Botswana

The Achievement of SADC Macroeconomic Convergence Targets in Botswana: Performance and Policy Issues
Republic of Botswana

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Abbreviations
AGOA ART BoB CPI CSO EU FIP GDP GoB IMF MFDP MIDP MTR NDP RISDP SACU SADC SOEs TFP VAT Africa Growth and Opportunity Act Anti-Retroviral Therapy Bank of Botswana Consumer Price Index Central Statistics Office European Union Finance and Investment Protocol Gross Domestic Product Government of Botswana International Monetary Fund Ministry of Finance and Development Planning Motor Industry Development Plan Mid-Term Review National Development Plan Regional Indicative Strategic Development Plan Southern African Customs Union Southern African Development Community State-Owned Enterprises Total Factor Productivity Value Added Tax

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INTRODUCTION

This report was commissioned on behalf of the Southern African Development Community (SADC)1 for the purposes of evaluating Botswanas progress in respect of the SADC Macroeconomic Convergence Initiative as specified in the Memorandum of Understanding signed by Member States in August 2002, and as further specified in the draft Finance and Investment Protocol (FIP) and the Regional Indicative Strategic Development Plan (RISDP). The report is based on information gathered in Botswana during October 2005. The targets and the time schedule to achieve them are set out below: Table 1: Macroeconomic Targets

Year Indicators Inflation annual rate Deficit/GDP Debt/GDP Current Account/GDP

2008 <9.5% <5% <60% <9%

2012 <5% <3% <60% <9%

2018 <3% <3% <60% <3%

In addition, the RISDP specifies the following quantitative macroeconomic targets: Table 2: Other Macroeconomic Targets Year Indicators Economic growth External reserves (import cover, months) Central bank credit to govt (% of revenues) Domestic savings (% GDP) Domestic investment (% GDP) 2008 7% 3 10% 25% 30% 2012 7% 6 5% 30% 30% 2018 7% 6 5% 35% 30%

As noted in the Terms of Reference (attached, as Appendix 3), the main purposes of the report are: to evaluate Botswanas recent progress with respect to the Macroeconomic Convergence criteria specified in the MoU and RISDP; to evaluate whether achievement or adherence to the Macroeconomic Convergence targets is likely in the short-tomedium term in view of forecasts of macroeconomic trends;

Funded by the Trade and Economic Development Component implemented by GFA Consulting Group under the GTZ Program to Strengthen the SADC Secretariat. The author of the report was Keith Jefferis (keith@econsult.co.bw).

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to evaluate Botswanas macroeconomic policy framework in terms of present and future effectiveness in achieving the macroeconomic convergence targets; and to propose a macroeconomic policy programme that will facilitate Botswanas achievement of the macroeconomic convergence targets.

The report is structured as follows. Section 2 details recent economic developments in relation to the SADC Macroeconomic Convergence targets, while Section 3 examines likely future developments and macroeconomic challenges, and evaluates current policy initiatives in relation to the Macroeconomic Convergence targets2.

Phase 1 of the project covers Botswana, Lesotho, Mozambique and Zambia. Separate reports are being produced for each country, as well as an overview report with country summaries and general conclusions.

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RECENT ECONOMIC DEVELOPMENTS & ACHIEVEMENT OF SADC MACROECONOMIC CONVERGENCE TARGETS

In this section, recent economic developments are reviewed in relation to the four SADC Macroeconomic Convergence Targets (inflation, budget balance, public debt and the current account of the balance of payments). The review also covers other macroeconomic variables, specifically economic growth, savings and investment, and reserve cover, as these are also highlighted in the RISDP and are important from the perspective of macroeconomic sustainability.

2.1

Economic Growth

Botswana has historically enjoyed consistently high economic growth rates, although growth has been slowing in recent years. Over the past decade (1994/5 2004/5), average GDP growth has been 7% a year, significantly below the 10.3% a year average growth rate over the previous two decades. This has partly resulted from a slowdown in the rate of mining sector growth (from 14.5% a year in 1974/5-94/5 to 9.8% a year from 1994/5 -2004/5). In anticipation of this mining sector slowdown, the policy emphasis has been on economic diversification; initially the expectation was that manufacturing would lead diversification, but more recently expectations have been broadened to encompass all tradeables sectors3. While overall growth in the most recent years (2004/05) was good, at 8.4%, this was led by substantial growth in the mining sector (18.2%), with disappointing growth of non-mining GDP. Figure 1: Economic Growth
16% 14% 12% 10% 8% % 6% 4% 2% Source: CSO 0% -2%
19 94 /9 5 19 95 /9 6 19 96 /9 7 19 97 /9 8 19 98 /9 9 19 99 /0 0 20 00 /0 1 20 01 /0 2 20 02 /0 3 20 03 /0 4 20 04 /0 5

Total GDP

Non-mining private sector value added

The focus on tradeables reflects the fact that in such a small economy, growth has to be export-led.

