Bifm Economic Review 2nd Quarter 2006 Economic Review The main reason for jump in inflation was noting that historically, peaks in Botswana’sSummary of the re-introduction of fees at government inflation have been short lived and followedEconomic secondary schools. According to the Central Statistics Office (CSO), this item alone added by rapid declines; for instance, inflation fellDevelopments 4.3% to inflation in January, while the impact from its highest ever level, 18.8% in May 1981, to only 7.6% in March 1982. of higher education fees was compoundedDr Keith Jefferis, by relatively high annual inflation for food, The dramatic impact of the increase in school fees on inflation does, however, bring intoChairman of alcohol & tobacco, fuel & power and transport & communications. Although the weight of question the reliability of the CPI as the basis for the calculation of inflation. As we haveBifm Investment government secondary school costs in the previously noted, the index is very out ofCommittee Consumer Price Index (CPI) basket is small at 1.2%, the increase in this item – which date (it is based on 1993/94 data) and does not reflect current or even recent expenditureSummary previously included only uniform costs – was patterns. In general, when CPIs becomeEconomic performance during the first quarter so high that it had a huge impact on the outdated they over-estimate inflation, and itof 2006 was mixed: inflation rose to overall CPI and inflation rate. is very likely that Botswana inflation is beinghistorically high levels, leading to higher Our forecast is for inflation to continue to overestimated due to the omission of itemsinterest rates, and there are no immediate rise slightly in next few months – although such as cellphones, airtime and computerssigns of improved economic activity in the it should peak at less than 18% - before from the CPI. The reason for the overestimatedomestic economy. On the plus side, however, declining the second half of the year (see Fig.2). is that new items such as these tend to fallthe 2006 budget was positively received, and Although the current inflation situation is of significantly and rapidly in price in the earlytrade data for 2005 shows extremely strong concern, there are good prospects for a rapid years after they become widely used andperformance across a range of commodities. decline in inflation in the second half of 2006 available, and this downward influenceThere are good prospects of improved and early 2007, as the impact of large on the price level is omitted from theeconomic performance, with faster growth one-off increases in prices resulting from the inflation calculation.and falling inflation, in the second half of May 2005 devaluation and the reintroduction There is also a problem arising from thethe year. of school fees drop out of the inflation weight of school fees in the CPI basket, calculation. Unlikely though it may seem atInflation which appears to be much higher than their the present time, it is quite conceivable thatInflation rose to 17.0% in February 2005, likely share of consumer spending. inflation will be back down around 6-8% bythe highest level for 13 years and not far February 2007, which would bring it close Government expects to raise P36 million fromfrom the historical peaks of 17.7% in to upper end of the Bank of Botswana (BoB) this measure in the 2006/07 financial year.June 1986 and 18.2% in January 1981 (see Fig.1). inflation objective range. It is also worth continue... Fig 1: Long-term Inflation Fig 2: Inflation - Actual and Forecast 20% 20% Actual Forecast 18% 18% 16% 16% 14% 14% 12% 12% 10% 10% 8% 8% 6% 6% BoB inflation objective range 4% 4% 2% 2% Source: Central Statistics Office and own calculations 0% 0% 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2002 Q2 Q3 Q4 2003 Q2 Q3 Q4 2004 Q2 Q3 Q4 2005 Q2 Q3 Q4 2006 Q2 Q3 Q4 2007
2 Economic ReviewThis equates to only 0.2% of estimated Setting the inflation objective is more Shortly before the MPS was released, theconsumer expenditure over this period, complicated this year given the existence of Bank increased interest rates by 0.5%, insuggesting that the 1.2% weight in the CPI the new crawling peg exchange rate regime, response to the sharp jump in Januarybasket is far too high – perhaps because the and the fact that the rate of crawl has an inflation, pushing the Bank Rate to 15%.impact of significant exemptions from school influence on inflation, through import prices. Isn doing so the Bank cited concerns aboutfees for poor households has not been taken inflation expectations and further upward Given that the crawl is ultimately underinto account. With a more appropriate control of the Ministry of Finance and inflation pressures. Not everybody found theweighting, school fees would have added Development Planning (MFDP), this illustrates explanation convincing, however; Standardonly around 0.8% to inflation, and inflation crucial importance of policy co-ordination Chartered Bank in London described it aswould currently be around 13% rather than between BoB and MFDP. “Wrong move. Wrong reason. Wrong time1”,the actual rate of 17%. noting that inflationary pressures were likelyIt is not unusual for a change in the price of The big question arising from the MPS is the to be subdued going forward. It is unlikelya single item to have a disproportionate credibility of the 4-7% inflation objective for that the hike in school fees will contributeimpact on the overall price level – for instance, 2006. Given that annual inflation is currently to a further round of upward priceit has happened in the past with BHC rentals 17%, and