Botswana: 2021 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Botswana

1. Botswana’s economy was already facing significant structural challenges and declining buffers when the COVID-19 pandemic struck. Thanks to large natural endowments and a track record of very strong policies and policy frameworks, the country has made impressive strides in economic and social development through the 2000s. Over the last four decades, extreme poverty rate has declined by about 40 percentage points to 16 percent; per capita income has quadrupled; and secondary school enrollment has increased from 20 per cent to above 80 percent. That said, persistently lower-than-anticipated diamond revenue (including through declining prices over 2016–20) and SACU transfers in recent years have exposed the country’s external and fiscal position to external shocks. Limited fiscal and exchange rate adjustment and hiccups in implementation o f structural reforms contributed to eroding reserves by about US$½ billion per year on average since 2014, reduced competitiveness and stymied the much-needed transformation of the economy toward an export- and private-sector led growth model as envisaged in the authorities’ National Development Plan 11 (NDP11) and Vision 2036. With growth decelerating, job creation remained anemic relative to the large number of young and more educated entrants into the labor force. In addition, climate change shocks have increased in recent years with severe droughts, affecting primarily the rural population and countering the government efforts to reduce poverty and inequality.

Abstract

1. Botswana’s economy was already facing significant structural challenges and declining buffers when the COVID-19 pandemic struck. Thanks to large natural endowments and a track record of very strong policies and policy frameworks, the country has made impressive strides in economic and social development through the 2000s. Over the last four decades, extreme poverty rate has declined by about 40 percentage points to 16 percent; per capita income has quadrupled; and secondary school enrollment has increased from 20 per cent to above 80 percent. That said, persistently lower-than-anticipated diamond revenue (including through declining prices over 2016–20) and SACU transfers in recent years have exposed the country’s external and fiscal position to external shocks. Limited fiscal and exchange rate adjustment and hiccups in implementation o f structural reforms contributed to eroding reserves by about US$½ billion per year on average since 2014, reduced competitiveness and stymied the much-needed transformation of the economy toward an export- and private-sector led growth model as envisaged in the authorities’ National Development Plan 11 (NDP11) and Vision 2036. With growth decelerating, job creation remained anemic relative to the large number of young and more educated entrants into the labor force. In addition, climate change shocks have increased in recent years with severe droughts, affecting primarily the rural population and countering the government efforts to reduce poverty and inequality.

Pre-Covid Context

1. Botswana’s economy was already facing significant structural challenges and declining buffers when the COVID-19 pandemic struck. Thanks to large natural endowments and a track record of very strong policies and policy frameworks, the country has made impressive strides in economic and social development through the 2000s. Over the last four decades, extreme poverty rate has declined by about 40 percentage points to 16 percent; per capita income has quadrupled; and secondary school enrollment has increased from 20 per cent to above 80 percent. That said, persistently lower-than-anticipated diamond revenue (including through declining prices over 2016–20) and SACU transfers in recent years have exposed the country’s external and fiscal position to external shocks. Limited fiscal and exchange rate adjustment and hiccups in implementation o f structural reforms contributed to eroding reserves by about US$½ billion per year on average since 2014, reduced competitiveness and stymied the much-needed transformation of the economy toward an export- and private-sector led growth model as envisaged in the authorities’ National Development Plan 11 (NDP11) and Vision 2036. With growth decelerating, job creation remained anemic relative to the large number of young and more educated entrants into the labor force. In addition, climate change shocks have increased in recent years with severe droughts, affecting primarily the rural population and countering the government efforts to reduce poverty and inequality.

Impact of the Pandemic and the Policy Response

2. Stringent containment measures imposed at the onset of the COVID-19 crisis have helped limit the spread of the virus and save lives (Figure 1). Botswana registered its first cases in late March 2020. Early on, the authorities responded by issuing a State of Emergency and imposing a 6-week nationwide lockdown followed by partial lockdowns, travel restrictions, mandatory mask wearing and social distancing measures, including bans on social events. With these measures coupled with targeted testing and contact tracing, Botswana kept the morbidity and mortality rate under control (3,172 cases, about 0.1 percent of the population, and 16 deaths as of end-September 2020).

Figure 1.
Figure 1.

Botswana: The COVID-19 Pandemic

Citation: IMF Staff Country Reports 2021, 098; 10.5089/9781513573045.002.A001

3. However, cases have accelerated since November 2020. Cases have been rising rapidly totaling about 44,000, while deaths exceeded 670 mid-April 2021. The South African variant, reportedly more contagious, has been detected. After deciding a phased lifting of travel restrictions in November to support the recovery of the tourism sector, Botswana government decided to impose a curfew to curb the spread of the virus. At end-March, the parliament app roved the extension of the State of Emergency for another 6 months.