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Figure 2: Non-mining private sector share of GDP

50% 48% 46% % of GDP 44% 42% 40% 38% Source: Calculations based on CSO data 36%
19 94 /9 5 19 95 /9 6 19 96 /9 7 19 97 /9 8 19 98 /9 9 19 99 /0 0 20 00 /0 1 20 01 /0 2 20 02 /0 3 20 03 /0 4 20 04 /0 5

Efforts to diversify the economy had some success during the 1980s and early 1990s, when the share of GDP attributable to the non-mining private sector grew steadily, but in recent years the economy has become less diversified (see Figure 2). As Figure 3 shows, the non-mining private sector has grown more slowly than GDP as a whole over the past decade, and has not managed to supplant mining as the engine of growth in the economy. Of some concern is the fact that over the past two years, the growth in value added of the non-mining private sector has averaged only 2.2% a year. There are various reasons for the slow growth of the non-mining sectors of the economy. It is possible that HIV/AIDS is having a major impact, perhaps subtracting up to 2-3% from growth rates that would otherwise prevail4. There are also concerns about the slow pace of regulatory reform and general economic liberalisation5 (these issues will be discussed in more detail in Section 3 below). Slower growth is also likely to be a result of declining fixed investment, which has fallen from over 30% of GDP in the early 1990s to less than 25% of GDP more recently. This in turn could be partially a consequence of the gradual rise in real interest rates over the period as monetary policy has focused on bringing inflation down.

4 5

See e.g., IMF (2001) and IMF (2004). See e.g. FIAS (2003), World Bank / BIDPA (2005) and Moodys (2005).

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Figure 3: Sectoral Growth Rates (avg 1994/5 2004/5)

Govt. Water and Elec. Total Trade Hotels & Restr. Fin. & bus. Serv. NMPS Soc. & pers. Serv. Transport Construction Manufacturing Agriculture Source: CSO -1% 1% 3% 5% 7% 9%

NMPS=Non-mining private sector

Avg. grow th rate 1994/5 -2004/5

2.2

Inflation

In common with other members of SACU, the main influence on domestic inflation is South African inflation, given that nearly half of the CPI basket is comprised of imports, and around 80% of imports come from South Africa. Inflation was somewhat high in the early 1990s, but has generally declined since then, assisted by South Africas relatively tight monetary policy and, since 2002, the appreciation of the rand against major international currencies. Over the decade from 1995 to 2005 Botswanas inflation varied between 6% and 12%. In recent years, with the exception of the inflation peaks following the introduction of VAT in 2002 and the 2005 devaluation, inflation has generally met the SADC 2008 single digit target. During 2005, however, inflation rose from 6.2% to 11.4%, and rose further to a peak of 14.2% in April 2006. The recent rise in inflation has been driven by the May 2005 devaluation, higher international oil prices, as well as increases in domestic telecommunications tariffs and the reintroduction of fees in government secondary schools. Nevertheless, the impact of many of these factors on inflation was expected to be short-lived, and by September 2006 inflation had fallen to 10.5% and was expected to be in single digits by the end of the year.

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Figure 4: Inflation

16% 14% 12% 10% 8% 6% 4% 2% Source: CSO 0% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

The most likely reason for the difficulties encountered in bringing Botswanas inflation down to average international or regional levels is productivity differences. Although data on productivity is poor, there is some evidence that Botswana has suffered from negative Total Factor Productivity (TFP) growth in recent years (Leith 2005, pp.109-112). Assuming that other countries have experienced higher, positive productivity growth, the productivity story provides a structural explanation for Botswanas inflation persistence. Bringing inflation down will therefore require concerted initiatives to bring about structural change in the economy through improved productivity growth.

2.3

Budget Deficit

The budget has been one of the strong points of the Botswana economy, with a long term record of budget surpluses during the 1980s and 1990s. Recent experience has been less favourable, however, with deficits in 1998/99, 2001/02, 2002/03 and 2003/04. This has resulted from a combination of a slowdown in revenue growth and continued rapid expenditure growth. Over the past ten years (1995/96 2005/6), total revenues have averaged around 39% of GDP. Expenditures have been on an upward trend, however, rising from around 35% of GDP in the mid1990s to 40% by the early-2000s (see Figure 5). Revenues are dominated by earnings from minerals, accounting for around half of total revenues on average, with revenues from SACU the second largest source, at around 20%. Until recently the third largest source was the governments share of profits from the Bank of Botswana, which in turn were derived from earnings on the foreign exchange reserves, although this has now declined in importance as the reserves have fallen and the cost of implementing monetary policy has increased6. Mineral revenues are high
6

In order to maintain control over short-term interest rates, the Bank of Botswana absorbs excess liquidity from the market through the issue of central bank paper. With rising

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for two reasons; first, the diamond mining industry is exceptionally profitable, and second, the Botswana government has negotiated a highly favourable revenue agreement with de Beers, its partner in the Botswana diamond mines7. Figure 5: Government Revenue & Spending

44% 42% 40% % of GDP 38% 36% 34% 32% Source: MFDP, CSO 30%
19 95 /9 6 19 97 /9 8 19 98 /9 9 19 96 /9 7 19 99 /0 0 20 02 /0 3 20 00 /0 1 20 01 /0 2 20 03 /0 4 20 04 /0 5 20 05 /0 6 20 06 /0 7

Revenue

Expenditure

Rev. trend

Exp. trend

These three revenue sources minerals, SACU and the BoB are all external, and have historically accounted for around 80% of total revenues. The fact that they are externally derived is important, as it means that Botswanas very high level of public spending and public service provision has been achieved without imposing a high tax burden on the domestic economy.

liquidity, and high interest rates, the cost of this liquidity absorption has risen sharply in recent years and has caused the BoB to incur losses.
7

The mines are operated by Debswana, a 50-50 joint venture between the Government of Botswana and De Beers.

