anchors should be calibrated so that assets are in line with the ARA metrics and include buffers needed for smoothing cyclical fluctuations.

5. The returns required for intergenerational equity can be achieved through alternative government policy choices on paths for investment and savings. Model simulations illustrate three policy paths for attaining the same annuity in 2050 by: (i) direct accumulation of financial assets (denoted ‘baseline’ scenario), (ii) lower accumulation of financial assets coupled with higher investments in infrastructure (denoted ‘infrastructure’ scenario), and (iii) even lower accumulation of financial assets coupled with investments in infrastructure, accompanied by structural reforms that raise TFP growth (denoted ‘infrastructure and TFP’ scenario). These scenarios, as well as other key modeling assumptions, are outlined below.

Framework of Analysis and Main Assumptions

6. Standard methods for the estimation and design of fiscal rules are employed and customized to incorporate important Botswana-specific issues. In particular, a large fraction of revenue comes from SACU proceeds, which are highly volatile. In addition, given that debt has been low and is expected to remain low, the emphasis for designing the fiscal framework is less on attaining debt sustainability, and more on preserving and building buffers. The framework for analysis adds such features to the analysis in IMF (2018). Since we consider long-term horizons for intergenerational equity, most variables will be assumed to grow in tandem with GDP (akin to a balanced growth path that prevails while mineral resources are available). The full dynamic general equilibrium effects of shocks and changes in policy are abstracted away, but may be useful for the eventual calibration of the fiscal framework in Botswana.

7. Government fiscal balance. In the framework of analysis employed, the government saves in financial assets (A), invests in physical capital1 (Ktg), has recurrent expenses (proportional to non-mining GDP with a time varying ratio µt), services debt (Dt), and obtains revenue from SACU proceeds and taxes on mining production (GDPtm) and non-mining production (GDPtnm). The overall deficit (d) at every period t is defined as:

d t = − S A C U t − τ t n m G D P t n m − τ t m G D P t m + I t g + μ t G D P t n m + ( r t g + Δ ) D t

where τtnmandτtm denote the average rate of taxation respectively on the non-mining and mining sectors, rtg and Δ respectively denote the average interest and amortization rates on government debt, and stAandItg respectively denote savings in financial assets and investment in physical capital. Public asset stocks, which can take the form of financial assets or physical infrastructure, evolve with the following laws of motion:

A t + 1 = A t ( 1 + r t A ) − d t A K t + 1 g = K t g ( 1 − δ g ) + ζ t I t g

where rtA and δA respectively denote the nominal return on assets and depreciation rate of physical infrastructure and ζt denotes the efficiency of investment spending.2 The law of motion for external financial assets focuses on the role of the government as driver of national savings (and thus current account and ultimately external financial assets).3 The second equation is a standard capital accumulation equation applied to infrastructure. In the baseline scenario, government capital (infrastructure) is assumed to be kept constant as a share of GDP, thereby growing at a pace given by nominal GDP plus the depreciation rate; the alternative scenarios relax this assumption. As will be detailed later on, infrastructure affects GDP through a production function setting.

8. Government debt. It is assumed that gross debt is kept constant as a share of GDP, which is a conservative assumption for Botswana (debt peaked around 2011 below 30 percent of GDP and has been on a declining path, and below 20 percent of GDP, since 2017). The government can, however, use its external assets to finance fiscal deficits (as has been the recent practice) or accumulate reserves with a nominal return of 9 percent, calibrated to match the average returns on assets over recent years4. During an initial five-year adjustment period, a gradual fiscal consolidation path is assumed with the overall balance converging to zero by 2024. Thereafter, given the anchor for assets and implied required savings in financial assets each period, and under the assumption of constant debt, the overall deficit is determined for each period (causing implied recurrent expenditures – the residual in the equation for overall balance – to adjust as a share of GDP via µt, namely any adjustment is assumed to take place on recurrent spending).

9. Mineral production and prices. Resource exhaustion is assumed after a 30-year horizon. Mining production is assumed to be constant in real terms for its lifespan, after which production halts. Commodity prices are also assumed to remain constant in real terms over this period. These assumptions are in line with current projections for diamond production and prices. Absent shocks, mining GDP would be driven by:

Y t m , p o t = Y 1 m η t − 1

where Ytm denotes the initial value of mining GDP and η is the constant balanced growth rate of the economy (assumed at a nominal rate of 7 percent).

