2007 Q2: Feature on Fiscal Sustainability Issues in NDP10Document Transcript
Bifm Economic Review 4th Quarter 2007 Economic ReviewSummary of with developments in the international improvement in confidence that has been economy – economic slowdown and rising evident over the past 18 months. TheEconomic inflation - impacting adversely on Botswana. improvement is particularly striking for firmsDevelopments focused on the domestic economy, of which Review of 2007 77% reported that current business Output & Business Confidence conditions were satisfactory, compared withDr Keith Jefferis No GDP data have been published since the only 21% in September 2005. An even higher proportion (85%) expect business conditions end of 2006 and so we are in the usual NewChairman of Year “black hole” with regard to information to improve through 2008. While the surveyBifm Investment on overall economic growth; although the surprisingly shows declining confidence CSO has undertaken to produce and publish amongst exporters, this may mainly reflectCommittee qu arte rly GDP d ata prom ptly , this commitment has generally not been fulfilled. the small size of the exporter sample in the survey. However, growth indicators suggest that A number of factors lie behind this upturn there has been a strong recovery, with the in business conditions and confidence. growth of business credit, government Domestically, government spending has beenBy most accounts the economic conditions spending and non-mining electricity ramped up, with expenditure in the first ninein 20 0 7 re pre sen te d a sign ific an t consumption all rising sharply during the months of 2007 rising by 22% compared toimprovement on 2006. Inflation was down, year (see Figure 1). Other indicators tell a 2006. Most of this increase was inexports grew strongly, government improved similar story: applications for business trading development spending, which rose by 60%its ability to spend its budget, and business licences in the second half of 2007 rose by over the first nine months of 2006. This mayconfidence was up. Due to lack of data we 13.5%, while non-mineral exports were up show that government has managed todon’t really know what was happening to 121% in the first nine months of 2007, both overcome some of the implementationeconomic growth and employment, but it is compared to the same periods in 2006.fair to assume that both should have constraints that have held back developmentperformed reasonably well. So far, Botswana The improvement in business conditions is projects in the past. While a high proportionhas been relatively immune from the impact shown in the results of the Bank of of development spending flows out of theof the turmoil in major financial markets and Botswana’s biannual Business Expectations country (e.g. expenditure on constructionthe sub-prime crisis. Looking forward to Survey. The latest results, for the second half materials and HIV/AIDS drugs), it nonetheless2008, however, things may not be so rosy, of 2007, show a continuation of the stimulates the domestic economy through Figure 1: Inflation Figure 2: Business Confidence Index (% of firms rating current business conditions satisfactory) Survey Date All Exporters Non-exporters Source: BPC, BoB, Econsult Source: BoB Source: BoB, CSO, Econsult
2 Economic Reviewemployment and expenditure on locally Figure 3: Export Growth, 2006 –7 (Jan – Sep)supplied goods and services. One of the 200&weaknesses of the Botswana economy is thatthe domestic private sector still remains 150%heavily dependent upon governmentspending – something that has to change in 100%the longer term – but it means that govern- 50%ment can boost economic activity throughincreasing spending in the short term, which 0%seems to have been happening recently. -50%Outside of this, the upsurge of mineralprospecting activity, the implementation ofnew mining and minerals processing projects, Source: CSO, Econsultand the likelihood of further large mining-related projects in the medium term, have benefitted from recovery from the Foot & Botswana beef in the EU, and would have ledshown dynamism in one sector of the Mouth Disease outbreak in 2006, as well as to the ending of beef exports to Botswana’seconomy that is not dependent upon drought (encouraging cattle sales), and a most lucrative market, which would have beengovernment spending. Important ongoing supply response to higher prices. Nickel and disastrous for the Botswana Meat Commissionprojects include the construction of the new copper benefitted from higher world (BMC), Botswana’s cattle farmers and the ruralDiamond Trading Company (DTC) facility and commodity prices, especially earlier in the economy.the opening of several new diamond cutting year. Textiles benefitted from strong demandfactories in Gaborone, the construction of Nevertheless, EPAs have been controversial growth in the region and internationally, andthe Norilsk Nickel Activox refinery near in some quarters. One of the main concerns success in utilising the opportunities offeredFrancistown, and the Diamonex diamond has been in respect of EU demands for by international trade agreements such as progressively liberalised access to developingmine near Lerala, all of which are providing the US Africa Growth and Opportunity Act country markets (in fact this is not specificallyan important boost to economic activity in (AGOA). All exports benefitted from improved an EU demand, but is a requirement if thetheir respective areas. Looking further ahead, international competitiveness under the EPAs are to be consistent with WTO rules).agreement is close to being reached on the crawling peg exchange rate regime. This is not relevant in Botswana’s case, asMmamabula coal/power project, and changesto the Mines & Minerals Act and the Electricity As a result of good export performance, South Africa already has such an agreementSupply Act to accommodate the project have combined with a slower rate of growth of with the EU (the SA-EU Trade & Developmentnow been passed. imports, the balance of payments continued Co-operation Agreement), which in practice to run a healthy surplus, estimated at P10.2 applies to Botswana due to its membershipTrade & Balance of Payments of SACU. Hence, in practical terms, the interim billion for the first nine months of 2007Externally, the regional and international (compared to P10.3 bn for the whole of EPA involved no further concessions oneconomic environments have been supportive 2006). The foreign exchange reserves have Botswana’s part. A second concern relatesfor much of the year, with buoyant global continued to rise, reaching P58.5 billion (US$ to the EU’s desire to include services andeconomic growth as well as strong growth 9.7bn) at the end of September, an estimated “new generation” trade issues (such asin the Southern African region. This has 32 months of import cover. intellectual property and public procurement)helped Botswana’s trade performance. Total in the EPAs; these issues are