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Figure 6: Structure of Government Revenues, 2004/05

Grants/other 2% Nontax revenue 8% VAT 11% Non-mineral income tax 11% Customs & excise 19%

Source: MFDP

Mineral revenue 49%

In recent years greater emphasis has been placed on generating revenues from domestic sources, which have in total risen to around 30% of revenues in recent years. Much of this is due to the introduction of VAT in 2002 (replacing a sales tax with narrower coverage), and improved collection efficiency for income tax. The general policy is to maintain a low tax environment, with a standard VAT rate of 10% and maximum income tax rate (both personal and corporate) of 25%. Although Botswana has received considerable grant funding from donors in the past, this source of revenues is now insignificant, due to Botswanas middle-income status; grants now account for around 1% of total government receipts. Expenditure is around 40% of GDP driven in part by the development needs of a large, sparsely populated country. The largest single category of expenditure is education, with 25% of the total in 2004. Public education spending is therefore equivalent to around 10% of GDP, which is amongst the highest level in the world, and reflects a strong commitment to improving the countrys human resource capacity. Other major spending sectors include economic services (roads, water, agriculture etc.) (17%), general administration (14%), health (11%), transfers to local government (11%), and defence (8%). Personnel costs amount to around one quarter of the budget, equivalent to some 10% of GDP.

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Figure 7: Government Budget Balance

10% 8% 6% % of GDP 4% 2% 0% -2% -4% -6% -8%
19 95 /9 6 19 96 /9 7 19 97 /9 8 19 98 /9 9 19 99 /0 0 20 00 /0 1 20 01 /0 2 20 02 /0 3 20 03 /0 4 20 04 /0 5 20 05 /0 6 20 06 /0 7

Source: MFDP, CSO Budget balance % GDP SADC target

2.4

Public Debt

Botswanas public debt is very low, and is considerably exceeded by government balances at the central bank. The combined surpluses on the government budget and the current account of the balance of payments means that there has been no need to borrow either domestically or externally. The small amount of foreign debt mostly reflects opportunities for concessional borrowing, although with Botswanas rising income, such opportunities are now rare. By 2004, external debt amounted to only 5% of GDP. Some domestic debt was issued in 2003, in the form of government bonds, but this was primarily for the purposes of developing the capital market rather than meeting government financial needs. Total public debt was around 10% of GDP in 2004, well below the SADC target of 60%. In view of the low debt levels, debt service makes up an insignificant component of the budget and the balance of payments. Botswana government balances at the Bank of Botswana have exceeded debt by a large margin for many years. At their peak in 2001 these balances amounted to nearly 90% of GDP, although they have subsequently declined to around 20% of GDP. Even at that level, they are approximately double the level of public debt. The reasons for the decline are as follows: the funding of a new pension scheme for government employees, which between 2001 and 2004 involved the payment of some P11 billion to meet existing liabilities; this represented a substantial proportion of the peak balance of P28 billion in 2001; the funding of budget deficits in 2001-3; the linking of the valuation of government deposits to the value of the foreign exchange reserves, which has declined in pula terms as the currency has appreciated against major international currencies since 2001.

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Figure 8: Domestic Government Balances & Debt

90% 80% 70% 60% % of GDP 50% 40% 30% 20% 10% 0%

96

97

98

99

01

00

02

03

19 95 /

19 96 /

19 97 /

20 00 /

19 98 /

20 01 /

20 02 /

19 99 /

20 03 /

04

Source: BoB, CSO

External debt

Domestic debt

Government balances

2.5 Current Account of the Balance of Payments

Botswana has run consistent current account surpluses over the past decade. The high level of export earnings from diamonds has supported a surplus on the trade account, and although exports have declined as a proportion of GDP from around 50% in 1999 to 35% in 2004, before rising to an estimated 44% in 2005 imports have also declined, thus maintaining a positive trade balance8.

The decline in imports as a proportion of GDP is evidence of economic diversification.

20 04 /

05

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Figure 9: Imports, Exports & Trade Balance

60% 50% 40% % of GDP 30% 20% 10% 0% 1995 Source: BoB, CSO 1996 1997 1998 Exports 1999 2000 Imports 2001 2002 2003 2004 2005

Trade Balance

Diamonds dominate Botswanas exports, accounting for approximately 75%-80% of the total. Other important goods exports include copper-nickel matte (10% of the total in 2005), textiles (5%), vehicles & parts (3%), beef (2%), and soda ash (2%). Textile exports have been boosted by exports to the US under the Africa Growth and Opportunity Act (AGOA), and have risen sharply in recent years, up from US$45m in 2002 to $220m in 2005. Figure 10: Balance of Payments
20%

15%

10% % of GDP

5%

0%

-5% SADC current account target -10% 1995 Source: BoB 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Capital & financial account

Current account

Overall balance

Other components of the current account are also important. Merchandise exports provided around two-thirds of total current account receipts in 2005, with other important contributors being travel (8%), investment income (6%), and official current transfers (mostly SACU receipts) (10%). On the debit side, imports accounted for only 55% of current account payments in 2005, with the main other items being investment income outflows (mostly 13

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dividend payments to De Beers) (21%), transport (6%) and travel (6%). In general, the services and income accounts record net deficits while current transfers records a surplus. One interesting development in the current account has been the growing importance of services trade. In the mid-1990s, services receipts were equivalent to less than 10% of merchandise export receipts; by 2005, this had risen to nearly 20%. The bulk of this comprises travel receipts incoming tourism which is therefore the second largest export commodity, after diamonds. While the structure of goods exports has not become significantly more diversified over the years, the overall structure of exports including services - has become more diversified. The overall current account balance has averaged 7% of GDP over the past five years, and is therefore well above the SADC 2008 target of minus 9% of GDP.