4. The COVID-19 disrupted activity in most sectors in the second quarter of 2020, with the economy recovering somewhat in the second half of the year (Table 1, Figure 2). The stringent restrictions on mobility and huge drop in global demand caused an unprecedented collapse in GDP (-11 percent y-o-y in H1 and -24 percent in Q2). The economic structure of the economy, relying o n diamond, tourism and “contact-intensive” services, has largely contributed to this contraction. Yet, the economy is bottoming out in the second half (-4.1 percent in Q4), led by buoyant domestic consumption, supported by the increase in public wages in September, and the relaxation of mobility restrictions. Diamond sales have also rebounded while tourism activity remained very slow. On annual basis, GDP growth stood at -7.9 percent, making Botswana one of the hardest hit countries in Sub-Saharan Africa.

Figure 2.
Figure 2.

Botswana: Real Sector

Citation: IMF Staff Country Reports 2021, 098; 10.5089/9781513573045.002.A001

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

5. The crisis has worsened social outcomes. The unemployment rate reached 24.5 percent in 2020Q4 from 22.2 percent in 2019Q4 and could increase further once the State of Emergency is lifted. Youth unemployment rate also rose from 28.8 percent to 32.4 percent. The World Bank estimates the extreme poverty rate (US$1.9/day in 2011 Purchasing Power Parity) to have increased to 16 percent in 2020 from 12.6 percent in 2019. Forecasts suggest the poverty rate would remain above the 2019 figure until 2022. Notwithstanding the government’s support, the disproportionate impact on poorer and more vulnerable households could lead to even more inequality.

uA001fig01

Poverty Headcount ratio and Cumulative GDP per Capita

Citation: IMF Staff Country Reports 2021, 098; 10.5089/9781513573045.002.A001

Source: World Bank, PovcalNer

6. Inflation remains well below the Bank of Botswana’s 3 to 6 percent objective. Inflation fell to 1.9 percent in 2020, from 2.8 percent in 2019, as lower import prices, especially oil prices, more than offset higher prices for domestically produced goods and services. The rise in domestic prices reflects the effects of increases in food prices, electricity tariffs and domestic wages.

7. The external position deteriorated further, but foreign reserves remain comfortably above adequacy levels. The CA deficit stood at 10.1 percent of GDP in 2020. Diamonds net exports declined by 40 percent (in US$), while non-diamond imports declined only by 5 percent. Exports of services also declined by 51 percent led by tourism. Despite positive valuation effects, reserves fell by US$1.2 billion to 7.3 months of imports at end-November.1 In response to the COVID-19 shock and given the low domestic inflation, the authorities moved the crawl rate from -1.5 to -2.9 percent in May 2020 and the REER depreciated by 3.5 percent y-o-y in December (Table 2, Figure 3).2

Figure 3.
Figure 3.

Botswana: External Sector

Citation: IMF Staff Country Reports 2021, 098; 10.5089/9781513573045.002.A001

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

8. The government put in place a large fiscal relief package that helped mitigate the economic, social and health effects of the pandemic. The government initially put in place a P4.7 billion (2.6 percent of GDP) economic COVID-relief package to mitigate the impact of the crisis on households and firms and reduce its scarring effects. In addition, P1 billion was provided as supplementary recurrent budget to the Ministry of Health and Wellness for COVID-related spending, and P1.3 billion as loan facility to benefit firms affected by the COVID-19 crisis (Text Table 1). Reflecting these measures, the cyclical drop in revenue, the salary increases for public servants and the GDP contraction, the fiscal deficit is expected to be about 11 percent of GDP in FY2020. The deficit was financed by domestic borrowing, fiscal buffers, and exceptional revenue from the BoB. Public debt is estimated to increase to about 23.5 percent of GDP in FY2020, still below the 40 percent debt ceiling limit, but with a further erosion of fiscal buffers (Table 3a3c, Figure 4).3

Figure 4.
Figure 4.

Botswana: Fiscal Sector

Citation: IMF Staff Country Reports 2021, 098; 10.5089/9781513573045.002.A001

Sources: Bank of Botswana, Haver Analytics, and IMF staff calculations.
uA001fig02

Botswana Buffers

(Billions of Pula)

Citation: IMF Staff Country Reports 2021, 098; 10.5089/9781513573045.002.A001

Text Table 1.

Fiscal Relief Package

(In million pula)

article image
Source: MFED and IMF staff calculations

9. Monetary policy has been eased. Since April 2020, BoB reduced the policy rate (by 100 basis points to 3.75 percent) and the reserve requirement ratio, and expanded the maturity of repo operations to 92 days and the eligible collateral to access its facility. These measures reduced interest payments on existing debt and supported credit growth (+5.3 percent in December). As a result, the share of credit to households in banks’ balance sheets increased (to 65.4 percent in The Government Investment Account balance stood at P5.6 billion in November 2020 down from P15,7 billion a year earlier. November 2020 from 63.7 in December 2019). About 70 percent of this credit is non-collateralized and carries higher interest rates (Table 4, Figure 5).