10. Non-mining potential GDP. Total potential GDP is given by the sum of potential mining and non-mining sector components, where the latter is given by the following production function exhibiting constant returns to scale:

Y t n m , p o t = z t ( K t g ) γ K t α H t 1 − α − γ

where zt denotes total factor productivity for non-mining production, K and Ht denote the physical capital stock (excluding public infrastructure) and human capital stock (assumed to follow a law of motion with depreciation), and coefficients α and γ are assumed to take values between 0 and 1. As such, the model allows public investment in physical capital to have positive spillover effects on TFP. In line with standard assumptions in the literature: α and γ measure 0.3 and 0.1, respectively.

11. Mining output and SACU revenue shocks, and their direct effects on GDP. To simulate the fiscal rule performance in the face of adverse commodity cycles and other sources of revenue, shocks to mining output and SACU proceeds are included in the model and jointly estimated using annual data for the period 1994–2018. An AR(1) process is assumed for the cyclical components of these variables (obtained using an HP filter with smoothing parameter 6.25), with mean-zero multivariate normal error term allowing for the shocks to be correlated, and estimated values are obtained for the persistence coefficients and variance-covariance matrix. These estimated processes are then simulated using 10,000 runs to produce shock series. Recent and reliable input-output matrices are not available for Botswana, but we assume that a one percent shock to mining production translates into a 0.04 percent shock to non-mining output, to capture the linkages between these sectors. This response would be in line with the average response of the last 5 years.

12. Alternative scenarios. An ‘infrastructure’ scenario assumes lower savings in financial assets, and that all of the lower savings are channeled to public investment in infrastructure. A scenario with the same investment in infrastructure but where structural reforms are implemented is also considered. Structural reforms are assumed to take time to start having effects (concretely, we assume that their effects start at year 6 and last for the next 8 years and reforms are assumed to increase non-mining TFP by 0.08 percent per year over an 8 year period, broadly in line with panel estimates of the effects of structural reforms on productivity for Botswana reported in the Staff Report).

Implications for Fiscal Balances and GDP

13. Achieving the target annuity in thirty years’ time requires realizing fiscal surpluses, after a five-year adjustment period, in each of these scenarios. The baseline, which assumes the capital stock ratio to GDP is kept constant over time, and high savings in assets, requires a target overall surplus of 0.8 percent of GDP. Higher investments in physical capital infrastructure is costly due to capital depreciation, despite delivering some positive spillover effects on TFP and hence fiscal revenues, requiring higher fiscal surpluses. If higher investments in physical capital are accompanied by structural reforms that substantially raise TFP, the fiscal surpluses required can be much smaller.

14. These alternative paths for reaching intergenerational equity generate different paths for real GDP. First, we allow changes in the overall balance (fiscal impulse) to have effects on non-mining GDP. The assumption is that for each 1 percent of consolidation (expansion) non-mining GDP contracts (expands) by 0.4 percent. Second, high savings in financial assets come with an opportunity cost of investing the value of these assets in productive capital which can generate higher growth, especially if accompanied by structural reforms that increase productivity in the economy.

Impact of Shock Realizations

15. Stochastic simulations, focused exclusively on shocks to mining and SACU revenues, show that necessary long-run asset accumulation and medium-term buffers remain within desired targets with at least 75 percent probability. Botswana has large financial assets and should be able to afford smoothing out large shocks. First, we considered the impact of a permanent shock to mining revenues (for a shock equivalent in the highest 80 percentile of the distribution). We then estimated the necessary resources so that adjustment in spending necessary after such a shock is not done immediately, but smoothly over 3–5 years, and found required buffers to be in the range of 2–3 percent of GDP. Second, we generated standard stochastic simulations (shocks exclusively based on mining and SCAU proceeds). According to these simulations, the probability that asset accumulation falls short of the target required for intergenerational equity, under the baseline, is less than 25 percent. The baseline also attains the ARA metric including cyclical buffers with at least 75 percent probability. Strategies that result in lower financial asset accumulation, including paths with higher investment in infrastructure, would leave the economy more exposed. This highlights the importance of debt management optimization strategies that take into account the cost of borrowing (as shocks could be smoothed out by borrowing) against returns on assets in financing fiscal deficits, as well as the relative risks associated with the respective financing strategies.

