IMF Executive Board 2018 Article IV Consultation with Botswana

IMF Executive Board 2018 Article IV Consultation with Botswana
Photo credit: BITC

06 Sep 2018

Botswana: Mining a New Growth Model

Botswana is one of the few countries in sub-Saharan Africa that has truly benefited from its mineral wealth. Revenues from diamond mines, combined with sound economic policies, have helped build infrastructure and kept the economy stable. But with high unemployment and limited export diversification, the diamond and public sector-led development model is showing its limits. 

The IMF’s latest assessment of Botswana’s economy says that while the near- and medium-term prospects look reasonably good, a much less favorable scenario looms if the development model is not revamped and certain reforms are not implemented.

On August 31, 2018, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Botswana.

Sizable buffers and prudent policies have kept the economy stable despite diamond market weakness and volatility, but progress with structural reforms has been mixed. The diamond cum public sector-led development model has been showing its limitations with sluggish growth and weak job creation. In recent months, the authorities approved key legislation to improve the business environment and announced plans to proceed with privatizations, rationalize parastatals, and relax restrictions on visas and work permits.

In 2017, despite higher diamond production, real GDP growth dropped to 2.4 percent primarily because of the closure of a major copper and nickel mining company. Non-mineral growth decelerated reflecting the indirect effects of the company’s closure on electricity and transportation, coupled with a small slowdown in trade and construction. Inflation remained near the lower end of the Bank of Botswana’s objective range of 3-6 percent, with the 12-month rate at 3.1 percent in July 2018.

The fiscal position was nearly balanced, as lower mineral and non-tax revenues were offset by higher SACU receipts, and higher outlays in wages and transfers were compensated by lower spending on goods and service and bursaries. At the same time, the real effective exchange rate remained stable, the current account balance maintained a large surplus, public debt remained low, and international reserves exceeded their adequate level by a comfortable margin.

In 2018-19, it is expected that improving conditions in the diamond market and fiscal stimulus will temporarily boost economic activity. The medium-term economic outlook will depend heavily on the successful implementation of critical structural reforms.

Staff report

Economic developments

Despite the closure of a major copper mine and volatility and weakness in the diamond sector, macroeconomic conditions have been stable in recent years, supported by appropriate fiscal and monetary policies. Banks’ profitability and liquidity declined, and nonperforming loans increased somewhat, but the banking system remains well capitalized.

Diamond market fundamentals improved in the past year. In 2017, higher demand from the U.S. and China led to a recovery in global production. Prices of raw diamonds remained broadly flat much of the year but started to pick up in the last quarter and in early 2018 (although they remain about 15 percent below their 2011 peak). In Botswana, while production increased, diamond exports and mineral fiscal revenue fell after a good year in 2016.

In 2017, economic growth slowed while inflation remained subdued. Despite higher diamond output, real GDP growth dropped to 2.4 percent primarily because of the closure of Bamangwato Concessions Limited (BCL), a major copper-nickel mining company. Non-mineral GDP decelerated slightly reflecting the indirect effects of BCL’s closure on electricity demand and transportation and a slowdown in trade and construction. In this environment, inflation remained near the lower band of the BoB target range of 3-6 percent, with the 12-month rate at 3.1 percent in July 2018.

The external position has been broadly consistent with fundamentals and desirable policies. The pula has remained stable in real effective terms and the current account balance has been in surplus, although the surplus appears to have been overestimated. The assessment that the external position is consistent with fundamentals is based on the view that, for intergenerational reasons, Botswana needs to accumulate foreign assets. International reserves fell from 58 percent of GDP at end-2015 to 41 percent at end-2017 but continued to exceed their adequate level by an ample margin.

The fiscal position has been nearly balanced and public debt remained low. Total revenue as a share of GDP declined in FY2017/18 (the fiscal year begins in April) compared to FY2016/17, as lower mineral and non-tax revenues offset higher receipts from the Southern African Customs Union (SACU). Current expenditure remained almost unchanged as higher wages and transfers to parastatals and local governments were compensated by lower bursaries for tertiary education and spending on goods and services. However, lower investment (partly due to under-execution) and lower electricity subsidies led to a decline in capital expenditure of about 1.7 percent of GDP. Lastly, continued prudent fiscal policies kept public debt (domestic and external) low at 19 percent of GDP at the end of FY2017/18.

Monetary policy has been accommodative. The Bank of Botswana reduced the benchmark policy rate to 5 percent in October 2017 in response to weak economic activity and low inflation. To align market interest rates with the policy stance, the BoB lifted restrictions on the issuance of central bank certificates. At the same time, an increasing demand for longerdated assets was satisfied by expanding the range of securities usable as collateral. Nonetheless, credit growth decelerated reflecting declining demand due to weaker economic activity and risk aversion.

Policy discussions

The discussions focused on how to preserve economic stability, unlock growth potential, and create jobs. Achieving these goals will require tax and expenditure measures to ensure a gradual return to fiscal surplus, together with a prudent monetary policy and reforms to strengthen public financial management, foster financial deepening, improve the business environment, upgrade skills in the labor force, and facilitate the development of sectors with latent comparative advantage.

Enabling an export-oriented and job-creating private sector

Job creation and economic diversification are central to Botswana’s development. While macroeconomic stability and public-sector reforms are important, a set of other structural reforms will need to be decisively implemented to develop the private sector, create jobs, and diversify exports. The reforms will have to be time-bound and aimed at lowering the cost of doing business, loosening labor market rigidities and improving skills, enabling the development of sectors with latent comparative advantage, and promoting financial deepening and inclusion.

