IMF Executive Board 2017 Article IV Consultation with Botswana
On July 28, 2017, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Botswana, and considered and endorsed the staff appraisal without a meeting.
Following a small contraction in 2015, economic activity recovered in 2016 with real GDP growth of 4.3 percent. Mineral production has remained subdued, but diamond sales rebounded as conditions in the global market begun to improve. Non-mining activities also expanded, supported by accommodative fiscal and monetary policies and reforms in the electricity sector. Year-on-year inflation has remained stable near the lower band of the Bank of Botswana’s inflation objective range of 3-6 percent, with the 12-month rate of inflation at 3.5 percent in in May 2017.
The fiscal position has also improved as the deficit narrowed from 4.6 percent of GDP in fiscal year 2015/16 (the fiscal year begins in April) to about 1 percent of GDP in 2016/17. This outcome was supported by a recovery in diamond revenues and constrained recurrent spending. Higher diamond sales also contributed to a large surplus in the external current account and helped sustain a high level of international reserves (45 percent of GDP at end-2016).
Botswana has maintained economic stability and high rates of economic growth over the years. Nevertheless, the country continues to face important structural constraints that are reflected in a low level of human capital and limited economic diversification.
Botswana has made impressive strides in economic development. The country is frequently mentioned as “An African Success Story”. It is deemed to have the best quality of governance and rule of law in Africa, its economic growth averaged 4.6 percent during the past two decades, and the poverty rate was reduced rapidly from 31 percent in 2003 to 19 percent in 2010. Owing to prudent fiscal and monetary policies, the authorities have accumulated substantial foreign exchange reserves and secured macroeconomic stability with low levels of public debt.
Despite these achievements, important challenges remain. Notwithstanding efforts to diversify the economy, large expenditures on public education, and plans to build skills in the labor force, the economy remains heavily dependent on diamonds, non-mining activities have not expanded enough, and unemployment has remained almost unchanged at about 18 percent in the past decade. Progress appears to have been hampered by various factors, especially weaknesses in implementation capacity and insufficient coordination within the government.
At end-2016, the government adopted a new six-year National Development Plan. The plan recognizes that outcomes in terms of reducing unemployment and inequality and promoting private sector development have not been satisfactory. The plan is also appropriately ambitious and articulates well a vision to address the challenges of unemployment, poverty, and income inequality. The plan, however, is quite broad in scope so its implementation will need to be more focused and complemented with time-bound measures and close monitoring.
There has been broad agreement between the authorities and IMF staff on policies and reforms in recent years, although some reforms have proceeded slowly. The authorities have pursued prudent macroeconomic policies and have stepped up efforts to upgrade the electricity and water infrastructure. Reforms in the areas of tax administration, state-owned enterprises (SOEs) and labor market have been gaining momentum, but implementation has been constrained by limited capacity, while reforms to improve the business environment and review the tax system have been proceeding at a slow pace owing to insufficient coordination among key agencies and hesitant political support.
As the recovery strengthens, the overarching theme in the authorities’ agenda revolves around fostering inclusive growth. Accordingly, while the discussions covered the macroeconomic policy mix and reforms to strengthen the financial sector and mobilize domestic revenue, the focus of the consultation was on measures to enable private sector growth, especially those to improve the efficiency of public investment, reduce costs of doing business, and build skills in the labor force.
A. Policy Mix and Reforms to Support Economic Stability
The near-term fiscal stance is appropriate. During 2017/18 and 2018/19, a mildly expansionary stance entailing small fiscal deficits is consistent with a residual non-mining output gap estimated to be about 1 percent. Revenues are projected to increase slightly in 2017/18 and decline in 2018/19 because of changes in SACU receipts, while the composition of spending will appropriately shift towards investment in infrastructure (especially projects in the transport and water sectors).
From FY2019/20 onwards, higher fiscal revenues and constrained spending are expected to result in fiscal surpluses. Domestic revenues are projected to increase in response to tax administration reforms (see below), while modest increases in the wage bill and lower transfers to parastatals are projected to lead to a string of fiscal surpluses. This stance is appropriate given the need to contain the growth of already high levels of public sector wages and to rationalize parastatals. Consequently, the public debt-to-GDP ratio is projected to fall over the projection period and remain within its legislated ceiling of 40 percent.