2.6

Other Macroeconomic Indicators

2.6.1 Savings and Investment

The RISDP includes targets for domestic savings of at least 25% of GDP and domestic investment of 30% of GDP by 2008. Botswana has easily exceeded the savings target in recent years, with savings of around 50% of GDP. Overall investment also exceeds the 30% target, although this includes a significant stockbuilding (inventory accumulation) component, which is a balancing item in the national accounts. The most important component of investment is Gross Fixed Capital Formation (GFCF), which is investment in fixed (productive) assets. On this, Botswanas record has been disappointing, with fixed investment on a downward trend to reach only around 20% of GDP in 2004/05. The downward trend in investment may be an explanation for the declining rate of growth in the non-mining privates sector.

2.6.2Foreign Exchange Reserves

Botswanas foreign exchange reserves have reached exceptionally high levels in the past, peaking at 40 months of import cover in 20019. Between 2001 and 2004 they declined significantly in import cover terms, although much of this reflected the impact of exchange rate movements as the rand and the pula appreciated sharply against the US dollar. However, they have subsequently recovered in 2005 and 2006, and at the end of 2005 reserve cover amounted to an estimated 22 months of imports. In US dollar terms, the reserves have grown significantly since the end of 2003, and by July 2006 were well above their previous peak (see Figure 11). Botswanas foreign exchange reserves therefore remain well in excess of conventional prudential levels and of the SADC RISDP target of 6 months of import cover.

Import cover is calculated in relation to imports of goods and services.

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Figure 11: Foreign Exchange Reserves

9000 8000 Reserves, US$ mn 7000 6000 5000 4000 3000 45 40 35 30 25 20 15 Import cover, months

19 99

Source: BoB, own calculations Reserves Import cover

20 01

20 02

20 00

19 98

20 03

20 04

20 05

20 06

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MEDIUM-TERM MACROECONOMIC PROSPECTS AND CHALLENGES

As noted in the previous chapter, Botswana starts from a highly favourable position with respect to the SADC macroeconomic convergence targets, with all of the targets being achieved as at 2005-6. In this chapter, prospects for continued adherence to the targets through to first designated year for assessing convergence performance (2008) are evaluated. Overall, the 2008 SADC macroeconomic convergence targets for inflation, budget deficit, public debt and current account balance should easily be met, as shown in Table 3. Table 3: Botswana Convergence Indicators 2005 2006 2007 2008 SADC target (2008) <9.5 >-5.0 <60 >-9.0

Inflation Budget balance (% GDP) Debt (% GDP) Current Account (%GDP)

Source: Botswana authorities

11.3 0.5 7.5 10.6

6.3 0.0 7.5 11.7

6.3 0.0 6.5 12.7

6.3 0.0 5.6 13.4

More detailed discussion of the expected performance for each of the four targets follows below.

3.1

Inflation

While there are no public, official forecasts of inflation, data provided for this study by the MFDP shows inflation expected at 6.3% in 2007-2008. The Bank of Botswanas medium term inflation objective range is 3%-6% (BoB, 2006). Notwithstanding the high inflation rate prevailing in early 2006, it is likely that Botswana will easily meet the SADC target of single digit inflation by 2008. This is based on the expectation that the largest single influence on Botswana inflation, South African inflation, will stay relatively low (below 6%) in the medium term. Given the level of economic growth expected in Botswana, there are unlikely to be significant domestic demand pressures pushing up inflation. However, bringing down inflation would be assisted by improvements in productivity growth, especially with respect to the medium- and long-term SADC inflation targets.

3.2

Budget Balance

Future fiscal sustainability requires containment of the long-term upward expenditure trend. The policy framework laid out in the Mid-Term Review of NDP 9 contains a commitment to maintain fiscal stability and a medium term balanced budget, which it is intended to achieve through a new fiscal rule, capping public spending at 40% of GDP through to 2008/09. The 40% expenditure target is related to the medium-term expected level of government revenues. If this objective can be achieved, the result will be a balanced budget, and hence Botswana will be comfortably within the SADC deficit target of 5% of GDP. 16

