This document details the scope and the main elements of the Country Partnership Framework (CPF) with the Republic of Botswana for FY16-20.

The previous Country Partnership Strategy (CPS), considered by the Board on May 21, 2009 and completed in 2013 has built a solid foundation to design the new World Bank Group program. The proposed CPF supports the government’s ongoing National Development Plan (NDP10) that has recently been extended until 2017. It also reviews the new NDP11 now under preparation.

The Systematic Country Diagnostic (SCD) was completed after Botswana’s General Elections in October 2014. The SCD drew on all available research and benefited greatly from the series of stakeholder consultations conducted in the country between March and September, 2014. The report was well received by the national authorities and sent for information to the Board on March 31, 2015.

The SCD identified the following priority development challenges: (a) Despite rapidly declining poverty, low job creation keeps inequality extremely high; (b) With the weakening of traditional growth drivers, a new growth model is needed that is jobs-intensive, export-oriented, and private sector-driven; (c) Despite broad and well-intentioned investment, inclusion barriers remain; (d) Sustainability is threatened as resource vulnerability challenges long-term growth and inclusion.

The CPF also considers the lessons learned and key suggestions presented in the FY09-13 Country Partnership Strategy Completion and Learning Report (CPS CLR). In particular, it notes the importance of assessing the client’s implementation capacity and providing implementation support. The CPF maintains a strong Advisory Services and Analytics (ASA) and technical assistance (TA) program. This was seen as a key strength of the CPS, and highly valued by the client. Proper consideration is given to introducing robust monitoring and evaluation systems since the latter were deemed essential for assessing the impact of government programs. The findings of the World Bank Country Survey 2013 are also taken into consideration.

During the two year period (FY14-15) not covered by any strategic document, the WBG engagement focused on implementation support to the lending operations initiated during the CPF FY09-13. No new lending operations were approved during FY14-15. The dialogue started with the Government of Botswana (GoB) in 2011 on economic diversification issues led to the government’s request for Reimbursable Advisory Services (RAS) in business environment, trade and industry policy, infrastructure services, access to finance, public sector management, and innovation and skills development. As a result, the Economic Diversification Competitiveness RAS was signed in February 2013 and implemented during 2015.

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Country Context and Development Agenda

Recent Economic Developments

After more than 40 years of sustained, often rapid growth, Botswana’s economy experienced a sharp contraction of almost 8 percent during the global economic crisis in 2009. This followed the collapse of the global diamonds market, highlighting the country’s macro and fiscal vulnerability and dependence on diamonds. The economy has rebounded well, having grown almost 6 percent per year since 2010.

Continued demand in the global market for rough diamonds, offset by declining prices in other key export commodities, resulted in a stable economic performance for Botswana in 2014. GDP growth slowed slightly to 5.0 percent, down from 5.8 percent in 2013. Value-added growth in the mining sector moderated to just over 4 percent, while growth in the non-mining private sector remained steady at around 5 percent, driven by strong growth in the services sector. This marks a continuation of the post-crisis structural change of the Botswana economy, which has seen the services sector jump from around 40 percent of GDP in the two decades prior to the crisis to 60 percent of GDP in 2014.

This structural shift to services is mirrored by a similar shift from export-led to consumption-led growth in the post-crisis years. Household consumption rose from less than 40 percent of GDP in the pre-crisis years to 54 percent between 2012 and 2013, with per capita consumption expanding nearly 9 percent annually in real terms between 2004 and 2013. In 2014, however, consumption growth decelerated sharply, with household consumption growing just 3.6 percent and government spending remaining flat.

The recent slowdown in consumption highlights concerns about rising household debt and the sustainability of consumption-led growth. Between 2004 and 2013, bank lending to households grew by more than 20 percent annually. This comes off a low base – bank credit to the private sector in Botswana still represents only around 30 percent of GDP. But this is almost double the level of a decade ago and comes amidst a backdrop of stagnant employment and wage growth.

Weak local demand is reflected in the sharp fall in inflation in recent years. After sitting well above the Bank of Botswana’s 3-6 percent target range for much of the last decade, Consumer Price Index (CPI) inflation fell within the range during 2013, and recently falling oil prices helped inflation reach a low of 3.8 percent in December 2014. In an effort to stimulate investment and consumption, and given the stable, low inflation outlook, the Bank of Botswana reduced the base interest rate by 100 basis points in February 2015 to 6.5 percent in 2013 – its lowest level in 25 years.