16. The above are conservative bounds as they are built assuming the nominal ceiling for recurrent expenditure of 7 percent binds (after the transition period). VAR estimations for Botswana, following the methodology of Frankel et al. (2013), show that fiscal policy has been neutral with respect to the business cycle over the recent decade. While this is better than most emerging and developing countries, for which fiscal policy has predominantly been procyclical – thereby exacerbating the underlying business cycle –, some countercyclical policy may be desirable, and the present framework would allow for some flexibility.

References

  • Frankel, Jeffrey A. & Vegh, Carlos A. & Vuletin, Guillermo, 2013. “On graduation from fiscal procyclicality,” Journal of Development Economics, Elsevier, Vol. 100(1), pages 32–47.

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  • International Monetary Fund, 2018, “How to calibrate fiscal rules: A primer,” How to Notes Series, Fiscal Affairs Department, Washington D.C.

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Appendix II. Details of a General Equilibrium Model for Botswana

1. The model is a dynamic general equilibrium model of a small open economy with multiple sectors. There are heterogeneous households, both within and across sectors. Urban and rural households differ with respect to their occupations as well as to their access to financial intermediaries. Within-sector heterogeneity is due to household specific shocks to productivity.

Economic Sectors

2. There are four types of occupations in the economy, three urban and one rural:

  • Agricultural workers (rural);

  • Entrepreneurs (urban);

  • Public sector workers (urban); and

  • Private sector workers (urban).

Households are confined to their sectors and cannot easily switch occupations.

Production

3. Small plot owners use their own labor to produce agricultural goods while large holders can employ others. Agricultural workers differ in their land holdings (some are small farmers and others own large plots) and employ land, labor and fertilizer to produce.

4. Public sector workers work for the government which does not produce marketable goods, while private sector workers provide their labor to the entrepreneurs. Private and public sector workers can also devote some of their time to household enterprises.

5. Entrepreneurs produce tradables and non-tradables using capital, labor and energy. Tradable goods can then either used for consumption or investment. Their price is determined in international markets (small open economy assumption). Non-tradables are produced only for the domestic market. Capital depreciates over time, so that new investments are necessary to maintain the capital stock.

6. Entrepreneurs also produce diamonds using a capital-intensive technology. Diamonds are a tradable good, and their prices are determined in international markets (Botswana influences the price of diamonds but from the perspective of the model what matters is that the price is exogenous so whatever influence Botswana has can be incorporated by moving the price as necessary).

Production Structure

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Preferences and Household Decisions

7. Households live forever and are forward looking. In every period, they decide how much of their disposable income to consume and how much to save or borrow, facing credit constraints. Households face uncertainty regarding their future income and are risk averse: they want to avoid large fluctuations of their consumption over time. Having access to a financial intermediary allows them to accumulate a buffer of financial wealth as insurance against future drops in income. Households facing more severe shocks can borrow to smooth consumption if they have access to finance.

8. Households also decide how to allocate their consumption expenditure over two food items (domestic agricultural goods and imported food) and the non-food goods (tradables and non-tradables).

9. Workers choose how much of their time to devote to the formal labor market and how much to work in the informal sector (defined as the output of household enterprises/production, not subject to income taxes) based on the income per hour that can be obtained in each sector.

Financial Intermediation and Financial Sector Policies

10. Financial intermediaries have two distinct roles in the economy:

  • They convert manufacturing and services goods into capital.

  • They allow households to save and borrow.

Fiscal Policy Parameters

11. The government in the model has access to a rich set of mineral and non-mineral taxes and transfers to pay the public sector workers, to finance subsidies, and to provide insurance to vulnerable households. These policies are captured by a set of exogenous policy parameters:

  • A tax on entrepreneurs’ capital income;

  • A tax on private and public sector workers’ wage earnings;

  • Royalties on diamond production; and

  • Sector specific and means-tested transfers and subsidies.

Idiosyncratic Shocks

12. Individual level productivity is subject to random changes over time, but these changes in productivity are different across households. At each point in time, some households are lucky while others are unlucky. There is no aggregate uncertainty and, given the large number of households, a law of large numbers applies, so that the distribution of shocks across households within each sector remains constant. That is, the number of unlucky households is always the same.

Equilibrium and Steady State

13. At each point in time, prices, wages, and interest rates are set to ensure that the markets for credit, labor and the goods produced only for domestic consumption clear. Moreover, given these prices (both in the present and future) and government policies, all household decisions are made to maximize the present value of lifetime utility. The prices of diamonds, and manufacturing goods are exogenously given.