that inflation in the two months adjustments; effectively it was equivalent toand BTC telecoms charges, and in both cases of January and February alone totalled 6%, a tax increase that will reduce spendingthe disproportionate impact reflected, in part, it is evident that there is no prospect of power, thus reducing demand pressures,an inappropriate weighting of these items in meeting the inflation objective at any time which are already weak. Furthermore, asthe CPI basket. More generally this illustrates during 2006, even though there is good school fees are not an input to any productiona problem with relying on the headline CPI prospect of a substantial decline in inflation costs – other than very indirectly throughmeasure alone, and emphasises the need for and possibly meeting the objective early in their possible impact on wages – they willa measure of core or underlying inflation 2007. This raises key issues with regard to not have any cost-push effect on other prices.which is less subject to volatility from a the appropriate measure of inflation for thefew items. Economic Activity inflation objective. The use of theMonetary Policy Following the increase in interest rates, tight conventional headline inflation rate does notThe BoB released the 2006 Monetary Policy appear to be appropriate, given that it can monetary policy will continue to restrainStatement (MPS) on February 27. It contained economic growth. Indications are that be highly volatile for reasons that areno great surprises, but did have one important domestic economic activity has remained unrelated to changes in the domestic demandinnovation in the inclusion of a medium-term sluggish in the first quarter of 2006. Our pressures that monetary policy addresses.inflation objective. The MPS admitted that index of economic conditions remains in very The volatility of conventional headline inflation2005 had been a difficult year with respect weak territory, with the signs of possibleto controlling inflation, and that due to a illustrates the importance of having a publicly recovery evident in the first half of 2005range of exogenous factors, including oil available measure of core inflation, as is the completely reversed by the end of the yearprices and the devaluation of the Pula, the case in most developed countries. While BoB (see Fig.3)2. This is consistent with the findingsBank had been unable to bring inflation within makes reference to its own measure of core of the Bank of Botswana’s recent Businessthe objective range of 4-7% in the second inflation, and even includes it in the MPS Expectations Survey3, which noted thathalf of year. This was despite a lack of charts, it is not generally publicly available. business confidence was “very low” in theinflationary pressures from domestic demand, In this volatile inflation environment, thegiven that credit and government spending second half of 2005, with only just over a credibility of the inflation objective would bewere both growing slowly. Going forward, quarter of respondent firms describing strengthened if an agreed measure of corethe inflation objective for 2006 was retained business conditions as “satisfactory”. inflation were calculated and published,at 4-7%, while a medium term (2006-2008) continue... preferably by the CSO, on a regular basis.inflation objective was introduced, at 3-6%. 1. On the Ground - Africa (21st February 2006) With the focus on core inflation – which weThis is a useful development, which aims to 2. The Index comprises a weight average of growth ratesfocus inflation expectations, and represents estimate to be currently around 13% - the of bank credit to the private business sector and non-mining electricity consumption.a step towards the introduction of a full BoB’s objective for 2006 becomes potentially 3. See www.bob.bwinflation targeting regime. achievable by the end of the year.
3 Economic ReviewThe survey also noted a deterioration in National accounts data released along with inaccuracies in the data and the potentialbusiness conditions during the year with a the 2006 Budget shows healthy overall for future revisions that could significantly“sharp drop in overall business confidence economic growth of 8.4% in 2004/05, up revise the published data. As an example ofsince the previous survey” in March 2005, from 3.4% in the previous year. However, this where inaccuracies may arise, there is anwhich is consistent with the Index of conceals a sharp contrast between the mining inconsistency between the negative outputEconomic Conditions in Fig.3. sector, where value added grew by 18.2%, growth recorded for the manufacturing sector and the non-mining private sector, where in 2004/05 and the rapid expansion of exportsHowever, one important finding in BoB’s value added contracted by 0.2%. Negative of manufactured goods (meat, textiles,Survey was the much higher level of growth was recorded by the manufacturing vehicles & parts and “other goods”), whichconfidence shown by exporters – 57% sector (-2.6%), trade, hotels and restaurants rose (in nominal terms) by 43% during thefinding conditions satisfactory – as compared (-6.6%) and social & personal services (-0.5%). same period.with firms producing mainly for the domestic Healthier growth was shown by the transportmarket. This presumably reflected, in part, 2006 Government Budget sector (+5.6%) and financial & businessthe beneficial impact of the 2005 The 2006 Budget, presented to Parliament services (+4.1%) (see Fig.5).devaluation on the export sector. on February 6, includes an overall spending The data also showed a further decline inThe favourable export environment also