Botswana’s external position is sound. The external position is broadly consistent with fundamentals and desirable policy settings. The external current account balance has been in surplus in most years and is expected to remain positive throughout the projection period, while international reserves and the net international investment position are also expected to improve over time. The real effective exchange rate has only appreciated slightly during the past decade (it is currently 2 percent above its 10-year average) and its volatility has been modest, partly a reflection of the exchange rate framework based on annual reviews to the rate of crawl and basket weights to reflect changes in trade patterns and expected inflation differentials. This policy is based on sound principles and continues to be appropriate.
Risks to the financial system are contained and financial supervision reforms will strengthen the system’s soundness. The team endorsed the authorities’ plans to set up the macroprudential policy function to enhance supervisory risk analysis, set up macroprudential measures as needed, and strengthen coordination among supervisors. It encouraged the authorities to proceed with plans to finalize the implementation of Basel II requirements in line with previous Fund advice; address the shortcomings identified by a recent assessment of the AML/CFT framework; build up a legal framework and prepare a contingency plan for crisis resolution; and move toward risk-based supervision of non-bank financial institutions (Selected Issues, Chapter I). The team also suggested setting up a legal department at the Bank of Botswana to advise on legal matters and monitor and update the legal framework.
Despite improved prospects in the global diamond market, revenue mobilization will be important to ensure stability and fund government outlays. The authorities agreed that there is a significant potential to boost domestic revenues through tax administration and tax policy reforms that could further insulate Botswana from fluctuations in diamond revenues or receipts from the Southern Africa Customs and provide additional funding for future fiscal expenditures.
A number of tax administration reforms are underway, but implementation has been challenging. Since 2015, the authorities instituted a requirement for electronic filling of taxes and set up a risk management unit at the Botswana Unified Revenue Service, although collection efficiency has been hampered by administrative costs and other constraints. Looking ahead, the authorities need to expedite the passage into law and implement the new Tax Administration Act (which modernizes tax procedures) and strengthen the audit and risk functions of the Large Taxpayers Unit (which collects the bulk of tax revenue).
Tax policy reforms can also be usefully considered. First, the authorities could streamline VAT exemptions and replace those used for social purposes (e.g. on food items and transportation services) with targeted social transfers. Second, they could simplify the personal income tax by instituting a single rate final withholding tax on all passive capital income and capital gains and relieving employees with a single source of labor income and no active capital income from filing annual tax returns. Third, they could accelerate plans to register and re-evaluate properties to broaden the tax base and geographic coverage. Lastly, they need to ensure that any corporate income tax concessions (including on economic zones) are granted sparingly and in the form of accelerated depreciation schemes or investment tax credits (Selected Issues, Chapter II).
B. Fostering Inclusive Growth
Despite high rates of economic growth during the past two decades, unemployment remains high. Growth has been centered on diamond production and diversification away from diamonds has been rather slow and non-linear.19 The public sector has become the main source of employment (it now accounts for 52 percent of total employment) but there is no room for further expansion. In sum, the capital-intensive nature of mining activities and the limited expansion of the private sector have then been reflected in persistently high rates of unemployment, including youth unemployment (33.3 percent in 2016), as well as in high income inequality (the Gini index compiled in 2010 is about 60, higher than in most middle-income countries).
Efforts to diversify the economy and create employment have been hampered by several constraints. The authorities formulated plans to improve the business environment and foster education and skills development and attempted to promote the expansion of several sectors. These efforts, however, proved too ambitious considering capacity constraints and coordination problems, leading to unsatisfactory results. According to a number of surveys (Doing Business, Global Competitiveness Report, Central Bank's Expectations Survey) the main impediments to private sector development have been weak contract enforcement, lack of access to reliable electricity, an unskilled labor force, concerns about permits for foreign workers, weaknesses in health and education services, and a small domestic market. A focused and determined approach will be needed to foster inclusive growth. In the latest National Development Plan (NDP11), the authorities recognize these shortcomings and discuss several strategies, including the development of selected clusters (Box 1). The next step should be to devise and/or implement a few plans with a manageable set of high-impact measures to improve the efficiency of the public sector, build skills in the labor force, and foster the development of a competitive private sector.