14. The economy is in a steady state. Aggregate variables and prices are constant over time, as is the distribution of wealth, income, and consumption across households. The income, wealth, and consumption of individual households however changes over time with the realization of their idiosyncratic shocks.
1

Botswana is one of the most unequal countries in the world. The Gini coefficient has increased from 0.495 in 2009/10 to 0.522 in 2015/16.

2

Exceptional capital gains by the BoB were made from a reallocation of the Pula Fund assets (which included investments in the stock market) to the liquidity portfolio (which involved transforming shares into liquid assets and realizing capital gains in the process).

3

Past episodes of turbulence in the diamond market were in general short-lived.

4

The public wage bill and the minimum wages have increased by about 17 percent.

5

SACU transfers for FY2020 are based on this year’s announced amounts in South Africa’s budget.

6

See section on the fiscal framework for more details.

7

These revenue measures could bring about 3 percent of GDP while expenditure measures (excluding wage policy) could lead to additional savings of 1.2 percent of GDP.

8

This is possible because the exchange rate pass-through to inflation is incomplete (estimated to 0.46 percent).

9

Foreign exchange reserves in excess of the amount required for daily foreign transactions kept in the Liquidity Portfolio (currently set at nine months of imports) are transferred to the BoB’s portion of the Pula Fund. If the Liquidity Portfolio declines below three months of imports, it receives a transfer from the Pula Fund.

10

The parastatals’ debt-to-GDP ratio stood at 4.5 percent of GDP at end-March 2019, half of which is held by Botswana Power Corporation.

11

For example, removing the VAT exemptions fuel, sugar and private education and health services would increase VAT receipts by 0.3 percent of GDP (see 2018 Article IV).

12

See 2018 Article IV for a detailed discussion of fiscal incidence and inequality.

13

The authorities are planning to introduce e-visa services next year.

14

In a recent Public Expenditure Review of basic education, the World Bank and the United Nations recommend to “shift the emphasis from providing more teachers to improving provision of much needed school infrastructure and ensuring availability of teaching and learning materials in the classrooms”.

15

Options for advancing the diversification agenda were discussed at a conference during February 6–7 co-hosted by the Bank of Botswana, the Fund, and key development partners, drawing on the experience of countries who had successfully transformed their economies.

16

The authorities are developing customized risk-based models and tools for AML/CFT supervision with the support of the IMF. A first pilot exercise was conducted by BoB and NBFIRA to test the implementation of the tools.

1

The authorities concurred with the assessment that reserves exceeded their adequate level.

2

The authorities preferred measure of reserve coverage takes the ratio to current year imports of goods and services excluding diamond imports for re-exporting purposes.

3

EBA-lite is an extension of EBA methodologies, uses annual data for 190 countries for the 1995–2016 period and incorporates fundamentals for low and middle-income countries. See further details of the EBA methodology in IMF (2019).

4

Since the CA and ER are measured relative to other countries, they not only reflect a country’s own characteristics but also external conditions within a simultaneously determined general equilibrium system. This also implicitly recognizes that developments in a small economy would mostly influence its own CA and REER, unlike those in a large country.

5

A recent technical assistance mission from the IMF’s Statistics Department focused on enhancing BOP data compilation including: (i) the under coverage of dividends paid to foreign investors, profits deposited in intercompany accounts by companies in the diamond industry, and dividends received by the government from its share investment abroad; (ii) the omission of imports and exports of services by companies in the diamond industry; and (iii) the overstatement of exports of travel and construction services for other private entities.

6

Staff made a conservative adjustment to the Cyclically adjusted CA Norm of +1.2 percent, given that diamond exports fell unexpectedly by more than 6 percent of GDP in 2019, while they are expected in 2020 and forward to be only 2 percent of GDP lower than in 2018.

7

About 90 percent of Botswana’s exports correspond to diamond sold at international prices. Although the exchange rate could affect the level of non-diamond imports, it has no bearing on Botswana’s output or sales of diamonds which are demand determined and sensitive to economic developments in the US and China. Thus, the large current account surplus is more a structural characteristic of the economy and is weakly dependent on the exchange rate. Moreover, the non-diamond current account deficit would be about 10 percent of GDP, suggesting that the Pula could be overvalued.