Figure 5.
Figure 5.

Botswana: Macro-Financial Linkages

Citation: IMF Staff Country Reports 2021, 098; 10.5089/9781513573045.002.A001

Sources: Bank of Botswana, Haver Analytics, and IMF staff calculations.Note: Credit and deposits are defiend within commerical banks.
Figure 6.
Figure 6.

Botswana: Social Protection and Labor Assessment

Citation: IMF Staff Country Reports 2021, 098; 10.5089/9781513573045.002.A001

Sources: IMF FAD Social Protection & Labor – Assessment Tool (SPL-AT).

10. The financial sector has proven resilient this far, but some risks may be looming.

  • Commercial banks remain adequately capitalized and liquid.4 NPLs have declined and provisioning has improved. However, some COVID-19 relief measures, notably the 6-month loan repayment moratorium, loans restructuring, and guaranteed loans to affected sectors, may have delayed the deterioration in asset quality. Thus, banks’ financial stability indicators may not fully reflect the impact of the COVID-19 shock (Table 5).5

  • To mitigate the negative economic effects of COVID-19 on households, while also ensuring sustainability, NBFIs introduced temporary measures, including restructuring and rescheduling of loan installments, life premium and retirement contributions for at least three months; discount on insurance products; reduction of interest rates on non-bank lending; and provision of quick turnaround time for processing insurance and medical aid claims. Such measures may have negatively impacted profitability of the sector in the short term. Yet, given their strong balance sheets at the onset of the crisis, NBFIs’ solvency risks remain low.

Outlook and Risks

11. Botswana plans to vaccinate 75 percent of the adult population by end-2021. The country has made an upfront payment to COVAX, the World Health Organization’s (WHO) vaccine arrangement, to acquire 940,800 vaccines under a two-dose regime, enough to cover about 20 percent of the population. In parallel, the authorities have reached agreements with vaccine manufacturers to acquire 1.9 million doses, enough to cover the entire adult population. The vaccination initiative is expected to cost a minimum of 1/3 percent of GDP.

12. Economic growth is projected to rebound in 2021, but the output losses from the crisis are expected to persist. Following an estimated contraction of 7.9 percent in 2020, real GDP is expected to grow by 8.3 percent in 2021. The recovery assumes a normalization of diamond production to pre-crisis levels in line with recent trends, the entry in production of Khoemacau copper mine, some containment measures but no nationwide lockdowns in response to the second measure accounted for 11.4 percent of the aggregate commercial banks’ loans and advances, which translates into P7.3 billion (74 percent of which was business loans), as at the end of June 2020. Business loans given moratoria were mainly concentrated on those extended to commercial real estate (33 percent), “restaurants and bars” (16 percent) and “Tourism and Hotels” (13 percent), industries. At the same time, banks restructured loans amounting to P5.8 billion (9.1 percent of total credit extended by commercial banks), with private businesses accounting for the largest share (73 percent). wave, and international tourism resuming in the second half of 2021 as vaccination ramps up. The effect of the projected fiscal consolidation is expected to be moderate in 2021, as consumption will continue to benefit from the lagged effect of the civil servants’ salary increase while investment will be supported by the shift in the composition of public spending from non-priority spending to capital spending (with higher fiscal multiplier). The recovery is expected to continue through the medium term, though at a slower pace as the government’s fiscal consolidation plan is implemented. Thus, output will remain below its pre-pandemic forecasted levels through the projection period.

uA001fig03

Scarring effect of the COVID on real GDP

(Billions of Pula, constant 2006)

Citation: IMF Staff Country Reports 2021, 098; 10.5089/9781513573045.002.A001

13. Inflationary pressures are expected to rise temporarily in 2021. Staff forecasts inflation to pick up to 4.8 percent on average in 2021 (from 1.9 percent in 2020), still within the central bank objective of 3–6 percent. This reflects the rebound in oil prices, the planned increase in the VAT rate, fuel levy, electricity tariffs, sugar tax, rentals, and sustained domestic consumption. These pressures are expected to linger through the first half of 2022 and ease thereafter.

14. In the near term, the fiscal and external positions are expected to improve but with limited room to address large future shocks.

  • The current account deficit is expected to narrow to -4.5 percent of GDP and -3.3 percent of GDP in 2021 and 2022, respectively, as the rebound of diamond production and favorable terms of trade are expected to more than offset the projected drop in SACU revenue.6 Reserves are expected to stabilize in 2021 and improve thereafter.

  • Despite the large drop in SACU transfers, the fiscal deficit is expected to narrow as the cyclical downturn in revenue fades; COVID-related spending is gradually phased out; and revenue and expenditure consolidation measures are implemented. Public debt as a share of GDP will continue to increase in the next two years, before declining in the medium term.