E. Enabling Private Sector Development
A range of measures to lower the costs of doing business and improve access to credit have been identified, but implementation needs to be accelerated. In 2015, the authorities, in cooperation with the World Bank, developed a Roadmap which contains important measures to facilitate the process to start a business, obtain construction permits, register property, enforce contracts, improve access to credit, and facilitate trade. However, only about one-third of the envisaged measures have so far been carried out, highlighting the importance of strengthening capacity, ownership, and accountability in the entities responsible for implementation. These measures would complement the above-mentioned reforms to facilitate visa procedures and permits for foreign entrepreneurs and workers which have been consistently mentioned as a challenge for doing business by the business community.
The authorities expressed their intention to move forward with the measures contained in the Roadmap. They plan to submit to Parliament related legislation this year and, going forward, submit to cabinet regular updates on the reforms to strengthen monitoring and accountability. The key measures are to create a one-stop shop for businesses, introduce risk-based inspections to speed up granting construction permits, broaden the scope of the creditor database to include both positive and negative credit data, allow lenders to enforce securities out of court through collateral agreements, establish a collateral registry for immovable and movable assets, and implement the Making Access Possible Plan to foster financial inclusion. The latter will be critical to facilitate a much-needed expansion of credit to small and medium enterprises.
Efforts to diversify the economy need to focus on removing distortions and improving competitiveness. NDP 11 identifies some key sectors (clusters) such as mining beneficiation, tourism, beef, and financial services and the authorities may pursue industrial policies to promote these sectors. In this context, and considering capacity constraints, high transport costs, the difficulties to increase economic integration with South Africa, and the risks associated with industrial policies, the staff suggested proceeding with an approach based on lowering costs and removing distortions (e.g. securing access to water and electricity, improving information technologies). If the authorities pursue industrial policies, they should first evaluate the potential comparative advantage of any activity and formulate time-bound quantitative targets for the reforms and projects envisaged, ensuring minimal government intervention and defined exit clauses (if results are disappointing).
The authorities should exercise caution with plans to set up special economic zones. Beyond the above-mentioned clusters, NDP 11 envisions eight economic zones. However, insufficient vertical integration, expensive inputs, lacking infrastructure, and high transport costs limit the scope to set up profitable production facilities. Given these constraints and the mixed experience with economic zones elsewhere, the authorities’ approach not to proceed with all zones at once and to monitor results and change course as needed is appropriate. Moreover, the staff recommended to focus on streamlining regulation and concessions rather than on fiscal incentives, and, if fiscal incentives are used, to rely on them sparingly and in the form of accelerated depreciation schemes or investment tax credits rather than tax holidays.
 SACU revenues depend mainly on South Africa’s projected customs and excise revenues and are shared across countries based on a formula (based on countries’ imports and GDP levels). The formula includes an adjustment mechanism where any over/underpayment from past forecasting errors is recouped two years later. These revenues tend to be quite volatile because: i) imports are more volatile than GDP; ii) custom receipts are affected by exchange rate developments; and iii) the adjustment mechanism tends to exacerbate the procyclicality of revenues (e.g. during bad times SACU revenues are lower due to reduced customs and excise receipts, and, to make things worse, this is usually accompanied by the repayment of past over-receipts as the downturn was most likely unanticipated and thus past receipts were too elevated). For Botswana, in addition, SACU revenues as a share of GDP have been on a declining path given low growth in South Africa and high GDP growth in Botswana. In FY2017/18, SACU revenues are expected to increase due to an adjustment aimed at compensating the underpayment in FY2015/16. In the following years, SACU receipts are expected to decline in line with projections of subdued GDP growth in South Africa.
