Public Information Notice No. 01/37

Public Information Notice: IMF Concludes Article IV Consultation with Botswana

April 13, 2001

On March 12, 2001, the Executive Board concluded the Article IV consultation with Botswana.¹

Background

Abundant diamond resources, coupled with sound macroeconomic policies, have enabled Botswana to achieve one of the highest growth rates in the world. Over the past 30 years, real per capita GDP growth averaged more than 7 percent a year, allowing Botswana to move from one of the poorest countries in the world to a position as a middle-income country today. Botswana remains heavily dependent on its diamond sector: it accounts for more than one-third of GDP and 70 percent of export earnings.

Real GDP growth increased to an estimated 7¾ percent in 1999/2000 (July-June) largely reflecting a rebound in the global diamond market. Other sectors of the economy also performed well, in part as a product of Botswana's market-friendly environment, sound macroeconomic policies, and investments in education and physical infrastructure.

Consumer price inflation (12-month basis) accelerated in 2000 to 8¾ percent by year's end reflecting buoyant demand, especially in the construction sector, but benefited from the appreciation of the pula against the South African rand. Botswana's rate of inflation continued to mirror broadly the core inflation in South Africa. This follows from the close trade ties between the two countries and Botswana's exchange rate, which is pegged to the rand and the SDR.

The overall fiscal balance returned to a surplus in 1999/2000 (April-March), from an unexpected deficit the year before. The significant improvement in the budgetary outcome mostly reflected the sharp rise in diamond revenue. Spending growth was brought down from a very high rate of increase the year before, when civil servant salaries were raised by 25 percent and development spending increased sharply.

Monetary developments in 2000 were characterized by a slowing of credit growth to the private sector, but from excessive rates of increase in 1998-99. The Bank of Botswana used open market operations—the sale of Bank of Botswana Certificates—to raise interest rates and tighten credit conditions. The pula was generally stable in effective terms, owing to Botswana's pegged exchange rate system. However, the pula depreciated by about 6 percent and 14 percent against the euro and U.S. dollar respectively, while appreciating by some 6 percent against the rand.

The external current account was in surplus by an estimated 17 percent of GDP in 2000. This surplus was largely attributable to the performance of the diamond industry. Imports remained strong, reflecting domestic demand developments. Gross international reserves rose to an estimated $6.3 billion at end-2000, equivalent to 36 months of imports of goods and services. Botswana, as a member of the Southern African Customs Union, is seeing its external tariffs decline.

Executive Board Assessment

Executive Directors agreed with the thrust of the staff appraisal. They noted that, since the conclusion of the last Article IV consultation in October 1999, GDP growth had rebounded, the fiscal deficit had been erased, and the current account surplus had widened. They observed that a recovery in the world diamond market largely accounted for these gains, which underscored the country's reliance on this single commodity. Directors also noted that consumer price inflation had risen over the past 24 months, but remained broadly in line with core inflation in South Africa. Still, due to a lack of timely data, Directors cautioned that it was too early to know whether underlying inflation pressures have abated.

Directors expressed concern over the economic and social consequences of AIDS. They welcomed the government's focus on combating the spread of the disease through AIDS education and awareness and medical intervention to reduce the mother-to-child transmission of the AIDS virus. They also welcomed programs to alleviate suffering by providing financial support to orphans and home-based care to AIDS patients. They encouraged the staff to remain ready to help evaluate the macroeconomic implications of advanced treatments once the nature and costs of these treatments became clear.

Directors noted that Botswana will face difficult choices among public spending priorities. They observed that one area of growing pressure would be AIDS-related demands; others include the anticipated plateau in diamond revenue and declines in SACU revenue. Directors welcomed plans to introduce a new VAT next year as means of partially offsetting these anticipated losses, but controlling spending should be a priority. They also cautioned against raising other taxes as higher direct tax rates could undermine the competitive advantage that Botswana maintains in this area.

Directors noted that key budget mechanisms to help accomplish spending restraint are in place, but stressed that further improvements in this area are needed. They welcomed efforts by the Ministry of Finance and Development Planning aimed at strengthening the development spending process, and encouraged the authorities to adopt a multiyear planning framework for the full budget. They argued that such an approach would match development and recurrent spending assumptions with revenue and macroeconomic projections and help further strengthen budgetary discipline. In this context, Directors also observed that improved reporting of Botswana's public finances could promote foreign investment by making the budget process more transparent.

Directors observed that Botswana's exchange rate peg had served the country well as the appropriate nominal anchor. They noted that the Bank of Botswana was able to maintain the peg, while at the same time it enjoyed some latitude in determining interest rates because capital markets were not yet well developed. They agreed, therefore, that increases in the bank rate over the past two years were an appropriate response to domestic demand pressures. They observed, however, that monetary policy decision making was constrained by the lack of timely economic indicators.

Directors commended the Bank of Botswana's efforts in the area of bank supervision. They cautioned, however, that demands for supervision could increase as the new financial services center develops. They urged the authorities to ensure that the center expanded at a measured pace so that it did not grow ahead of supervision capabilities.

Directors noted that long reporting lags, especially in the national accounts and some fiscal data, had hampered efforts to assess macroeconomic conditions. They welcomed plans, therefore, to introduce quarterly national account data, to be produced with a one quarter lag. They also encouraged the authorities to adopt the recommendations of a recent technical assistance mission on balance of payments statistics and to harmonize the reporting years used for the major economic sectors. In addition, Directors urged the authorities to complete the process of participation in the Fund's General Data Dissemination System.

It is expected that the next Article IV consultation with Botswana will be held on the standard 12-month cycle.