Introduction

1. Our Botswana authorities appreciate the constructive engagement with staff during the Article IV consultation. They broadly agree with staff’s assessment of the key policy challenges and priorities.

2. Botswana has enjoyed a prolonged period of robust growth supported by prudent macroeconomic management, strong institutions and good governance practices. In recent years however, the public sector and mineral sector led growth model has faced significant challenges, with a decline in mining proceeds and SACU revenue. Consequently, macroeconomic imbalances have emerged, with persistent fiscal deficits, and declining reserve buffers. At the same time, the economy has struggled to transition beyond the upper middle-income status, and to generate sufficient employment and achieve economic diversification.

3. Recognizing these challenges, the Government which assumed office in November 2019, has prioritized the transformation of the economy into a diversified private sector led and knowledge-based economy focused on employment generation, particularly for the youth. Further, the authorities view economic diversification as an important pillar to support the country’s graduation to the high-income bracket by 2036.

Recent Economic Developments and Outlook

4. After robust growth of 4.5 percent in 2018, economic growth is estimated to have slowed to 3.6 percent in 2019 owing to decreased diamond production alongside weaker performance in related downstream industries; coupled with the effects of a severe drought in 2018 and 2019. This notwithstanding, economic activity is projected to expand by

4.4 percent in 2020 and 5.6 percent in 2021, influenced by the expected recovery in mining production. Risks to the outlook include sluggish external diamond demand, potential adverse impact on global demand from the coronavirus epidemic, and subdued growth in South Africa – a major destination for the country’s non-mineral exports.

5. Headline inflation averaged 2.8 percent in 2019, remaining slightly below the Bank of Botswana’s (BoB) medium term objective range of 3–6 percent. This was largely the result of slower increases in the cost of electricity, transport, insurance and rentals. In 2020, inflation is however expected to edge up to 3.5 percent as administered prices are revised upwards. It is expected to remain within the objective range in the medium term.

6. The current account balance turned from a surplus of 2.1 percent of GDP in 2018 to a deficit of 4.3 percent of GDP in 2019. The deterioration in the current account balance reflects a sharp decline in diamond export proceeds and lower customs union (SACU) receipts. This notwithstanding, reserves, estimated by the authorities at 14 months of import cover in 2019, continue to provide an adequate buffer. Looking ahead, the current account is expected to rebound into surplus by 2023 against the backdrop of fiscal consolidation, the coming on stream of a new copper mine, and an increase in diamond output.

Fiscal Policy

7. Botswana’s fiscal policy is guided by rules that recognize the need for prudence and judicious use of revenue from an exhaustible resource. Accordingly, with lower revenues, the fiscal stance is shifting from an expansionary mode to gradual fiscal consolidation, focused on rationalizing expenditure, enhancing the efficiency of spending, and expanding the tax base. While the fiscal deficit is estimated at 5.8 percent of GDP in 2019 up from 4.6 percent in 2018 amid a decline in mineral revenues, lower SACU transfers, and underperformance in tax collection, a lower deficit is expected in 2020 supported by fiscal adjustment. Reform plans include containing the wage bill, reducing subsidies and restructuring or selling inefficient SOEs. Fiscal consolidation efforts aimed at generating budget surpluses in the medium term will thus be anchored on a combination of expenditure control, efficiency measures, SOE reform and enhanced domestic revenue mobilization efforts.

8. The authorities continue to implement measures that will strengthen tax administration. A comprehensive review of the Value Added Tax (VAT) Act, Income Tax Act, and tax administration measures is currently underway and is expected to enhance revenue collection. This package of bills is expected to be submitted to Parliament for approval by July 2020. While the authorities agree that there is scope to increase VAT rates to align them with the regional average, they have prioritized improving efficiency in tax collection and plan to review the VAT rate at a later date. In the short term, various government fees and charges that have not been adjusted for over a decade will be adjusted upwards as of April 1, 2020 and annually thereafter. In the medium term, the authorities will enhance the capacity of their large taxpayer unit with additional specialist staff, and training. The authorities are also taking steps to improve tax compliance by promoting the use of e-tax filling through public education campaigns. The authorities also note the need for analysis that will clarify the reasons for the decline in tax efficiency rates.

9. The authorities aim to reduce the government footprint in the economy, with a specific emphasis on reforming state-owned enterprises (SOEs) and downsizing the SOE sector. As part of the efficiency drive, the authorities are planning to scrutinize subsidy schemes in order to improve targeting of social benefits to the most vulnerable. In addition, an audit of expenditures on education and health will be conducted, while the appraisal, design and costing of public sector investment projects will be improved, and approved projects reprioritized. To minimize waste, the authorities are piloting a zero-based budget in selected ministries, with the aim of rolling it out to all ministries in the medium term. Similarly, the authorities will seek to improve delivery of public infrastructure through a Public Private Partnership model once the PPP procurement law (which is at its final approval stage) is promulgated, and a new strategy for delivering mega projects is developed.

10. Going forward, the authorities will continue to review the current fiscal framework to address its weaknesses and examine alternatives with a view to strengthening fiscal outcomes. This will include improving operational guidance. They are open to refining their proposals for a new fiscal rule, to address potential weaknesses such as revenue volatility. They have requested technical assistance in this regard.