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While the framework is sound and sustainable, there will nonetheless be challenges in achieving it. There are very high levels of expectations regarding the ability of government to provide services to the population, which may make it difficult to contain expenditure growth; indeed, a very high dependence upon government is one of the major challenges facing Botswana as it attempts to diversify the economy and maintain macroeconomic stability. Variations in government spending tend to have a considerable knock-on effect on the growth rates of other sectors of the economy, and if other areas of the economy are growing slowly, demands for higher government spending tend to increase. Medium term trends are for three of the major sources of revenue to decline in relative terms. Earnings from the Bank of Botswana have already dropped considerably, and are no longer a major revenue source (accounting for 2.5% of total revenues in 2004/05). SACU revenues are likely to decline as trade liberalisation leads to generally reduced tariff levels, compounded by the effect of specific trade agreements such as the free trade agreement between South Africa and the EU. Mineral revenues are also likely to grow only slowly as production from the three main diamond mines has reached a plateau. Therefore, as the economy diversifies away from dependence upon the diamond sector, in the medium to long term revenue is likely to decline as a share of GDP10. If so, expenditure will eventually need to be reduced as a percentage of GDP, below 40%, if overall budget balance is to be maintained. Containing expenditure in the future will also be made more difficult by the impact of HIV/AIDS. While in many respects, the governments initiatives to deal with HIV/AIDS have been exemplary, they have nonetheless been expensive, especially since the introduction of free anti-retroviral therapy (ART) through the public health service. Health spending has increased from 5% to 12% of total spending since 1999 (from 2% to 5% of GDP). Current plans involve a considerable further expansion of ART provision, which will require efficiency improvements and possibly cutbacks in other areas of spending if overall spending is to be contained.

3.3

Public Debt

If the forecast balanced budgets are achieved, government balances should be stabilised (at least in nominal terms even if not in relation to GDP) and there will be no need to incur additional debt. However, it is possible that the government will issue further domestic debt for capital market development purposes, or foreign debt to take advantage of the countrys credit rating and establish a track record in the international financial markets. Nevertheless, Botswanas public debt should be comfortably within the SADC target of 60% of GDP.

10 The diamond sector is taxed at a high rate (mineral revenues averaged 62% of mining

sector GDP between 1994 and 2003), reflecting its profitability. Tax rates on other economic activities tend to be lower. Therefore, as the economy diversifies and the share of mining in GDP declines, the overall average tax rate will fall (as a % of GDP). For more details of long-term budget projections, see Jefferis (1999).

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3.4 Current Account of the Balance of Payments

The main determinant of the current account balance is export performance. This has recently been very positive, driven largely by the good performance of international commodities markets. In the short-tomedium term, export prospects are good, especially given price trends for commodities exports and the likelihood of new mining ventures11,12. Further ahead, however, there is more uncertainty, as in around ten years time diamond production in the Debswana mines will have to move underground (it is currently all from open pit operations) and this will make it difficult to maintain volumes, profits and export earnings. Other exports are also subject to some uncertainty. Beef exports are threatened by supply constraints and continued losses at the monopoly export abattoir (the Botswana Meat Commission). Textiles have done well under AGOA, but may not be viable once the AGOA third country fabric concession comes to an end in 2007. Exports of vehicle components are supported by concessions under the SACU Motor Industry Development Plan (MIDP), but may not be viable once these concessions are phased out. Hence the importance of continuing to develop other exports, whether new mineral products or other goods and services. Tourism offers considerable potential; as noted above it has become increasingly important as an export product, and importantly has done so without being subject to any subsidies, special concessions or trade preferences. Official forecasts of the current account balance provided for the purposes of this study show the current account balance rising to 13.4% of GDP by 2008, notwithstanding the anticipated slowdown in the growth of diamond exports. While Botswana will easily achieve the 2008 SADC current account target of a balance better than minus 5% of GDP, achieving the 2012 and 2016 targets will require successful export diversification.

3.5

Medium-term challenges

3.5.1Economic Growth Expectations are that economic growth may fall below the indicative SADC targets in the short-to-medium term. In its Mid-term Review of National Development Plan 9 (NDP 9) (GoB, 2005e), the government forecasts an average growth rate of 4.3% a year though to 2008/09. Mining sector GDP is projected to grow at an average annual rate of 1.7% over this period, and non-mining GDP at 5.7%13. Achieving this would require a significant
11 While diamond prices are subject to somewhat different influences to the prices of

metals and industrial minerals, supply and demand projections suggest that the diamond market will remain tight which will support prices in the medium term.
12 Recent corporate announcements have indicated the likelihood of one or two new

diamond mines and a new copper mine opening by 2008. A new gold mine opened in late 2004.
13 The MTR of NDP 9 (GoB 2005e) assumes that diamond production will remain at current

levels of around 31 million carats through to 2008/09. Real growth will come from new

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turnaround from recent growth rates, where mineral sector growth has been higher than non-mineral growth. Other commentators project similar growth slowdowns: the IMF forecasts real GDP growth of 3%-4% from 2005 to 2010 (IMF, 2006), while the credit rating agency Standard and Poors, in its 2005 review of Botswana, similarly forecasts medium-term growth of 3.5% - 4%. These growth rates fall far below the 7% growth target laid out in the SADC RISDP, and indeed will be inadequate to address the problems of unemployment, poverty and inequality; it is therefore essential that measures are taken to boost the prospects for growth. The medium-term challenges facing Botswana in achieving sustainable growth in general and macroeconomic convergence in particular include the following: (a) (b) (c) (d) (e) (f) (g) reversing the long-term slowdown in economic growth; reducing the levels of unemployment and poverty; raising levels of fixed investment; managing the impact of HIV/AIDS, and reducing HIV prevalence; ensuring fiscal sustainability; promoting economic diversification; facilitating the emergence of new sources of export earnings.