15. The outlook is subject to significant uncertainty with risks tilted to the downside (Annex II and Annex V).

  • Near term. The COVID-19 pandemic could last longer than envisaged, which would affect employment, domestic demand, diamond exports, tourism receipts, SACU transfers and government expenditure. Even if the pandemic wanes as expected in the baseline, the uneven nature of the recovery could delay expected improvements in labor markets, people’s livelihoods, and the balance sheets of firms in hospitality-related sectors. At the same time, in an environment of low real interest rates and excess liquidity, increased lending to households could possibly fuel inflation further with attendant effects on poverty, and increase households’ indebtedness. Other risks stem from contingent liabilities (state-owned enterprises (SOEs), guaranteed loans) and a larger-than-expected deterioration in the corporate sector that could increase unemployment once the State of Emergency is lifted, impair banks’ balance sheets, and amplify the scars of the crisis. On the upside, a faster rollout of vaccines worldwide could lead to a resumption of tourism activity, higher SACU revenue in FY2022 and higher demand for diamond exports.

  • Medium term. Weaker-than-expected diamond revenue amid shifts in consumer preferences (see Figure A1.1) and greater competition from synthetic diamonds could weaken current account and fiscal balances, put pressure on external buffers, and increase public debt. On the upside, accelerated implementation of the ERTP could improve potential growth over the medium term.

Authorities’ Views

16. The authorities broadly agree with Staff’s outlook and risks assessment. They are more sanguine on the diamond outlook and are encouraged by the positive outcome of the first three “sights” (global wholesale event) by De Beers this year. They nonetheless acknowledged the high uncertainty and vowed to continue to monitor developments closely. In addition, BoB continues to see elevated financial stability risks if Botswana does not exit the AML/CFT Grey-listing. Finally, the authorities concurred with the staff that implementation of the planned fiscal consolidation and the ERTP are critical to preserve macroeconomic stability and create sustained, high, job-rich, and diversified growth.

Policies to Entrench the Recovery and Facilitate Transformation

Discussions focused on the calibration of macroeconomic policies to navigate the uncertain outlook and sustainably support a more even recovery while facilitating structural transformation.

A. Macroeconomic Policy Mix

Fiscal Policy

17. The authorities’ MTFF aims to support the recovery and lay the foundation for higher growth potential, while ensuring fiscal sustainability. To create space for transformative investment in infrastructure and human capital, the authorities’ budget for FY2021 envisages to enhance revenue mobilization by increasing the VAT rate by 2 percentage points, fuel levy, sugar levy, tax on plastic bags and withholding taxes, estimated to yield about 1 percent of GDP. They also initiated a tax amnesty to increase revenue collection this year by about ½ percent of GDP. On the expenditure side, measures include containment of the wage bill,7 cuts in non-priority spending and “efficiency gains” in grants and subventions and transfers to local government. For the remainder of NDP11, the authorities also envisage to expedite fiscal reforms, including better targeting of social spending, restructuring of parastatals, and strengthening of the public investment management framework.8

18. Staff welcomes the commitment to fiscal sustainability and recommends that the planned adjustment be implemented without further delay. Under the baseline, the envisaged pace and size of consolidation and the shift in spending composition are appropriate to gradually reduce the deficit and rebuild buffers. The plan will help achieve a balanced primary budget by 2026 and keep the debt below 30 percent of GDP. The fiscal consolidation plan will allow for rebuilding asset positions in the Government Investment Account and the Pula Fund, while the re-orientation of expenditures towards investment and human ca pita l development will raise productivity, create jobs, and help diversify the economy and revenue sources. At the same time, the envisaged incentives for training and financial support to transformative sectors will facilitate the reallocation of factors to new sectors. These measures will benefit future generations and insure against volatility.

19. There is a need to maintain targeted support to firms and households still affected by the pandemic and make the support state-contingent or conditional to reduce moral hazard. The extension of the State of Emergency and the industry support facility will help households and firms cope with the crisis through end-2021. This will help address the uneven nature of the recovery across sectors and mitigate the regressive impact of planned increase in the VAT rate and other taxes and fees on the most vulnerable. 9 Additional support would be required if the pandemic is more protracted than expected and the recovery is uneven. Given the uncertainty on the evolution of the health crisis, and that a shortfall in mineral revenue could entail a significant increase in the debt ratio and force a sharp adjustment, staff is of the view that the recommended targeted support would need to be financed through the following additional measures:

  • On the revenue side, measures could include increasing progressive tax measures such as property taxes and reducing VAT exemptions while compensating the most vulnerable. In addition to the planned tax amnesty that could help reduce tax arrears, there is a need to expedite the promulgation of tax bills and continue tax administration reforms, including accelerating e-filing.

  • On the expenditure side, extending the wage freeze to FY2022, means-testing of scholarships to tertiary education, and cost recovery in some public services (e.g. electricity and water tariffs) could provide savings and also lead to a better targeting of social spending.