Lowering the Cost of Doing Business

In recent years, Botswana lost some ground as an investment destination. Despite recent improvements, including the set-up of a one-stop center for registering new businesses and legislation to allow online business registrations, the pace of reforms during the past decade has been rather slow, with the country losing 10 places in the Doing Business rankings (it now ranks 81st out of 190 countries). Furthermore, Botswana ranks 153rd in the "starting a business” category and ranks lower than some upper-middle income countries in this and other categories.

The authorities stated their commitment to improve the business environment. They plan to update in collaboration with the World Bank their 2015 doing business roadmap, considering the delays incurred and possible changes in priorities. The staff noted that quick wins include the adoption of electronic filing for all companies, streamlined requirements for licensing, and reforms to improve creditors’ rights. At the same time, a more focused list of reforms should be targeted, with clear timelines and accountability and close monitoring by the High Level Consultative Committee chaired by the President.

Implementing Market-Friendly Sectoral Reforms

Diversification plans appropriately focuses on sectors the authorities see as having comparative advantage. The authorities have engaged an international consulting firm to advise on the steps to develop the beef, tourism, and financial services sectors, which are perceived as having the potential to create jobs and generate export receipts. The steps will likely follow recommendations and actions envisaged in earlier studies by the World Bank, external consultants, and the BoB. Staff noted that, to unlock these sectors’ potential, it will be critical to remove government-induced distortions and bottlenecks while promoting greater competition and prioritizing public investments and reforms in areas with the highest payoffs and positive externalities.

In the cattle and beef sector, for instance, reforms are needed to boost scale and productivity and facilitate entry of firms. With quota and duty-free access to the EU market and a large potential to produce high-quality beef, it is estimated that exports could easily triple from current sales of US$80 million if the market is liberalized. Key short-term actions should be to:

  • Remove the Botswana Meat Commission (BMC)’s export monopoly to allow new investments and participants in the market, privatize the company, and reduce excess capacity by selling the Francistown abattoir (a facility that is underutilized and unprofitable);

  • Align prices paid to high quality producers on international prices (at present, prices are preset) and allow for the exportation of live animals to raise profitability for domestic farmers and increase competition; and

  • Liberalize imports of beef to serve the domestic market and consider allowing for imports of live animals to be slaughtered domestically (to use idle capacity) to either serve the domestic market or re-export to other countries in the region.

Tourism is also deemed to have significant potential. It is estimated that a focused and well-executed strategy could, in the medium to long-term, nearly double export receipts and employment compared to current levels of about US$700 million and 26,000 people, respectively. Such a strategy could entail:

  • Producing detailed estimates of costs and benefits of exploiting different tourism regions to prioritize investments in product and geographic diversification;

  • Addressing supply-related restrictions through specialized training in hospitality services and business management, improvements in air access (e.g. foster competition in domestic and regional flights), and investments in the airport infrastructure and internet connectivity in regions with clearly identified potential;

  • Eliminating bureaucratic rigidities and developing a tourism-friendly environment by liberalizing restrictions for work permits and visas, adopting simplified requirements for the provision of tourism facilities and services, and promoting the dissemination of information; and

  • Considering ways to capture a larger portion of the value chain and minimize leakages, particularly by reviewing the licensing system and the lease value of land in tourist sites in future bidding rounds.

Deepening Financial Development and Fostering Inclusion

There is room to boost the contribution of the financial system to the economy. Despite a deepening of capital markets in the past decade, the system remains underdeveloped. Access to finance by the corporate sector is limited, and nonbank financial intermediation has yet to become a full-fledged alternative. The private sector credit-to-GDP ratio stands at 31 percent of GDP compared to 100 percent in upper middle-income countries and lending is concentrated on credit to households (60 percent of total loans). To address these issues, the staff underscored the importance of the following measures:

  • Strengthen the creditor database and collateral registry for assets to improve information on borrowers’ creditworthiness and support enforcement of loan contracts;

  • Increase the volume and frequency of government bonds issued to develop a reliable yield curve that can be used as a price benchmark for other assets;

  • Improve electronic connectivity in the financial system to facilitate advanced transactions and strengthen the clearing house to facilitate trade in derivatives; and

  • Adopt the Principles for Financial Market Infrastructures published by the Committee on Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissions (IOSCO) to ensure effective regulations to develop securities’ markets.

In addition, developing mobile payments could foster financial inclusion. A low cap on the amount of daily mobile payments and account balances, high transaction costs, and limited options for mobile transactions discourage payments and deter inclusion. Staff advised the authorities to gradually increase this ceiling and strengthen supervision, allow inter-operability across networks and with bank accounts, promote other payment mechanisms, and foster cross-border mobile money transfers, all of which will increase efficiency and lower costs for low-income households.

The authorities broadly agreed with the staff recommendations on the business environment, labor market, sectoral reforms, and financial development. They attributed delays in doing business reforms to the need to change several regulations at the same time and reiterated their commitment to accelerate implementation of reforms as highlighted by the recent passage of multiple laws and President Masisi’s announcements. On the issuance of additional government bonds, they noted that they would like to strike a balance between the cost of issuance, the goal to develop the financial market, and the risk of crowding-out financing of public enterprises.

Source International Monetary Fund
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Date 06 Sep 2018
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