Public Information Notice No. 02/126

Public Information Notice: IMF Concludes 2002 Article IV Consultation with Botswana

November 1, 2002

On October 9, 2002, the Executive Board of the International Monetary Fund (IMF) 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.

HIV/AIDS is Botswana's foremost economic and social challenge. The government is tackling the virus head on through prevention programs and it intends to provide advanced drug therapies to all those in need. Health spending was increased by 50 percent in the 2002/03 (April-March), but the long-term cost implications of HIV/AIDS are unclear.

Real GDP growth slipped to an estimated 1¼ percent in 2001/02 (July-June), largely reflecting a downturn in the global diamond market and a drop in Botswana's diamond production. The nonmining sectors performed better, especially the service industries. Their success is in part a product of Botswana's market-friendly environment, sound macroeconomic policies, and investments in education and physical infrastructure.

Consumer price inflation fell below 6 percent at the end of 2001, reflecting the tight monetary policy but also better inflation performance in Botswana's trading partners and a modest appreciation of the pula in effective terms. Inflation picked up in early 2002 as food prices in the region shot up, but subsequently retreated to under 6 percent in June 2002.

The overall fiscal balance moved into deficit 2001/02 (April-March), only the second deficit in 20 years. It is mainly attributed to the decline in mineral revenue, but also a 16 percent rise in government spending.

The Bank of Botswana held interest rates unchanged over the period October 2000-June 2002. Yields on Bank of Botswana Certificates have been steady in the 12½-13 percent range, but real interest rates have increased as inflation has come down. The pula was buffeted by volatility in the South African rand exchange rate against major currencies in 2001 and into early 2002, but the country's pegged exchange rate arrangement worked well, holding the effective exchange rate to an appreciation in the 5-7 percent range.

Botswana's external current account recorded a surplus of 10¼ percent in 2000 reflecting the buoyant global diamond market in that year. The current account is estimated to have been in surplus also in 2001, albeit considerably smaller mainly because of lower diamond export earnings. End year reserves were US$5.9 billion (32 months of imports). Botswana, as a member of the Southern African Customs Union, is seeing its external tariffs decline.

Executive Board Assessment

Directors noted that since the last Article IV consultation, Botswana's economy has been hit by several negative shocks, including a temporary decline in global diamond demand, the near 40 percent depreciation in the South African rand in 2001, and the regional food crisis. Directors commended the authorities for pursuing prudent macroeconomic policies, which, together with Botswana's substantial financial reserves, have helped the country weather these adverse external shocks.

Looking ahead, Botswana's medium-term growth prospects will depend on the continued sustained development of the nonmining economy, as diamond production and revenue reach a plateau, and on decisive action to contain the enormous social and economic costs of the HIV/AIDS pandemic. Directors were encouraged by the authorities' demonstrated commitment to meet these challenges successfully through the continued implementation of sound and market-friendly economic policies.

Directors commended in particular the government's head-on approach to the challenges of HIV/AIDS, by adopting a coordinated response that aims at preventing further spread of the infection, alleviating suffering, and treating all patients with advanced medication. They also welcomed the establishment of a national AIDS coordinating agency to help spearhead the program at the highest political level and help to mobilize international support. While the cost implications of the authorities' response are still highly uncertain, Directors noted that its budgetary impact is likely to be very high over time. They welcomed the authorities' commitment to expenditure restraint and public revenue enhancement, including the recent introduction of the VAT. Looking ahead, Directors urged the authorities to use the forthcoming National Development Plan 9 as the appropriate planning tool for addressing the budgetary impact of HIV/AIDS in a comprehensive manner, and for making the difficult choices concerning government resources and spending in a medium-term policy framework.

While Botswana's tight monetary stance is appropriate in view of demand and inflationary pressures, Directors agreed that an easing of monetary policy would be desirable to promote business investment and support the medium-term diversification objective. They stressed, however, that moves in this direction should be part of a broader effort to achieve a better balance between fiscal and monetary policies, and should be made only as demand conditions permit. To facilitate a better coordination of monetary and fiscal policies, Directors saw merit in the proposal of adopting the domestic budgetary balance as the main measure of the fiscal stance.

Directors considered that Botswana's exchange rate arrangement and inflation objective continue to constitute an appropriate framework for ensuring financial stability. A number of Directors saw scope, however, to further improve the transparency of the framework. Directors noted, that adherence to the framework was tested during 2001 and early 2002 by significant swings in regional currencies, which had resulted in an erosion of competitiveness. They underlined the need for close monitoring in the period ahead. Directors also underscored that continued structural reforms to lower domestic costs, as well as wage moderation, will be key to strengthening competitiveness.

Directors commended the authorities' commitment to structural reforms aimed at promoting private sector activity, and welcomed in particular their efforts to address shortages of skilled labor, make more serviced land available to the private sector, and update their privatization policy. They also encouraged the authorities to consider turning over to the private sector some of the projects anticipated under the National Development Plan. Directors noted that the quality of banking supervision is adequate, and welcomed the authorities' plan to review supervision of the nonbank financial sector in view of the recent rapid growth in this area. They also recommended that the authorities enhance their supervisory capacity over banks in the international financial services center. Directors commended the efforts to combat money laundering and the financing of terrorism, and encouraged them to follow up on recent Fund technical assistance in this area.

While welcoming Botswana's commitment to good quality statistics, Directors urged stronger efforts to reduce reporting lags and better harmonize data in the various macroeconomic accounts. Some Directors also encouraged the authorities to give a higher priority to the collection of timely data on poverty indicators.