20. Strengthening the fiscal framework is paramount to better anchor fiscal policy and increase credibility. This requires i) revamping the fiscal rule in line with past Article IV recommendations to benefit future generations while allowing for countercyclical policy,10 ii) implementing medium-term budgeting involving a complete re-orientation of budget engagements to cover the full 3-year time horizon; budget communication must be reformed to align with the objective of multi-year strategic budgeting; establishing differing levels of authority to discuss the budget before it is tabled in Parliament; restructuring the budget on the basis of a unitary definition—fully integrating the recurrent and development budgets; and analyzing fiscal policy and the budget from a risk perspective, including assessing the credibility of the baseline projections and the risks arising from the SOE sector, iii) improving accounting and reporting by accelerating the implementation of the new chart of accounts, migrating to GFSM 2014 and increasing the coverage of fiscal statistics,11 iv) strengthening the fiscal risks management framework given the uncertain outlook and mounting contingent liability risks.

21. A special attention should be given to emerging fiscal risks.

  • The plan to further rely on public-private partnerships (PPPs) to finance infrastructure projects needs to be accompanied by the adoption of appropriate legal and institutional frameworks to limit risks given that these arrangements often entail sizable contingent liabilities. In addition, existing plans to increase capacity at the PPP unit at the MFED would help safeguard public finance from risks arising from PPPs and cope with a growing PPP portfolio.

  • The COVID-19 shock could exacerbate contingent liabilities associated with parastatals (about 5 percent of GDP) and loan guarantees to the private sector (0.5 percent of GDP). Hence, there is a need to expedite the plans to rationalize parastatals, including merging those with overlapping mandates and restructuring/privatizing loss-making SOEs and enhancing their governance. Going forward, there is a need to design effective mechanisms for intragovernmental coordination; define clear ownership and financial oversight functions; compile timely and comprehensive financial data on SOE performance; continue to build capacity to assess SOEs’ performance; and regularly publish their financial statements and evaluation reports in a timely manner.

22. Over the medium term, civil service reform will be key to the success of the fiscal consolidation. The 2019 two-year wage increase agreement with civil service unions exceeded productivity gains and inflation and thus exerted significant strains on the government’s resources. It may have also widened the already significant gap in compensation between the public sector and the private sector. Such practices should be avoided going forward to prevent further pressures on the budget and help strengthen the attractiveness of the private sector as an employer, without which it would be difficult for the government to achieve its structural transformation objective. Staff recommends a careful monitoring of salary increases in the parastatal sector 12 and designing a civil service reform that better aligns public sector wages to productivity over the medium term. This will ensure that the wage bill remains under control as planned.

23. As buffers are eroding, the authorities are diversifying their financing sources in line with past staff advice. They have already stepped up domestic issuance to finance the FY2020 deficit and will continue with this strategy in coming years. They are also negotiating a budget support with the World Bank and the AfDB and are exploring different external financing options, including syndicated loans, to finance the deficit in FY2022–23. A more active debt management strategy is needed. The financing strategy should result from a comparison of returns on assets and the cost of issuing debt, including in domestic and foreign markets.

  • The regular issuance of medium-and long-term maturities in the domestic market should help build the yield curve and support secondary market development. The success of this strategy will hinge on enhancing the efficiency and liquidity of the domestic bond market (see below) and coordination of issuance plans from various public sector entities.

  • When issuing debt in foreign markets, the currency composition of external borrowing should be tailored to the composition of revenue to hedge against exchange rate risk.

Authorities’ Views

24. The authorities reiterated their commitment to fiscal sustainability and broadly agreed with staff’s assessment and advice. While acknowledging uncertainty and risks, they indicated that their objective in the short term is a deficit below 4 percent of GDP. Should downside risks materialize, they envisage to reprioritize spending and increase some fees. They requested a TA that will help them redesign and calibrate a fiscal rule in the context of the National Development Plan 12. To achieve the planned fiscal consolidation, they see scope for higher revenue mobilization through a broadening of the tax base, introduction of new taxes 13 as well as tax administration reforms. In this context, they stressed that pending tax bills are being finalized with assistance from the Fund and will be presented to parliament in the July session, and that the revenue authority intend s to use electronic billing machines to reduce tax evasion. Reforms in the parastatal sector are also one the authorities’ top priorities.

Monetary and Exchange Rate Policy

25. Monetary policy should remain accommodative in the near term. Further reductions in interest rates risk tipping inflation outside the BoB objective range and fueling credit to households with attendant risks to financial stability. At the same time, a rapid increase in the policy rate could compromise the fragile recovery, and exacerbate existing vulnerabilities in households balance sheets. Given the large negative output gap and as long as expected inflation remains within BoB’s objective range, staff is of the view that BoB should keep the monetary policy rate unchanged. That said, Bo B should carefully monitor the second-round effects of supply shocks and administrative price changes on inflation expectations, as well as the development of credit and demand.