These issues are clearly inter-related. A reduction in unemployment is necessary to bring poverty down, and this requires an increase in the rate of economic growth. With the main diamond mines unlikely to generate significant growth in future, a diversification of economic activity is essential for continued growth, and as the domestic market is small, this requires new exports. Raising the growth rate requires higher investment. Managing HIV/AIDS is important because of its impact on economic growth and poverty, but this also has fiscal implications. With government revenues from diamonds and other key sources growing slowly, and additional expenditure demands as a result of HIV/AIDS, ensuring fiscal sustainability will be challenging, but is essential if macroeconomic stability is to be maintained. The core problem is how to achieve the growth of non-traditional exports. This in turn requires Botswana to be a competitive producer of a range of goods and services, and also to ensure that domestic and foreign investment can flow into those activities that are, or can potentially be, competitive. Five main constraints can be identified to achieving the objective of nontraditional export-led growth: (i) (ii) (iii) (iv) (v) the level of the real exchange rate, competitiveness and inflation; dealing with HIV/AIDS; productivity; unavoidable cost factors, such as Botswanas landlocked location and distance from ports; manageable costs, such as bureaucratic constraints to business.

mines, the output of which will be small relative to current diamond output, and hence will add only a small amount to overall growth.

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Real exchange rates, competitiveness and inflation: the devaluations of the pula in 2004 and 2005 have restored the REER to a level that appears to be more consistent with its long-term equilibrium value, and has boosted Botswanas international competitiveness. Nevertheless, Botswana needs to make further efforts to bring inflation down so as maintain international competitiveness. This will require a sustainable combination of monetary policy, exchange rate policy and productivity improvements. Ultimately a choice will have to be made between moving to a combination of a floating exchange rate and an active monetary policy, or maintaining a pegged exchange rate and forgoing an active monetary policy, thereby keeping domestic interest rates in line with international levels. The new exchange rate policy introduced in May 2005 represents the adoption of a more flexible exchange rate, with the move towards a band rather than a peg for the pula permitting market forces to play some role in the determination of the exchange rate, along with a more active monetary policy. In the long-term, however, the SADC objective of monetary union will require harmonisation of exchange rate policy with other SADC members. HIV/AIDS has been addressed by the government through concerted efforts focused on a broadly-based strategy based on awareness raising, behaviour change, prevention, care and treatment. Botswana has an extensive programme of ART provision through both the public and private health systems, and although it is anticipated that this will prolong lives and help to bring down mortality rates, HIV/AIDS remains a major economic and social burden. Financially, it impacts on households, firms and the government, reducing savings, investment and growth. It significantly increases pressures on the government budget at a time when revenue growth is slowing, requiring cuts in other areas of government spending if fiscal sustainability is to be maintained. It has also worsened an already serious problem of a shortage of skilled and experienced labour in the country. In the medium-term a major expansion of the ART rollout programme is anticipated, and further investigation of how to achieve this without a significant increase in fiscal resources is necessary. Productivity. Amongst the causes of high inflation are structural factors, specifically inadequate productivity growth14. The solution to bringing inflation down (to meet the medium and long-term SADC targets) lies in structural reforms, including improved education and training, better management in the public and private sectors, an improved work ethic, and increased economic flexibility. Cost factors. There are some unavoidable contributors to the high cost of doing business in Botswana. The countrys location means that extensive land transport is necessary to move goods to and from sea ports, and in the process, international borders need to be crossed. Climate and topography means that water is scarce, and hence expensive. Large size and low population density mean that provision of economic infrastructure and services is expensive throughout much of the country.
14 One recent set of data indicated that TFP growth in the non-mining private sector was

1.1% a year between 1997 and 2003 (BNPC, 2005). This compares with productivity growth rates of 3% a year or more that would be expected in a dynamic, growing economy.

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While many of these costs are unavoidable, efforts need to be made to improve efficiency to bring them down as far as possible. Furthermore, other costs need to be brought down to compensate for those that are unavoidably high, in order to keep the overall cost level competitive. These include costs related to business regulation and licensing, land availability, cross-border trade and availability of skills (see e.g. FIAS, 2003 and World Bank, 2005). Key reforms needed include: improving the efficiency of the business licensing system (and thereby reducing the costs to business); this is the intention of revised legislation being implemented in 2006; improving the efficiency of the work and residence permit system so that firms can more easily source foreign skills where skilled citizen labour is not readily available; improving the efficiency of land allocation and land markets implementation of the privatisation programme and deregulation of relevant markets and industries (such as telecommunications); These constraints are being addressed by government through appropriate reforms in the relevant procedures and policies. The National Employment, Manpower and Incomes Council (NEMIC) has been given the overarching responsibility for ensuring implementation of these reforms.

