Economic Review

Bifm Economic Review 2nd Quarter 2007

Figure 1: Inflation Figure 2: Real Prime Lending Rate – Botswana and South Africa

The second quarter of 2007 has seen generallypositive economic developments, with fallinginflation, a cut in interest rates, good externaltrade performance and indications of risingeconomic growth and confidence. However,economic assessments from the WorldEconomic Forum and the InternationalMonetary Fund point to some economicweaknesses and urge reforms to improve theinvestment climate. Finally, although thereare concerns about the slow pace of economicdiversification, trade data suggests that thediversification policy has been more successfulthan is sometimes believed.

Inflation and Monetary Policy

The second quarter of the year has seencontinued success in containing inflation,which declined to 6.3% in April from 6.5%in March, before rising slightly to 6.4% inMay. This represents the lowest inflation levelfor two years. However, despite the declinein the annual rate of inflation, recent monthshave seen some cost pressures, particularlythose arising from rising global and regionalfood prices. Notably, the prices of bread,cereals, meat and dairy products have allexhibited sharp price increase in the last threemonths. The prices of alcohol and tobaccohave also risen sharply. With foodstuffsaccounting for 22% of the CPI basket, andalcohol and tobacco a further 9%, thesetrends, if sustained, will inevitably have asignificant impact on inflation going forward.There are also concerns about risinginternational oil prices; although these havenot yet fed through to Botswana fuel pricesin a major way, if current international pricesare sustained then local prices will eventuallyhave to rise.

Although there are inflationary concernsstemming from food and oil prices, it isencouraging that inflation has fallen withinthe Bank of Botswana’s 2007 objective rangeof 4%-7% for the past three months. Goingforward, our forecast is for inflation to remainat around current levels for most of 2007,although rising food and fuel prices maycause inflation to rise above this. Nevertheless,

we consider it likely that inflation will remainwithin the 4%-7% range for the next 12months (see Figure 1).

In June 2007 the Bank of Botswana (BoB)cut its benchmark interest rate - the BankRate - by half a percent to 14.5%, a relativelymodest cut given the sharp decline inflationover the past 12 months, from a peak of14.2% in April 2006. The Bank of Botswana’sreluctance to reduce rates earlier was drivenby concerns about future inflationarypressures arising from domestic demand. Forinstance, the rate of bank credit growth, at18.4% in April, is relatively high and wellabove the BoB’s preferred range for creditgrowth of 11%-14%. Nevertheless, whilethere may be inflationary pressures, as notedabove, these are likely to come largely fromregional and international food and oil prices,which are largely beyond the control ofBotswana’s monetary policy. Tight monetarypolicy also reflected a desire to suppress thepotential inflationary impact of the crawlingpeg exchange rate regime, which tends toadd to imported inflation.

Prior to the recent cut, real (inflation adjusted)interest rates had reached their highest everlevel in Botswana, and even after the ratereduction remain well above real interestrates in neighbouring South Africa, whichhas a similar inflation rate to that ofBotswana. Whereas the real prime lendingrate in Botswana is now around 9%, in SouthAfrica it is only around 6%, notwithstanding

Source: BoB, CSO, SARB, Stats SA, EconsultSource: BoB, CSO, Econsult

Summary ofEconomicDevelopmentsDr Keith Jefferis,Chairman ofBifm InvestmentCommittee

Economic Review2Figure 3: Business growth indicators Figure 4: Business Confidence Index

(% of firms rating current business conditions satisfactory)

Figure 5: Export Growth, 2006 Q1 – 2007 Q1(US$)

Figure 6: The Most Problematic Factorsfor Business in Botswana

the fact that South Africa probably has highereconomic growth, and hence greater demandpressures, than Botswana (see Figure 2). Withsuch high real interest rates, there has beenincreasing concern in the private sectorBotswana’s growth is being unduly restrictedas a result, and the rate reduction will comeas a welcome relief to firms and households.

Economic Activity

The most recent GDP data, covering theperiod to June 2006, indicated that growthin the non-mining private sector was around2.5% during 2005/06. However, there areno GDP data available covering the last twelvemonths, and so interpretations of recenteconomic growth have to rely on other data.

Of this, data on bank lending to the privatesector suggest that growth is healthy, withcredit up 10.6% in real terms over the twelvemonths to April 2007. Although this is slightlylower than the 15% real growth recordedtowards the end of 2006, 12 months agothe real growth rate of bank credit to the

private business sector was only 2.2%, sothe increased growth rate is indicative of animprovement in business conditions.

Data on electricity consumption also suggeststhat recovery is well under way (see Figure3). Non-mining electricity consumption grewby 10.6% in the year to April 2007, comparedonly 1.8% a year earlier.

A further indicator of the strength ofeconomic conditions is the number ofapplications for business licences under theTrade and Liquor Act. While this does notinclude all new businesses, it does include awide variety of trading businesses, and thenumber of applications provides an indicationof new business activity. In the first half of2007, the number of new licence applicationswas 2 094, compared to 1 979 in the firsthalf of 2006, an increase of 5.8%. This isconsistent with a healthy growth rate for thenon-mining private sector in the range of4%-6%.