Monetary, Exchange Rate and Financial Sector Policies

11. The primary objective of the Bank of Botswana’s (BoB) monetary policy is price stability. As a result, the economy has experienced a sustained decline in inflation from over 15 percent in 2008 to around 3 percent. Informed by the medium-term inflation outlook, the BoB continues to pursue an accommodative monetary policy stance to support economic activity. In this vein, on August 29, 2019, the Monetary Policy Committee (MPC) cut the Bank Rate by 25 basis points for the first time since October 2017. The Bank stands ready to adjust its policy stance as needed under a data driven approach.

12. The BoB has taken measures to enhance monetary policy operations and liquidity management in the banking system. On April 30, 2019, the central bank replaced its 14-day Bank of Botswana Certificates (BoBCs) with a 7-day BoBC as the main instrument for liquidity management. The new instrument has enabled shorter and simpler forecasting horizons, improving liquidity management. In addition, BoB implemented reserve averaging to determine the primary reserve requirement and this is expected to further improve liquidity management for commercial banks.

13. The authorities note that the crawling band exchange rate framework has served the country well, contributing to the maintenance of a relatively stable real effective exchange rate and macroeconomic stability. The authorities also note that the current crawling band exchange regime allows for significant flexibility to realign the exchange rate with economic fundamentals as needed. In this regard, the authorities implemented a 1.5 percent downward crawl of the exchange rate in 2020. Going forward, they will continue to use this flexibility to correct any misalignments as they arise.

14. The financial sector remains safe, sound, and profitable although the high household debt and liquidity in the banking system warrants close monitoring. Accordingly, the Monetary Policy Committee is carefully monitoring developments in household debt and is prepared to act as warranted. The Committee believes that financial stability risks from household debt are well contained at this time. With regard to overall financial stability, in 2019 the Financial Stability Council was formed comprising the Central Bank, Non-Bank Financial Institutions Regulatory Authority, Financial Intelligence Agency and the Ministry of Finance & Economic Development. The Council formulated the Macro-Prudential Framework for the Botswana.

15. On financial technologies, banks and non-bank financial institutions in Botswana have embraced automation and Fintech, which is becoming increasingly entrenched in financial sector operations. Accordingly, financial institutions are adopting risk management strategies to address cybercrime and related financial crimes. For its part, BoB is planning work on new laws, regulations, strategies and operations to accommodate changes linked to digitization and financial technologies.

Structural Reforms

16. The authorities are committed to structural reforms to transform the current public sector dominated growth model to a diversified, private sector led, knowledge economy. This strategy will be implemented through strategic interventions supported by investments in critical human and physical capital, as well as the development of a vibrant agricultural sector and export promotion. Plans are underway to provide the necessary support infrastructure in special economic zones covering financial services, base metal beneficiation, mining supplies and logistics, coal beneficiation, horticulture, agro-business, and beef and leather production. There is also a cluster development initiative aimed at improving business productivity, value chains and competitiveness. To facilitate faster and cheaper business registration, an online business registration system was launched in June 2019. Moreover, key legislation has been enacted including the Trade Act and the Industrial Development Act, both of which will support business development.

17. The authorities consider reduction of poverty and inequality, and strengthening of social protection systems, as an integral part of the economic transformation agenda. In this regard, the poverty reduction framework will be enhanced. A draft National Poverty Eradication Policy has been completed, and a National Social Protection Framework will be developed to harmonize the various social protection programs and boost efficiencies. The authorities will also implement labor market reforms and invest in human capital to help ameliorate high youth unemployment. To guide investment in human resources and improve employment prospects of graduates, the authorities will commence the implementation of the National Human Resource Development Plan in 2020. Additionally, an Internship and Apprenticeship Framework and Policy, as well as the Labor Market Information System will be further developed to address labor market information gaps and help bridge the skills mismatch.

18. The authorities plan to improve the operational efficiencies of State-Owned Enterprises (SOEs). Given the strategic role of SOEs in the economy, the authorities plan to re-examine their role, enhance their efficiency, rationalize and align them with the new government service delivery model and the transformation agenda. A special Cabinet subcommittee chaired by the Minister of Finance was established to undertake a comprehensive review of all SOEs and their future role in the new development model. Meanwhile, immediate actions are being considered to restructure and improve the performance of the Botswana Meat Commission and the National Development Bank.

19. Since the October 2018 assessment by the Financial Action Task Force (FATF), the authorities have been taking decisive steps to implement the required recommendations to accelerate the country’s exit from grey listed countries. A follow up assessment in April 2019 found that despite substantial progress in addressing many of the identified deficiencies, further actions were required in some areas. Since then, the national AML/CFT policy and strategy have been adopted and risk assessments on legal persons, legal arrangements and non-profit organizations have been finalized and will soon be shared with banks and other financial institutions. In addition, the BoB and Non-Bank Financial Institutions Regulatory Authority now have risk-based AML/CFT supervisory manuals in place. The authorities are committed to implementing outstanding actions prior to the next review at the end of this year.

Conclusion

20. Recognizing the challenging global and domestic environments, the authorities are making determined efforts to implement far reaching reforms to transform the economy into a diversified, private-sector led, knowledge-based economy. To this end, they intend to undertake gradual fiscal consolidation, address external vulnerabilities, maintain exchange rate flexibility, deepen structural reforms, and intensify diversification efforts. They look forward to continued Fund engagement and technical assistance.