3.6Summary and Conclusion Macroeconomic Convergence Programme

Botswana is well set to achieve the 2008 convergence targets contained in the macroeconomic convergence programme, and doing so will not require any change from established policies, which are well-focused on achieving macroeconomic stability. However, there are a number of medium-to-long term issues that need addressing to ensure that higher rates of economic growth are achieved. This is required for a number of reasons. First, to meet the 7% growth target laid out in the RISDP. Second, if economic growth is low, it will be more difficult to meet the medium and long term macroeconomic convergence targets (for 2012 and 2018) laid out in the RISDP. Third, a low rate of growth will make it difficult to meet Botswanas own targets as contained in Vision 2016, including the reduction of unemployment and poverty. Therefore, a common set of policies is needed to meet the medium and long term SADC macroeconomic convergence objectives, to meet economic growth objectives, and to meet Botswanas own national development objectives. These are focused on enhancing economic diversification and export diversification, through the following inter-related measures: ensuring that the overall balance of macro- and micro- economic policies supports an open, competitive economy pursuing increased integration into the regional and international economies; achieving higher investment by both domestic and foreign investors; improving regional and international competitiveness through enhancing the investment environment, increasing productivity and reducing costs 21

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reducing administrative barriers to investment and introducing reforms to improve efficiency (for instance, dealing with issues such as those identified in the FIAS report, including improving the availability of land for investors, reducing the bureaucracy associated with business licences and work and residence permits); deregulating sectors such as telecommunications to encourage improved competition and efficiency; removing distortions and improving the functioning of the labour market; improving efficiency in the parastatal sector; pursuing privatisation, including contracting out and public-private partnerships, where possible; reducing the tax burden to the extent possible consistent with fiscal sustainability; with regard to macroeconomic policy, ensuring that exchange rate and monetary policy achieves low inflation, supports international competitiveness and encourages investment; improving the availability and quality of statistical information to support high quality economic analysis and policy evaluation. Achieving the medium to long term SADC macroeconomic convergence targets will depend on the successful implementation of this policy framework.

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REFERENCES & DOCUMENTS CONSULTED

Bank of Botswana (2006) Monetary Policy Statement 2006 (Gaborone: Bank of Botswana) Botswana National Productivity Centre (BNPC) (2005) Productivity Statistics (Gaborone: BNPC) Central Statistics Office (2005) Household Income and Expenditure Survey 2002/03 (Gaborone: CSO) FIAS (2003) Botswana: Further Improving the Regulatory and Procedural Framework for Encouraging Private Investment (Washington DC: world Bank Group) Government of Botswana (2005) Mid-Term Review of NDP 9 (Gaborone: Ministry of Finance and Development Planning) IMF (2001) The Macroeconomic Impact of HIV/AIDS in Botswana, Working Paper 01/80 (Washington DC: IMF) IMF (2004) Botswana: Selected Issues and Statistical Appendix Country Report 04/212 (Washington DC: IMF) IMF (2006) Botswana: 2005 Article IV Consultation Staff Report, Country Report 06/66 (Washington DC: IMF) Jefferis, K. (1999) The Long Term Impact of Structural Economic Change on Government Spending, BIDPA Working Paper No.20, June (Gaborone: Botswana Institute for Development Policy Analysis) Leith, J C (2005) Why Botswana Prospered (Montreal: McGill-Queens University Press) Moodys Investors Service (2005) Botswana (London and New York, November) World Bank / BIDPA (2005) Diversifying Botswanas Exports: An Overview (Gaborone and Washington DC: BIDPA and World Bank) World Bank (2005) Doing Business in 2006 (Washington DC: World Bank)

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APPENDIX 1: BOTSWANA MACROECONOMIC DATA AND FORECASTS

Year [1] 1995 1996 National Income and Prices GDP current prices P mn 14,204 17,731 GDP current prices US$ mn 5,125 5,371 Real GDP Pmn, constant 1993/4 prices 12,699 12,029 GDP growth % 5.5% 5.6% Inflation %, eop 10.8% 9.6% Government Budget Revenue & grants o/w minerals o/w domestic revenues o/w grants Expenditure o/w personnel costs Revenue & grants o/w domestic revenues o/w mineral revenues o/w grants Expenditure o/w personnel costs o/w personnel costs Grants Budget balance Budget balance 1997 20,115 5,513 14,544 14.5% 7.8% 1998 23,756 5,654 15,582 7.1% 6.4% 1999 28,245 6,115 16,728 7.4% 8.4% 2000 38,129 7,492 18,262 9.2% 8.5% 2001 33,681 5,793 18,537 1.5% 5.6% 2002 38,528 6,107 20,301 9.5% 10.6% 2003 42,378 8,594 20,985 3.4% 6.4% 2004 48,902 10,434 22,742 8.4% 7.8% ======= Est./F'cast ======= 2005 2006 2007 53,441 10,559 23,720 4.3% 11.3% 57,981 24,740 4.3% 6.3% 64,359 25,829 4.4% 6.3%

P mn P mn P mn P mn P mn P mn % GDP % GDP % GDP % revenue % GDP % GDP % exp % GDP P mn % GDP

5,464 2,591 980 37 5,195 1,227 38.5% 6.9% 18.2% 0.7% 36.6% 8.6% 23.6% 0.3% 270 1.9%

7,395 3,640 1,118 83 6,092 1,377 41.7% 6.3% 20.5% 1.1% 34.4% 7.8% 22.6% 0.5% 1,302 7.3%

8,281 4,681 1,430 112 7,406 1,686 41.2% 7.1% 23.3% 1.4% 36.8% 8.4% 22.8% 0.6% 875 4.4%

7,678 3,187 1,977 138 9,065 2,153 32.3% 8.3% 13.4% 1.8% 38.2% 9.1% 23.8% 0.6% 1,388 -5.8%

11,963 6,687 2,112 126 10,428 2,419 42.4% 7.5% 23.7% 1.1% 36.9% 8.6% 23.2% 0.4% 1,536 5.4%

14,115 8,368 2,364 65 11,537 2,743 37.0% 6.2% 21.9% 0.5% 30.3% 7.2% 23.8% 0.2% 2,579 6.8%