increase of approximately 15% in the 2006/7 the fixed investment rate to 20.3% of GDP,shows up in export data. In 2006 total financial year, including a pay rise for public which does not augur well for future growth.exports rose by 36% to P22.5 billion, with sector employees of 8% in April. However, Also of concern was the figure for errors andincreased export values across almost all omissions which, at 11.1% of GDP, suggests continue...commodities. Over the past two years (i.e.between 2003 and 2005), total exports Fig 3: Index of Economic Conditionincreased by 61% (see Fig.4). Although part 60of this increase was simply the valuation 40 strongimpact in local currency terms of thecumulative 20% devaluation of the Pula % devlation from mean 20over the two years, in foreign currency terms 0 neutralexports were still up 40%. This was partlythe result of buoyant commodity markets -20and healthy world economic growth, leading -40 weakto price increases that benefited diamond, Source: Own calculationscopper, nickel and gold exports. One very -60 2000 Q2 Q3 Q4 2001 Q2 Q3 Q4 2002 Q2 Q3 Q4 2003 Q2 Q3 Q4 2004 Q2 Q3 Q4 2005 Q2 Q3 Q4 2006impressive result came from the textilessector, where exports rose nearly fourfoldin two years. This was due largely to the Fig 4: Increase in Major Exports 353% Pula terms, 2003-5beneficial impact of the preferential access 100%to the US market under the Africa Growth 90%and Opportunity Act (AGOA). Higher textiles 80% 73% 70%exports drove the general increase in non- 61% 60% 58%traditional exports (i.e. excluding meat, 50%diamonds and copper-nickel), up 81% 43% 40%between 2003 and 2005. These results 32% 30%strongly suggest that export competitiveness 20% 16% 14%and performance was assisted by the 10%devaluations of February 2004 and 0% Soda Ash Vehicles Meat Other Diamonds Total Copper Textiles & parts goods exports nickelMay 2005.
4 Economic Reviewthe additional spending is not spread equally Revenues are projected to increase by 11.3%; in real terms is small- but because theacross categories; essentially, recurrent however, much of this is due to an additional revenues are mostly sourced fromspending will be contained while enabling exceptional one-off payment from SACU non-domestic sources, marking a departurea sharp increase in development spending related to the transition from the old to the from recent trends of raising increased revenue(see table 1). new SACU agreement. Without this, the from domestic sources such as VAT. HenceThe expenditure total was set in terms of the projected revenue increase would have been the domestic impact of greater spending isnew “Fiscal Rule” introduced in the much smaller, at around 5%. Nevertheless, not offset by higher taxes. The 8% publicMid-term Review of NDP 9, which was the government budget is in good shape, sector pay rise should also provide some reliefapproved by Parliament in December 2005. with healthy surpluses anticipated for to the household income squeeze, evenThis commits government to keeping 2005/06 and 2006/07 (at approx 3% and though the increase is below current inflation.expenditure at or below 40% of GDP, a level 1.5% of GDP respectively), although without The structure of spending projected for 2006/07that is consistent with medium-term revenue the SACU payment, the projected 2006/07 is little changed from the current year. Educationexpectations. budget might well be showing a deficit. remains the largest single sector of spending,While the increase in development spending The generally positive reception for the at 25% of the total, followed by general publicwill enable the unblocking of many projects 2006/07 budget reflects the fact that it is administration (16%), economic services (16%)that have been held up for budgetary and health (11%). moderately expansionary at a time of sluggishreasons, it may be difficult to spend the full activity in the domestic economy. This Economic Outlookamount of the increase given the likely expansionary impact is not specifically Conditions are likely to remain difficult inimplementation constraints. because of the increase in spending – which the first half of 2006, with firms and consumers faced with rising inflation, high Fig 5: Economic Growth by sector, 2004/05 interest rates and sluggish domestic demand. During the second half of the year, however, MIning Transport there should be some improvements, with Fin. & Bus. Serv a pickup in economic activity driven by Government increased government spending and the Agriculture public sector pay increment, from which the Water & Elec construction and retail sectors should Construction Soc. & Pers. Serv. particularly benefit. The economy should also Manufacturing benefit from the impact of strong export Hotels & restr performance, which is likely to continue Trade Source: CSO through the year as commodity prices stay -10% -5% 0% 5% 10% 15% 20% high and the beneficial impact of past devaluations continues to feed through. During the second half of the year, inflation Table 1: Government Spending by Category should begin to fall and there may even be Category 2005/06 2006/07 Increase scope for cuts in interest rates before the (P million) (P million) (%) end of 2006, which would provide further Recurrent 15,796 17,233 9.1 support to higher growth. o/w wages, salaries etc. 5,436 5,998 10.3 o/w other recurrent 10,360 11,235 8.4 Development 4,450 6,035 35.6 Bifm Botswana Limited Asset Management. Property Management. Private Equity. Corporate Advisory Services. Total 20,246 23,268 14.9 Private Bag BR 185, Broadhurst, Botswana Tel: +(267) 395 1564. Fax: +(267) 390 0358. Website: www.bifm.co.bw