26. A more active liquidity management will be essential to smooth interest rate volatility and enhance the monetary policy transmission. The large fiscal deficits may entail significant swings in domestic liquidity, and potentially crowd-out private sector credit. These effects could be larger with a potential removal of Botswana from the AML/CFT Grey-listing, despite its positive effect on integration into the global financial system. Thus, staff recommends setting the reserve requirement as a buffer against the fluctuations of the autonomous factors of liquidity, conducting regular OMO at fixed-rate full-allotment, and complementing these actions with fine-tuning operations to smooth volatility. Staff welcomes the BoB’s plan to replace the Bank rate with the BoB certificate rate as the main monetary policy instrument to enhance policy transmission. Staff recommends pursuing the development of the unsecured interbank and REPO markets to strengthened monetary policy transmission.

27. Despite some real depreciation in 2020, the external position remains moderately weaker than suggested by fundamentals and desirable policies. The exchange rate is assessed to be moderately overvalued (8½ percent). Under staff’s baseline, the current account balance is expected to improve but remain weaker than the norm in the near term. This would exert further pressures on international reserves. Over the medium term, the anticipated fiscal consolidation together with the recovery in external demand will contribute to narrowing the gap and gradual reserves accumulation. However, this scenario hinges on favorable diamonds projections that reflect the strength of activity in the United States, India, and China.

28. The flexibility within the current exchange rate regime should continue to be used. This would allow to gradually reduce real overvaluation, help the economy adjust to shocks, and facilitate structural transformation, while avoiding de-anchoring inflation expectations. The pass-through of nominal effective exchange rates to inflation is estimated to be lower than 0.4 for the first two quarters, and below 0.5 over a year. The expected pick-up in inflation in 2021–22 hence limits the extent to which a real depreciation could be achieved through changes in the crawl rate in the near term while maintaining inflation within the 3–6 percent objective range and inflation expectations anchored. However, as inflation pressures abate and with progress on fiscal consolidation, there will be a need for a steeper crawl to help address the residual overvaluation harmful to Botswana’s structural transformation.

Authorities’ Views

29. The authorities broadly agree with staff’s recommendations. On monetary policy, BoB indicated it will monitor closely inflation expectations and strengthen its communication to keep them well anchored. The authorities also appreciated the timeliness of the upcoming TA mission on monetary policy implementation and operations that will help with the possible transition to the BoBC rate as the monetary policy rate. On exchange rates, the authorities agreed with staff assessment but noted the important role that the objective of a stable REER has played in anchoring investors’ expectations. They expressed concerns on the impact of greater exchange rate flexibility could have on capital flows and financial deepening, while stressing the importance of structural reforms and fiscal adjustment in maintaining external stability, enhancing competitiveness, and promoting economic transformation.

Policies to Safeguard Financial Stability

30. Major government interventions have mitigated immediate macro-financial risks, but they remain a concern. An uneven recovery could increase corporate vulnerabilities, while the expiration of the debt moratorium could be followed by higher NPLs. These risks could add to structural vulnerabilities in the banking system: households indebtedness–in particular the large share of unsecured loans– could further increase in a context of low interest margins; and concentration on wholesale funding exposes banks to liquidity risks, increases their funding costs and reduces their profitability. At the same time, further reliance on domestic borrowing to finance the fiscal deficit will increase the sovereign-financial nexus. Thus, staff recommends to:

  • Continue targeted support to viable firms through liquidity provision and loan restructuring. The measures should be time-bound and designed with sufficient skin in the game (e.g. loans as opposed to guarantees). Relatedly, staff welcomes the recently revised insolvency framework which should facilitate voluntary credit workouts in commercial courts and thus the reallocation of resources toward more productive sectors.

  • Maintain the r educed CAR at 12.5 percent and reassess this decision on a regular basis based on a close monitoring of risks to financial stability and evolution of credit. Tighter macroprudential policies should be put in place in the event of excessive credit growth, especially toward households. These could include measures, such as lower debt-to-income and debt-service-to-income ratios or put limits on unsecured loans. Such measures would also encourage a reallocation of credits toward more productive sectors.

  • Closely monitor risks, including through enhanced reporting, regular stress-testing and financial oversight. Also, any forbearance in recording NPLs should be avoided, as such practice weakens the quality of supervision.

  • Strengthen crisis preparedness and bank resolution framework by expediting the preparation of the banking act and operationalizing the deposit insurance mechanism.

Authorities’ Views

31. The authorities have more nuanced view on the risks related to households’ indebtedness. They noted that the ratio of credit to households to GDP remains low and that the credit gap does not show signs of overheating. While acknowledging the large share of non-collateralized loans, they highlighted that a large share of credit to households goes to public sector employees, who are less vulnerable to loss of income, in the form of direct payroll deduction lending schemes.