Selected Issues Paper
Reforms to mobilise domestic resources
Botswana has the second lowest tax to GDP ratio among Southern African Customs Union (SACU) members. The same is true regarding its taxation of income and taxation of goods and services. Moreover, the value-added tax (VAT), the corporate income tax (CIT) standard rates, and the personal income tax (PIT) top marginal rate are the lowest in the customs union Government revenue is heavily dependent on mineral revenue and revenue from the SACU sharing pool. The non-mineral tax revenue-to-GDP ratio has been around 20 percent since fiscal year 2010/2011 except in 2012/13. In recent years, more than half of this share has come from the SACU pool. In other words, domestic revenue mobilization – essentially PIT, CIT, and VAT revenues – has fallen to less than 10 percent of GDP. Moreover, SACU revenue plus mineral revenue (taxes, royalties and dividends) has exceeded 63 percent of total government revenue during the past five years. Even though fiscal sustainability is not a near-term concern, the inherent volatility of revenues on which the authorities have little control poses a risk for the medium to long term. Clearly, the authorities could potentially raise tax rates in case of an economic mishap, but raising rates is not likely to be a good response in case of a persistent or permanent shock. Instead, the best course of action would be to reduce the dependence on uncontrollable sources of revenue through tax reforms aimed at enhancing domestic resource mobilization and reducing inefficiencies and distortions. These comprise key tax administration improvements and tax policy changes that may increase CIT, PIT, VAT, and property tax revenues.
This chapter summarizes key reforms to efficiently mobilize revenue in Botswana. The country has been engaged in extensive technical cooperation with the IMF’s Fiscal Affairs Department (FAD) and the Regional Technical Assistance Center for Southern Africa (AFRITAC South) in recent years, with the reports from these activities documenting constraints and containing several recommendations. In the area of tax administration, the Botswana Unified Revenue Service (BURS) has already adopted or is considering to adopt several of those recommendations. In the area of tax policy, the authorities have yet to implement most recommendations. This Annex revisits the main reforms in the context of the Article IV consultation discussions and the authorities’ strong interest in reversing the recent decline in domestic revenue as a share of GDP.
Publication and sharing of tax data should be a priority. Both the Ministry of Finance and Economic Development (MFED) and the BURS websites do not provide statistics on tax collection and its details, and no detailed information on tax statistics has been made available to Fund staff during the recent round of discussions. Reportedly, not even the tax policy unit of the MFED has tax statistics that may assist its policy making function, an undesirable situation in an upper middle-income country like Botswana.
Addressing the unemployment challenge
Despite robust growth, unemployment and income inequality in Botswana have remained high. Since 1991, real GDP growth in Botswana has averaged nearly 5 percent while the unemployment rate has remained persistently high (averaging 18 percent of the labor force). For its part, income inequality is also high by international standards, with a Gini index of nearly 60. The authorities have recognized the need to successfully address the problems of unemployment and inequality, but results thus far have fallen short of expectations. Unemployment and inequality are closely linked. Since wages and salaries are the main source of household income in Botswana, the high rate of unemployment has been a key contributor to income inequality. This is a particularly pervasive problem for young people (including college graduates who have one of the highest rates of unemployment) which has constrained the development of the non-mining economy.
Employment in Botswana has shown little responsiveness to changes in economic activity. During the period 1992-2016, the correlations between unemployment rate and real GDP growth and between employment growth and real GDP growth have been quite low. This is true also for youth unemployment, which averaged 31 percent during the same period. Econometric analysis confirms the limited inclusiveness of growth, with the coefficient that measures the responsiveness of the unemployment rate to GDP growth – the Okun’s coefficient – not being significantly different from zero.
Labor Market: Diagnosis of Constraints and Policy Options
Botswana’s employment challenge is related to constraints in both the supply and the demand for labor. On the supply side, lack of skills in the labor force and skill mismatches have been the most serious challenge, compounded by an overly restrictive policy on permits for foreign workers and high wages in the public sector. On the demand side, a small domestic market, shortages of electricity and water, and barriers to set up and fund businesses have resulted in high costs and lack of profitable investment opportunities, effectively deterring entry of new businesses and employment creation.
Labor demand. A small domestic market and lack of regional economic integration constrain competitiveness in Botswana. Botswana and its neighbors, except for South Africa, have very small open economies. A joint effort towards economic integration of the region has been pursued trough SADC, a free trade area protocol established in 1996 and ratified in 2000 among 15 sub-Saharan African countries. However, progress has been slow, mainly because several countries have been reluctant to take down tariffs on goods and services, eliminate provisions promoting local content and subsidies to industries, and remove visa restrictions. An added complication has been that SADC countries belong to various regional groups (COMESA, SACU, EAC), which creates difficulties on the implementation of trade policies.