Following four straight years of deficit (averaging more than 5 percent of GDP) between 2009 and 2012, higher diamond shipments and prices returned the current account to a significant surplus in 2013 (at 10.4 percent of GDP). The recent improvements in mineral exports have enabled Botswana to rebuild its reserves, which were severely depleted by the crisis. The collapse of exports during the crisis led to a fall in foreign exchange reserves from 90 percent of GDP in December 2008 to just 55 percent of GDP in December 2013. Slow rebuilding has brought foreign exchange reserves to P79 billion, an all-time peak in pula terms, sufficient to finance at least 13 months of imports.

While export growth overall is positive, Botswana has come to rely even more on diamonds, which in 2013 accounted for almost 90 percent of goods exports and more than 80 percent of total exports, up from just 61 percent in the five years prior to the crisis. One factor contributing to this is the evolution of exchange rates. Between January 2013 and December 2014, the pula depreciated almost 17 percent against the US dollar (the trading currency for diamonds) while appreciating 10.5 percent against the South African Rand (the main market for non-minerals exports and the principal source of imports). Nonetheless, diamond exports comprise a significant share of domestic value added, accounting for almost 23 percent of total GDP.

Economic growth in Botswana is set to slow on the back of weaker diamond prices and slower growth in key trading partners. With the slowdown in demand in China and some other large economies, diamond prices have fallen by 14.7 percent between mid-2014 and mid-2015 and output is also being cut. In addition, growth is also slowing sharply in South Africa, one of Botswana’s key export partners. Real GDP growth is forecast to ease to 2.6-3.0 percent in 2015 and to recover to the 4 percent range in 2016-17 as cuts in diamond production help stabilize prices.

Still, with diamonds comprising one-third of government revenues and transfers from the Southern African Customs Union (SACU) a further one-quarter, there will be a significant fiscal deterioration. The fiscal balance is expected to swing from a surplus of 14.5 percent of GDP in 2014 to a deficit of 2 percent of GDP in 2015, and then remain at a slight deficit between 2016 and 2017. But public debt remains low (it had peaked 26.5 percent of GDP in 2011- 2012 and fell to 22.3 percent of GDP in 2014-2015, with domestic debt at just 7 percent). With the significant savings amassed in the Pula Fund and high levels of international reserves, Botswana has ample fiscal space to smooth this shock and avoid any sharp adjustment measures. But the deterioration in the growth and fiscal outlook only underscores the risks associated with a high dependency on diamonds and therefore the need for diversification. Botswana has to bolster its international competitiveness and attract investment in tradable sectors outside of mining. Foreign direct investments (FDI) represent on average just over 3 percent of GDP annually.

Keenly aware of its overexposure to diamonds, along with its heavy reliance on revenues from the SACU customs pool, the government has continued to exercise fiscal prudence to build deeper financial buffers. The Ministry of Finance and Development Planning (MFDP) has made a formal proposal to Parliament to adopt two new fiscal rules. The first of these rules aims to broaden revenues sources by requiring non-mining revenues to amount to at least 30 percent of non-mining GDP. The second aims to force tighter controls on spending and ensure greater long-term savings by requiring that 40 percent of mineral revenues are set aside in an intergenerational savings fund.

The slow down in growth also shows that government spending must be both efficient and effective to support growth and poverty alleviation. The government faces two main challenges on the expenditure side: reducing the public wage bill and improving the efficiency of spending on public investment projects. While annual growth of the wage bill has continued to fall since FY10-11, expenditures on wages remain consistently above budgeted levels – 20 percent above in the case of FY12-13. Underspending against the capital budget has been a consistent problem; in FY12-13 and FY13-14 development budget was underspent by an average 20 percent. The International Monetary Fund plans to conduct an Article IV consultation at the end of 2015.

Poverty declined sharply and living standards improved in Botswana over the last decade. Between 2003 and 2010, poverty fell from 30.6 percent to 19.4 percent. The largest decrease in poverty incidence occurred in the rural areas, and poverty had become more urban. This rapid reduction in poverty stemmed mainly from increasing agriculture incomes, including subsidies, and demographic changes that led to a reduction in household sizes and dependency ratios. Improvements in rural area labor market outcomes, access to education, progressively from primary to secondary and tertiary education, as well as increases in the amount of household loans, were important sources of poverty reduction and welfare improvements. Social transfers also benefited the poor, accounting for about 3.9 percent of the reduction.