B. Structural Policies

32. The parliament has approved an Economic Recovery and Transformation Plan (ERTP) in October 2020. The ERTP aims at reducing the potential economic scars from the COVID-19 crisis, accelerating structural transformation, and increasing job creation and inclusiveness (citizen empowerment). To achieve this objective, the authorities will continue to focus on traditional sectors (e.g. cattle, tourism, mining), import substitution (local content requirement, protection), and different programs support to MSMEs. At the same time, they plan to i) boost investment in digitalization (including e-government), human capital development and R&D, ii) reduce the government footprint, iii) enhance the business environment, and iv) strengthen accountability and governance to improve implementation. Successfully implementing this strategy requires a continuous appraisal of existing sectoral programs, assessment and adaptation to changes in markets and risks and opportunities (learning externalities, environmental risks), focusing o n promising sectors, tackling market and government failures, and addressing key bottlenecks in a cost-efficient manner.

33. Diversification policies should be designed in an incentive-compatible manner. This should be done with a view to enhancing competitiveness, creating jobs, especially for the youth, and fostering productivity gains, including through innovation and technology upgrade. In particular:

  • Reduce reliance on import substitution and protectionist policies, especially if these are not time bound and deter competition.

  • Enhance competitiveness. Government support should be conditional on productivity gains and performance, help promote technological and quality upgrade (e.g. through certification), and foster innovation. These efforts should be complemented with a reduction of network costs through greater competition, leveling the playing field between public and private companies, enhancing the efficiency of SOEs, and spatial planning/geographic clustering to minimize costs. More targeted higher education and vocational training and promoting internships and exchanges of skills would help reduce skills mismatches.

  • Reduce information frictions and facilitate access to market through platforms, language services, visas, open skies agreements, trade fairs, buyer-seller matching, country image, collective reputation, and relationship-building.

  • Promote regional integration and regional value chains, which could be reciprocal reduction of non-tariff barriers, coordination of industrial policies and promotion of cross-border investment.

  • Attract FDI and knowledge transfer (including both more advanced technology and management know-how).

  • Strengthen and clarify mandates of export and investment promotion agencies.

35. Botswana is expected to accelerate its transition to the digital economy. It plans to invest 1½ percent of GDP (about 22 percent of total development expenditure) in this sector during 2021–23. As showcased during the COVID-19 shock in several countries, digital technologies could enhance Botswana’s resilience and efficiency, expand access to global markets, improve public service delivery, boost transparency and accountability, improve learning, and foster the creation of new jobs. The latter will be particularly important in the context of regional trade integration, as the AfCFTA framework will likely increase the scope for increased trade in services and e-commerce. Staff also welcomes the authorities’ efforts to reduce the digital divide (Annex VI).

36. The parliament approved Botswana climate change policy in April 2021. This includes promoting renewable energy sources (by implementing the Integrated Resource Plan), reducing subsidies to the use of fossil fuels, and increasing fossil fuel fees. Full implementation of the climate agenda in the ERTP will reduce Botswana’s dependence on carbon-intensive energy sources, enhance its energy generation capacity, promote exports and private sector activity, enhance its climate resilience, and support its transition to higher income status. Transition to a greener economy will also support the livelihoods of the poor who typically rely on subsistence agriculture, and the tour ism and mining sectors.

37. The authorities are implementing a multipronged strategy for financial development and inclusiveness, consistent with past staff recommendations. Despite large domestic savings, Botswana’ credit to the private sector remains low compared to other countries at similar levels of development. Domestic credit is concentrated on households and non-tradable sectors. To increase resource mobilization and efficiently allocate them, the authorities’ strategy aims at deepening financial markets, revising the regulatory framework and strengthening supervision, and upgrading the infrastructure, while leveraging technology (FINTECH) to increase efficiency and inclusiveness. In this context, in addition to reforms to the National Payment System, the authorities are finalizing several bills related to the credit information and collateral framework. That said, the following additional measures are needed:

  • Clarify the role of development banks. In particular, there is a need to separate their social role from their development mandate, and enhance their supervision, governance, and accountability.

  • Deepen the domestic bond market. This will require a coordinated approach from public and private issuers, including the following:

    • Issuance of a longer benchmark maturity for government debt securities, eligibility of government securities as high-quality liquid assets, a formal market making agreement for primary dealers, a pricing mechanism as well as variety of instruments that maximize market demand.

    • On the back on the new benchmark tenor, the private sector and various public sector entities should be encouraged to issue longer maturity securities to reduce maturity mismatches. There would be ground, in particular for banks, to replace volatile time deposit for issuances of longer-term bank bonds.

Other Surveillance Issues

38. Data provision is broadly adequate for surveillance (Informational Annex). The authorities have continued to improve statistics, with adequate support from AFRITAC South and IMF. Staff urges the authorities to move to GFSM 2014 and improve the classification of current and capital expenditures and accelerate the collection of financial accounts of extra-budgetary entities, including SOEs.