The Bank of Botswana has released the results

of its bi-annual business confidence survey,carried out in March 2007 (see Figure 4).The results of this survey (available in moredetail at www.bob.bw) show a markedimprovement in business confidence, withthe proportion of businesses rating currentbusiness conditions satisfactory rising from52% in September 2006 to 66% inSeptember 2007; even higher levels ofconfidence are recorded for expectedbusiness conditions in the second half of2007 and into 2008. It is also noticeable thatfor the first time, confidence levels amongstfirms selling primarily into the domesticmarket exceed confidence levels amongexporters.

External Trade

Botswana continues to benefit from a positivetrade performance. Since 2003, exports haveincreased at an average annual rate of 27%,while imports have increased at only 13% ayear. Although much of this export growthhas been driven by higher diamond exports,

Source: Bank of BotswanaSource: BoB, BPC, Econsult

Source: CSO Source: WEF

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Economic Review3non-diamond exports have been growing ata faster rate. The result has been rapidlyincreasing trade surpluses, which at P10billion for the 12 months to March 2007,is equivalent to around 16% of GDP.

The commodities driving exports can be seenfrom Figure 5, which shows the growth ofexports by major commodity in the first quarterof 2007 over the same period in 2006,measured in US dollar terms. While totalexports increased by 22% over this period,there was extremely rapid growth – of over150% - for copper-nickel, meat, and textiles.Diamonds made a minimal contribution toexport growth over this period.

World Economic Forum AfricaCompetitiveness Report

The World Economic Forum has publishedthe 2007 Africa Competitiveness Report(ACR), which amongst other things includesan updated Global Competitiveness Index(GCI) and a Competitiveness Profile for eachAfrican country.

In comparison with other countries in sub-Saharan Africa, Botswana does well in theGCI rankings: as in the previous GCI (2005),Botswana is rated third in sub-Saharan Africa(after South Africa and Mauritius). However,performance on a global scale is less good,with Botswana rated at no. 83 (out of 128countries). Furthermore, relative globalperformance has slipped, as in the 2005-06GCI rankings, Botswana was rated at number72 (out of 117 economies).

The Competitiveness Profile also providesinformation on the most problematic factorsfor doing business, which for Botswana areshown in Figure 6. Interestingly, inefficientgovernment bureaucracy is rated the mostproblematic, with factors related to theworkforce (education and skills, work ethicand labour regulations) coming next. Alongwith access to finance, these factorsaccounted for nearly two-thirds of responses.

IMF Article IV Assessment

One June 28th the IMF released a PublicInformation Notice relating to its Article IVassessment of the Botswana economy. Asusual the IMF was generally positive in itsassessment of the economy. However, it didraise some concerns and made suggestionsas to how economic management could beimproved. Amongst the key issues notedwere that diamond production (and henceexport earnings and government revenues)would peak in around 15 years time and

decline sharply thereafter (as productionmoves underground). In view of the fiscalimplications of declining diamond production,the government is urged to cut spending (asa proportion of GDP) and broaden the taxbase, and not to rule out possible futureincreases in tax rates. Secondly, the IMFexpressed concern regarding potentialconflicts between the objectives of monetarypolicy (using interest rates to fight inflation)and exchange rate policy (using the crawlingpeg regime target the real effective exchangerate), and urged that the first of theseobjectives be given priority. The IMF alsorecommended that the exchange rate basketweights and the rate of crawl should bepublicly disclosed. More generally, the IMFsaid that consideration should be given totighter monetary policy to fight inflation. Italso urged continued efforts to undertakelabour market reforms, implementprivatisation and improve the investmentclimate, in order to boost competitivenessand support economic diversification.

There are some oddities in the IMF note,however, with sloppy or misleading use ofeconomic data. For instance, it noted thatthe real effective exchange rate (REER) hadappreciated during 2006 as a result of higherinflation, whereas its own data published inthe note showed that the REER haddepreciated substantially – as intended,meaning improved competitiveness - as aresult of the 2004 and 2005 devaluations.Also, it quotes a 35% adult HIV prevalencerate for Botswana from UNAIDS, whereas infact the actual (and correct) prevalence ratecited by UNAIDS is 24%.

Feature:

Is Economic DiversificationTaking Place?

See next page

Economic Review4

and of gross domestic expenditure. However,this share has been steadily declining; untilthe mid-1980s we imported around 60% ofwhat we consumed and invested, whereasit is now down to around 40%, indicatingthat domestic production now accounts fora greater proportion of what we consume(see Figure 9 overleaf). This is a sign ofsuccess, given that reducing dependenceupon imports has been one of the objectivesof economic diversification.

Further evidence of diversification successcan be found in the trade data. Export datashows that the structure of exports ischanging (and we know that because of thesmall domestic economy, diversification hasto be export-led). Firstly, goods exports havebecome more diversified. After a long periodwhere the share of diamonds in total goodsexports rose, to over 80%, over the past fewyears non-diamond exports have beengrowing faster than diamond exports, andthe share of diamond exports fell to 72% in2006. A second trend has been the increasingimportance of services exports; the share ofservices in total exports (of goods and services)has been rising, with services exports growingfaster than both diamond and non-diamondgoods exports, mostly reflecting the growthof the tourism sector.