Poverty reduction has been accompanied by significant improvements in shared prosperity. Consumption per capita among the bottom 40 percent of population grew 4.9 percent annually in real terms between 2003 and 2010, compared with just 1.1 percent for the upper two quintiles. Botswana’s performance on the “shared prosperity indicator” was among the best in Africa, although just average compared with other upper middle income countries. Consumption growth in rural areas was far above urban areas. And in urban areas, per capita consumption actually declined for the top 40 percent of the income distribution between 2003 and 2010, suggesting the possibility of a squeeze on the urban middle class.

Inequality remains high but has fallen significantly. Between 2003 and 2010, inequality expressed by the Gini coefficient fell from 64.7 to 60.5, with a majority of the fall caused by welfare improvement in the rural areas, while inequality in the cities had increased slightly. With a Gini of 60.5, Botswana remains one of the most unequal countries in the world. Demographic characteristics such as household size and number of children – in conjunction with the changes in the geographical location, level of education and labor participation – play a significant role in explaining the inequality.

Despite these positive trends in poverty and shared prosperity, poverty remains a serious concern in Botswana. Poverty has a strong regional dimension, with acute levels found in more remote areas, most prominently in the far northwest, as well as in the west and southwest of the country. It is also closely linked to specific demographic indicators. Children, large households, households with low educational achievement, and the unemployed or inactive all suffer disproportionally from poverty. Moreover, a large fraction of the population remains vulnerable to a significant risk of falling back into poverty. This risk is still higher among rural households that depend on small-scale subsistence farming.

Development Challenges

Botswana’s key development challenge is to find a new growth model that creates sufficient, broad-based employment. While Botswana has made substantial progress in poverty reduction over the past decade, both poverty and inequality remain high for a country of its income level. This is because growth in Botswana, being driven by the minerals sector, has not been linked to job creation. Therefore, the SCD concludes that eliminating poverty and improving the welfare of the bottom 40 percent of the population will require moving away from Botswana’s traditional growth model. That model has depended on extractives and involved channeling diamond revenues through the government, with subsequent high investment in education, health, and infrastructure. While the model has served well over several decades, it also has significant weaknesses: (i) it has been inadequate in generating jobs, contributing to high inequalities, and (ii) it has created a strong dependency on the state, both as the main investor and employer in the economy.

Transition to a new growth model would only be possible by developing a competitive and export-oriented private sector. The private sector in Botswana remains shallow, albeit entrepreneurs are emerging. The formal private sector created just one job for every six new entrants to the labor market over the past decade. The SCD argues that a more outward-oriented private sector, particularly in employment intensive sectors where Botswana can exploit global or regional comparative advantage, would be key to sustaining poverty reduction. As the domestic economy is small, the success of private sector development will depend on export markets. Botswana’s firms need to be better integrated into regional value chains, which requires addressing trade policy and trade facilitation barriers. The inward-looking investment environment needs to be reformed, and the high costs of operating in Botswana need to be addressed to encourage entrepreneurs to invest in export-oriented activities. Acknowledging that the process of necessary structural changes will take time, the SCD focuses on increasing the opportunities and returns to self-employment by raising productivity of smallholders and microenterprises.

Sustainable job creation for the poor and vulnerable, especially youth and women, is essential for addressing the twin goals. The sharp decline in unemployment over the last decade – from 23.9 percent to 17.2 percent between 2002-2003 and 2010, was shared across gender. Still, unemployment for males decreased more significantly than for females, resulting in a much larger gap between female and male unemployment – from 4.7 to 7.0 percentage points. Participation trends show some important differences across gender. Even though female participation remained relatively constant, while male participation declined substantially, the male participation rate remains more than 13 percentage points higher than the female rate.

The trends in participation and employment vary across age cohorts. While the differences are not dramatic, it is clear that the older population has gained at the expense of the younger population. The biggest decline in employment came in the 25-34 age group, while the biggest growth happened in the 55-64 age group. Within Botswana’s labor market, the formal private sector accounts for little more than 39 percent of total employment, with less than 20 percent of the working age population earning a wage in the private sector. The failure of the formal private sector to deliver quality employment, especially to the growing youth population, is a significant challenge and a serious barrier to structural transformation of the economy. In addition, the employment growth to date – coming in subsistence agriculture, public sector, and local non-tradables – raises major concerns about sustainability.

A step change in the productivity of Botswana’s firms is dependent on substantial improvements in human capital. The SCD notes that, despite huge public investment in the education sector (around 8.5 percent of GDP), outcomes are not only unequal but also weak across the board. The shortfalls of the education system coupled with a labor market failure to create employment opportunities, restricts the long-term prospects for youth – the segment of the population already impacted most by high unemployment. Ensuring equitable access to the secondary level of diverse education and training options would be especially critical for a diversified and inclusive economy.