The availability of electricity and water has also been a longstanding concern. Problems with electricity supply have been – inter alia – associated with the malfunctioning of Morupule B, the major power plant in the country, that experienced repetitive machine failures due to structural defects in project design, leading to frequent outages and forcing the country to import almost half of its electricity needs during 2014-15. Morupule B, the largest power station in the country, was expected to be completed by October 2012, but by the end of 2013 only two units were in operation. The remaining two units were completed in 2014. The plant has been beset with machine failures, forcing the facility to run at about a third of its capacity. Another challenge facing is associated with water provision, as the existing infrastructure is inadequate in size and suffers from weak maintenance.
Botswana has been successful in ensuring access to clean water but water losses and sanitation problems have been a concern, with more than 95 percent of the population having access to improved drinking water sources. However, as the country relies heavily on groundwater (60 percent), it remains vulnerable to droughts. In addition, the water system has operational problems related to under-dimensioning and insufficient maintenance, which leads to water losses. Finally, despite some progress, sanitation remains an issue, with only 64 percent of the population having access to improved sanitation.
In the electricity sector, steps have been taken to improve production and reliability. An international expert has been hired as CEO of the Botswana Power Corporation (BPC) and a plan to improve the financial sustainability of the company has been developed (Masa 2020) with the goal of reaching financial self-sufficiency by 2022. This entails downsizing the company, shifting the production of electricity to the private sector while maintaining the distribution side, and gradually liberalizing tariffs.
Similarly, prospects for the water sector have improved, but challenges remain. Water supply improved as dams received inflows form rain following two years of drought. Furthermore, a second North-South water carrier – to irrigate as much as 35,000 hectares – is expected to be completed by 2022 and other large projects are also under consideration, including the Chobe-Zambesi carrier (that would channel water from the Zambezi), the Lesotho Island water transfer (through South Africa) and the Botswana/Namibia/South Africa underground.
Lastly, the cost of doing business has been unnecessarily high because of distortions and bureaucratic procedures. The main challenges are: (i) Starting a business: in Botswana, it takes 48 days to start a business compared to just 6 days in Mauritius. To address this issue, the authorities need to introduce a unique identification number for each company and use this number as the only reference for interaction between the company and government agencies. Additionally, the authorities should establish a one stop shop to speed up starting a business. (ii) Obtaining construction permits: in Botswana, it takes 17 days to get a construction permit, compared to 10 days in Namibia. Since the legislation does not permit to classify construction by risk level, all new constructions require inspection. This can be addressed by amending legislation to introduce a risk-based on-site inspection system; (iii) Accessing to credit: there is not credit registry in Botswana, while the credit bureau covers only about ½ of adults, collects only negative information, and is not easily accessible to the lender; and (iv) Trading across borders: the time it takes to process documentation is too long and can be usefully shortened.
In 2015, the authorities adopted a roadmap for reforming Botswana’s business environment, but progress now needs to be accelerated. For instance, important reforms such as the one government principle, reducing the excessive number of licenses and permits (which are already approved), and establishing creditors databases, still need to be implemented. Insufficient progress with these reforms has highlighted the importance of strengthening capacity, ownership, and accountability of the entities responsible for implementation. In addition, regular updates on the implementation of the reforms could be submitted to Cabinet to increase accountability.
Proceeding with pending reforms and investments on the above areas will lower costs and foster private investment and employment. In particular, the following actions will be important in the period ahead:
Ensure a consistently improved performance of the Morupule B Power Station within internationally accepted operational standards.
Make the Botswana Energy Regulatory Authority fully operational, ensure that prices charged by private producers to BPC are in line with marginal costs to avoid rent extraction, and take the necessary actions to avoid any abuse of market power.
Review the structure of electricity subsidies with a view to rationalize and set rates based on efficiency grounds and commercial criteria and avoid political interference. To protect the poor, subsidies on tariffs for residential consumers can be usefully replaced by a targeted scheme of direct transfers. Pending the design and implementation of such scheme, tariff increases for lower-income households will need to be contained.
Lower non-revenue water losses by reducing leakages in the existing infrastructure.
Adopt the unique identification number and implement the one stop shop.
Introduce risk-based on-site inspections to speed up the granting of construction permits.
Collect positive and negative data in the Creditor Database.
Allow lenders to enforce securities out of court through a collateral agreement and establish a collateral registry for immovable and movable assets; and
Reduce the number of documents required for export and import and establish a single electronic window to lower international trade costs.