One of the objectives of economic diversificationhas been to reduce Botswana’s dependenceupon diamond exports, and this has to a certain

extent been achieved. In the early 1990s,exports of goods and services other thandiamonds could only pay for around 30% ofimports of goods and services, whereas by2006 non-diamond exports covered the costof 61% of imports. This is another sign thatthere has been some diversification.

The contrasting stories told by GDP data andtrade data are shown clearly in Figure 10over leaf, which shows indices ofdiversification, one using GDP data and oneusing export data (goods and services), overthe period 1992-2006. Although they showsimilar year-to year changes, the GDP seriesclearly shows a downward trend indiversification, while the export series showsan upward trend.*

Why there is such a difference? Although inprinciple they measure similar things, thedata sources for trade and GDP data arequite different. The national accounts data(used for GDP calculations) are primarilyderived from surveys (such as the survey offirms). The quality of the resulting datadepends upon both the quality of the sampleframe from which survey respondents areselected, and the responsiveness of thosesurveyed. In recent years both have beenquestionable, with an increasingly outdatedregister of economic establishments uponwhich firm surveys are based, and problems

Feature:

Is Economic Diversification Taking Place?

*Index of Diversification = 1 – HHI (Hirschman-Herfindahl Index of Concentration).

Figure 7: Trends in the Diversification of Economic Activity Figure 8: GDP shares (constant prices)

Source:CSO Source: CSO

There has been concern for a number ofyears that Botswana’s economic diversificationstrategy has been unsuccessful, and that theeconomic structure remains overly dependentupon minerals, and upon diamond miningin particular. This concern is supported byreference to data on Gross Domestic Product(GDP), which points to three distinct periodsof approximately ten years each over the past30 years. Figure 7 shows trends in the non-mining sector’s share of GDP and an “Indexof Diversification”. From the mid-1970s untilthe mid-1980s diversification declined, as themineral sector grew rapidly and its share inGDP expanded. From the mid-1980s untilthe mid-1990s there was rising diversification,as non-mining sector growth took off. Fromthe mid-1990s to the present, however,diversification appears to have declined oncemore.

Interestingly the period of increaseddiversification was driven not by an increasedshare of manufacturing in GDP (or ofsecondary industry more generally), but byincreased output of non-government services;these grew from 12% of GDP in 1983/84 to30% of GDP in 1994/95, much of which wasin turn due to the growth of banking,insurance and business services, as well astrade, hotels & restaurants (see Figure 8).

However, the picture may not be as gloomyas the GDP data suggests, as other data showa somewhat different story. Historically,imports accounted for well over 50% of GDP

Economic Review

with low response rates.

Trade data are different, however, as theyare derived from customs records; in principleevery shipment of goods entering or leavingBotswana is recorded through customsdeclarations, and at most border posts datacollection is now automated. Trade data arenot based on sample surveys, and are muchmore comprehensive. And at least for exportsthere is no reason to believe that there isany systematic bias in the recorded values,so the data should be accurate.

A clear example of the contrast betweenproduction (GDP) and export data can beseen in the textiles sector. Virtually all ofBotswana’s textile production is exported,so the sector’s gross output (recorded for

the purposes of GDP calculations) should bevery similar to the value of its exports.However, as Figure 11 shows, this is nolonger the case. Until 2001, exports andgross output were very similar, as would beexpected. Since that time, however, textileexports have shown dramatic growth, asnew firms have set up in business, many ofthem taking advantage of exportopportunities to the USA under the AfricaGrowth and Opportunity Act (AGOA). GDPdata, however, show only a minimalincrease. One possible explanation for thisis that these new firms are not being includedin production surveys for GDP purposes.Another possible explanation is that exportscomprise goods which are being importedand “transhipped” rather than beingproduced in Botswana. However, textile

Bifm Botswana LimitedAsset Management. Property Management. Private Equity. Corporate Advisory Services.Private Bag BR 185, Broadhurst, Botswana Tel: +(267) 395 1564. Fax: +(267) 390 0358. Website: www.bifm.co.bw

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import data shows no dramatic increase inimports during the period when textileexports have shot up, so this is unlikely. It ismore likely that the GDP data are inaccurateand are under-recording textile production.If there is an “outdated sample bias” thiswould lead to a systematic under-recordingof diversification in the GDP data (as the newfirms that characterise a successfullydiversifying economy are more likely to bemissed out of production surveys). It mayalso lead to an under-recording of associatedeconomic trends, such as overall GDP growthand employment creation. Fortunately theCentral Statistics Office is undertaking acomprehensive updating of the Enterprisesand Establishments Register, which shouldlead to a more accurate recording of GDPand employment developments.

Figure 9: Imports of Goods and Services

Source: CSO

Figure 11: Textiles production and Exports

*9 monthsNational accounts yearsSource: CSO

Figure 10: Index of diversification, GDP and Export Measures

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