8

See further details in IMF (2011, 2013 and 2014). A separate methodology is used for non-market access countries but is not relevant for Botswana which is an upper middle-income country with little external debt and an investment grade rating.

9

As in Eichengreen et. al. (1997), an exchange market pressure (EMP) index is constructed as the weighted average of reserve losses, exchange rate depreciation, and increases in interest rates. An episode of EMP occurs when the index deviates more than 1.5 times standard deviations from its average.

10

Additional buffers are suggested for countries with commodity exports that exceed 50 percent of total exports. Botswana’s commodity exports account for 80 percent of exports of goods and services (90 percent of goods exports). However, the IMF’s methodology for commodity exporters relies on futures’ prices which are unavailable for diamonds. Nonetheless, considering the decrease in diamond exports and the market weakness and depressed diamond price, staff considers that a weight of 25 percent for exports could be appropriately used to reflect volatility in diamond prices.

11

Botswana’s pula is pegged to a basket of currencies that comprises the South Africa’s rand and the SDR (with a 45 percent weight for the former). While not exactly a fixed exchange rate regime, its operational details are closer to it than to a flexible exchange rate regime. Using the weights for flexible exchange rates would, by design, yield a lower level of adequate reserves compared to the weights for fixed exchange regimes.

12

The liquidity portfolio covers six months of non-diamond imports. It’s most recent level is by itself adequate according to the IMF’s metric.

1

Public debt is defined as central government debt only. Botswana doesn’t produce consolidated debt data for the overall public sector (including local governments, extra-budgetary funds, and parastatals).

1

An extended version of the model can also consider government investment in human capital.

2

In the simulations, it is assumed that ζt is constant and unitary implying that investment is perfectly efficient. Lower values of ζt would result in lower capital accumulation, higher required overall surpluses, and lower GDP.

3

Movements in private absorption that are not proportional to GDP are thus abstracted away, as they could be only properly captured in a full dynamic general equilibrium setting, which is outside of the objectives of this preliminary analysis of the effects of fiscal rules in Botswana.

4

The investment strategy of reserves recently changed to include assets other than foreign risk free government bonds; it is managed by external asset managers and 9 percent was the most recent data; sensitivity of the analysis to this rate of return was performed.

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Cover IMF Staff Country Reports
Botswana: 2019 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Botswana
Author:
International Monetary Fund. African Dept.
Volume/Issue:
Volume 2020: Issue 078
Publisher:
International Monetary Fund
ISBN:
9781513537375
ISSN:
1934-7685
Pages:
78
DOI:
https://doi.org/10.5089/9781513537375.002
Figure 1.

Botswana: Improved Living Standards, but High Inequality and Persistent Unemployment

A Persistent Decline in Revenue

(Percent of GDP)

Fiscal and External Buffers

(Percent of GDP)
Figure 2.

Botswana: Macroeconomic Developments

Non-Mining Output-Gap

(Percent of potential GDP)
Figure 3.

Botswana: Macro-financial Linkages

Growth-at-Risk: Projected GDP Growth Distribution, Bostwana, 2020
Figure 4.

Botswana: Fiscal Rules for Intergenerational Equity and Smoothing Fluctuations

Growth Effects of Structural Reforms Through TFP

Rainfall and Livestock Population

(Thousands for liverstock and millimiters for rainfall)

Proj. Average Temperature Change by 2100, RCP 4.5

Botswana: Average Annual Precipitation Projections

(Percent deviation)

Response of the Credit Gap to one S.D of the Real Lending rate

Response to one S.D of the Real Lending rate

Medium-term Sectoral Effect of Lower Diamond Prices

(Share of GDP)

Medium-term Macro Effect of Lower Diamond Prices

Tertiary Enrollment

(Distance from UMI median, percent of standard deviation)

Digital Adoption Index

(Distance of score from UMI median, percent of standard deviation)

Business Environment

(Scores, higher is better)

Savings and Investment

(Percent of GDP)
Figure A2.1.

Botswana: Key External Sector Indicators

Real Effective Exchange Rate

(Index. 201S December=10Q)

Gross Reserves

(Percent of GDP)

Composition Metric

(Percent of GDP)
Figure A4.1.

Botswana: Public DSA – Composition of Public Debt and Alternative Scenarios
Figure A4.2.

Botswana: External Debt Sustainability: Bound Tests 1/ 2/