12,709 6,996 2,779 59 13,671 3,446 37.7% 8.3% 20.8% 0.5% 40.6% 10.2% 25.2% 0.2% 962 -2.9%

14,318 7,503 4,133 84 15,710 3,947 37.2% 10.7% 19.5% 0.6% 40.8% 10.2% 25.1% 0.2% 1,392 -3.6%

16,197 8,163 4,972 61 16,276 4,142 38.2% 11.7% 19.3% 0.4% 38.4% 9.8% 25.4% 0.1% 78 -0.2%

17,957 8,682 5,313 348 17,383 5,129 38.3% 10.9% 17.8% 1.9% 35.5% 10.5% 29.5% 0.7% 574 1.2%

21,697 10,889 6,672 220 20,122 5,436 40.6% 12.5% 20.4% 1.0% 37.7% 10.2% 27.0% 0.4% 1,575 2.9%

24,144 11,389 6,542 363 23,222 5,998 41.6% 11.3% 19.6% 1.5% 40.1% 10.3% 25.8% 0.6% 922 1.6%

25,744

25,744

40.0%

40.0%

0.0%

Public Debt External Debt P mn External Debt % GDP Domestic debt (GoB bonds) P mn Domestic debt (GoB bonds)GDP % Total debt % GDP GoB balances at BoB P mn GoB balances at BoB % GDP

1,440 10.1%

1,791 10.1%

1,968 9.8%

2,423 10.2%

2,425 8.6%

2,426 6.4%

2,917 8.7%

2,195 5.7%

10.1% 6,460 45%

10.1% 11,664 66%

9.8% 15,364 76%

10.2% 18,955 80%

8.6% 19,899 70%

6.4% 24,219 64%

8.7% 27,881 83%

5.7% 16,544 43%

1,989 4.7% 2,500 5.9% 10.6% 10,529 25%

2,189 4.5% 2,500 5.1% 9.6% 9,418 19%

2,144 4.0% 1,750 3.3% 7.3%

7.5%

6.5%

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1995 Balance of payments Expts of goods & serv. Merchandise exports o/w diamonds o/w diamonds Merch. Imports fob Trade balance Services imports Services exports Current account Capital & financial acc. Overall balance Exports (goods) Imports (goods) Trade balance Services exp./XGS Current account Capital & financial acc. Overall balance Reserves Reserves Reserves Import cover P mn P mn P mn % total exports P mn P mn P mn P mn P mn P mn P mn % GDP % GDP % GDP % % GDP % GDP % GDP US$ mn P mn % GDP months 6,710 5,989 3,994 67% 4,451 1,538 1,232 722 831 54 591 42% 31% 11% 11% 6% 0% 4% 4,695 13,249 93% 28.0

1996 7,912 7,372 5,272 72% 4,879 2,493 1,143 541 1,643 162 1,722 42% 28% 14% 7% 9% 1% 10% 5,234 19,076 108% 38.0

1997 11,062 10,295 7,675 75% 7,026 3,269 1,609 767 2,634 82 2,318 51% 35% 16% 7% 13% 0% 12% 5,675 21,619 107% 30.0

1998 9,978 8,708 6,061 70% 8,380 328 2,258 1,270 860 721 256 37% 35% 1% 13% 4% -3% 1% 5,941 26,485 111% 29.9

1999 13,999 12,292 9,813 80% 8,664 3,629 2,427 1,706 2,859 1,032 1,829 44% 31% 13% 12% 10% -4% 6% 6,229 28,852 102% 31.2

2000 15,306 13,649 11,398 84% 9,047 4,603 2,793 1,657 2,782 835 1,941 36% 24% 12% 11% 7% -2% 5% 6,317 33,880 89% 34.3

2001 15,602 13,519 11,259 83% 9,370 4,149 3,093 2,083 3,492 2,942 1,023 40% 28% 12% 13% 10% -9% 3% 5,897 41,182 122% 39.7 0.1432 0.1720

2002 17,951 14,843 12,474 84% 10,365 4,477 3,290 3,108 1,245 1,371 336 39% 27% 12% 17% 3% -4% 1% 5,474 29,926 78% 26.3 0.1829 0.1585

2003 18,155 14,970 11,707 78% 10,529 4,441 3,230 3,184 2,288 1,764 797 35% 25% 10% 18% 5% -4% 2% 5,339 23,717 56% 20.7 0.2251 0.2028

2004 20,856 17,345 13,133 76% 13,441 3,904 3,715 3,511 1,352 1,407 272 35% 27% 8% 17% 3% -3% -1% 5,660 24,200 49% 16.9 0.2336 0.2134

2005 27,838 23,579 16,982 72% 14,432 9,147 4,402 4,259 8,096 719 7,036 44% 27% 17% 15% 15% -1% 13% 6,309 34,610 65% 22.1 0.1814 0.1976

2006

2007

12%

13%

Exchange rate (eop) USD/BWP 0.3544 0.2744 0.2625 0.2243 0.2159 0.1865 Exchange rate (avg) USD/BWP 0.3608 0.3029 0.2741 0.2380 0.2165 0.1965 Sources: Central Statistics Office; Bank of Botswana; Ministry of Finance and Development Planning; IMF [1] Calendar year, or national accounts/financial year beginning:

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