39. Staff welcomes the recent steps toward compliance with the International Cooperation Review Group recommendations and encourage the authorities to address remaining strategic deficiencies in its AML/CFT framework. Botswana has made good progress in the area of AML/CFT supervision. Yet, efforts should remain in order to further strengthen the overall AML/CFT regime and mitigate any possible risks of pressures on correspondent banking relationships as a result of the grey listing process. In particular, the authorities are encouraged to take additional steps with respect to the analysis and dissemination of financial intelligence, terrorist financing investigations, and implementation of effective targeted financial sanctions regime.

40. Staff welcomes the enactment of the COVID-19 Relief Fund Order, which would improve transparency and governance of the fund. The Order provides an institutional mechanism for the management and auditing of the COVID-19 Relief Fund. However, publication of the COVID-related procurements and contracts are lagging behind. Staff welcomes the authorities’ plans to publish the execution report as well the publication of all COVID-related procurement contracts, including beneficial owner information.

Staff Appraisal

41. The authorities’ decisive response to the pandemic has helped mitigate its social and economic impact. The authorities’ relief package provided timely support to households and businesses, reducing the fallout from the pandemic. The implementation of the relief package through a dedicated Pandemic Relief Fund to enhance transparency and tracking of spending is commendable. In addition, successful implementation of the ERTP will help reduce the potential economic scars from the COVID-19 crisis.

42. Growth is expected to recover, but uncertainty is high. Careful management of mineral resources and track record of very strong policies and policy frameworks have allowed Botswana to enter the crisis with larger fiscal space than most countries . This ha s helped its economy navigate through the crisis and a relatively strong recovery is underway. But the outlook is subject to significant downside risk and hinges on the evolution of the pandemic, availability and deployment of vaccines, and diamond revenue. At the same time, a steadfast implementation of supply side reforms could promote private sector activity and diversify the sources of growth. In this context, the immediate priority remains securing and ensuring a successful rollout of vaccines to a share of the population large enough to keep the pandemic under control and prevent health systems from being overwhelmed. The next priority is to enhance Botswana’s resilience to shocks and lay the foundation for sustained, high, and job-rich growth.

43. Successful implementation of the planned fiscal consolidation is critical to achieve fiscal sustainability and rebuild an asset base that will benefit future generations and deal with future shocks. Measures planned in the budget are appropriate. That said, until the pandemic is over, it is necessary to maintain targeted support to households and illiquid but solvent firms and make the support state-contingent or conditional to reduce moral hazard. Going forward, fiscal reforms are needed to lock-in consolidation efforts. These include civil service reform that helps align future wage increases with productivity, acceleration of plans to rationalize the parastatal sector and improve its governance, and a strengthening of the fiscal framework, including revamping the fiscal rule to better anchor fiscal policy and increase credibility and enhancing the fiscal risks framework.

44. Monetary policy should remain accommodative in the near term, while carefully monitoring second-round effects of supply shocks on inflation expectations, as well as credit developments. A more active liquidity management and the transition toward the BoBC rate as the policy rate will enhance monetary transmission. Going forward, however, continuing to use the flexibility within the current crawl arrangement would allow to gradually reduce real overvaluation and help the economy adjust to shocks and facilitate structural transformation, while avoiding de-anchoring inflation expectations.

45. The financial sector is sound but the authorities should remain vigilant to possible latent risks and continue reforms to improve financial deepening and inclusiveness. In particular, there is a need to maintain a targeted support to solvent but illiquid firms while reducing moral hazard. It is however imperative to avoid any forbearance in recording NPLs, and to closely monitor risks, including through enhanced reporting, regular stress-testing and financial oversight. The macroprudential policy stance should be tightened in case of excessive credit to households. In addition to ongoing reforms to enhance resource allocation, there is a need to clarify the role of development banks and improve their governance and oversight, and deepen the domestic bond market thr o ugh a coordinated approach from public and private issuers.

46. The approval of the Economic Recovery and Transformation Plan lays the ground for the country to accelerate its structural transformation. The focus on promoting non-mineral exports, manufacturing, and transformative sectors (including digital, green and climate adaptation technologies) should help diversify Botswana’s economy. But to be successful, the strategy needs to rely less on import substitution and protectionist policies, and more on enhancing competitiveness and strengthening institutions and accountability. A swift implementation of the ERTP is imperative to strengthening Botswana’s resilience and ensuring sustained high and job-rich growth.

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

Table 1.

Botswana: Selected Economic Indicators, 2015–26

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Sources: Botswana authorities and IMF staff estimates and projections.

Calendar year, unless otherwise indicated.

The projection is based on current value added and projected growth rates by different types of minerals.

Year beginning April 1.

The non-mineral primary balance is computed as the difference between non-mineral revenue and expenditure (excluding interest receipts and

Includes central government-guaranteed debt.

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

Table 2.

Botswana: Balance of Payments, 2015–26

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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, 2015/16–26/271

(Billions of pula)

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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, 2015/16–2026/271

(Percent of GDP)

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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: 2015/16–2026/271

(Percent of non-mineral GDP)

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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).