not included inexports for the first nine months of the year One important trade development that the interim EPA and will be addressed as fullwere up 37% (in pula terms) over the same occurred at the very end of 2008 was the EPAs are negotiated.period in 2006. What is interesting is the signing of an interim Economic Partnership Inflation & Monetary Policysources of this growth. Although diamonds Agreement (EPA) between Botswana and theremain by far the largest export, at around European Union (as did Lesotho, Namibia, For most of the year, inflation developments65% of the total, the growth of diamond Swaziland and Mozambique). The interim EPA were positive; the inflation rate declinedexports over this period was only 19%. The provides for improved access for Botswana sharply from 8.5% at the end of 2006, andmore dynamic export sectors were meat (up beef to the EU, with reduced tariffs (zero by March was below 7% and hence within86%), nickel (& copper) (up 118%) and compared to 5% under the previous Cotonou the Bank of Botswana’s inflation objectivetextiles (up 182%). These performances Agreement) and no quotas. Failing to sign the range. However, towards the end of the yearreflected a variety of factors; the meat sector EPA would have led to much higher tariffs on inflationary pressures started mounting, and
3 Economic Reviewby December it was back up to 8.1%. This not appear that the two were linked. By the What are the implications for Botswana? Aswas driven primarily by developments in middle of 2008, valuations on the BSE had a highly trade-dependent economy, theglobal food and energy markets. By the end reached unrealistically high levels; for instance, impact of changes in global economic activityof 2007, international oil prices had risen by price/earnings (p/e) ratios for the commercial are potentially far-reaching. The USA is theover 80% from their low point in early bank shares that dominate the BSE were largest market for Botswana’s exports, asJanuary 2007, and there were also sharp over 30, and the domestic market as a whole the major world consumer of diamonds andincreases in food commodity prices, notably had a p/e ratio in the low 20s. Many the primary market for Botswana’s textilefor fooodgrains (maize, wheat etc.) and dairy commentators argued that a correction was exports. Any slowdown in US growth,products, with The Economist food overdue, regardless of international especially if led by a drop in consumercommodity price index up 37% over the developments, and this appears to have been expenditure, would negatively affectyear. The impact of these developments was what has happened. With p/e ratios for the Botswana’s exports. However, if suchfelt globally, and most countries experienced banks at just over 20, and for the market as problems are largely confined to the USArising inflation. Although Botswana’s relative a whole at 15.5 at the end of the year, and are short-lived, then other sources ofposition was not affected – by November valuations are now more realistic. The prices economic growth (Europe and majorthe inflation differential between Botswana of dual listed mining shares on the foreign developing countries) will help to cushionand major trading partners had fallen to its board of the BSE followed similar trends, the impact. But if US recession leads to alowest level for some time – the increase in rising by 33% between January and August sharp slowdown in global economic activity,inflation was nonetheless unwelcome. but then falling by 13% through to with the impact widely felt, then Botswana’sFortunately, underlying inflation remains export earnings could fall significantly. The December, largely reflecting trends inlower, with the trimmed mean core inflation value of copper-nickel exports has already international metals prices.measure falling to 7.4% in December. been adversely affected by falling metals The Outlook for 2008 prices in the second half of 2007, and thisOn the monetary policy front, the Bank of would be intensified by a global recession.Botswana maintained its inflation objective The beginning of 2008 has been characterised As a result, Botswana’s three major exportsrange of 4%-7% for 2007, along with a by unusually high levels of uncertainty in the (diamonds, copper-nickel & textiles), aremedium term objective of 3%-6%. Once global economy. The sub-prime crisis in the vulnerable to a US-led global slowdown. Thisinflation fell within the range, the Bank felt US has spread internationally, and although would be compounded be a weakeningable to reduce interest rates by 0.5% in it was initially hoped that this would be short- dollar, the currency in which all three ofJune, leading to a reduction in the Bank Rate lived and contained, the impact has persisted. those exports are priced, further reducingto 14.5%. This was maintained until the end Moving into the New Year, fears of recession export earnings.of the year, despite concerns about rising in the USA are intensifying, with manyinflation and domestic demand pressures. commentators rating the chances of recession The tightening of credit conditions andOf particular concern was the growth of at 50-50. Two scenarios can be envisaged. increase in risk aversion in major financialbank credit, which increased from 18.6% If the US does not slip into recession, but markets, even if prolonged, should have noannually at the end of 2006 to 27.8% in simply experiences a period of slower (or major influence on Botswana. As the countryNovember 2007, and remained outside of zero) growth, global economic activity will is a net creditor, and the government doesthe BoB’s target range for credit growth of temporarily weaken and growth will fall not borrow on international markets, there11-14% throughout the year. below trend. Nevertheless, the impact would will be little direct impact, although projects be short-lived and, supported by a likely requiring major loan finance – such as theThe Botswana Stock Exchange (BSE) easing in monetary policy around the world, Mmamabula Energy Project – might findexperienced a “year of two halves”, with a global growth would rebound in the second raising such loans more difficult, or morecontinuation of 2006’s rapid growth in the half of the year. However, if the US does expensive. Notwithstanding the tighteningDomestic Companies Index (DCI) through slide into recession, with a period of negative of international liquidity, domestic financialto August, during which time the index rose economic growth, job losses and a markets should remain highly liquid.by 60%. From August onwards, however,the situation was reversed, and by the end contraction in real incomes, this is likely to Domestically, the main economic problem isof the year the DCI had declined by 15% have a widespread impact on the world likely to be inflation, with several nasty shocksfrom its peak; over the year as a whole, the economy. Global growth would slow due in the first half of the year. Rising inflationindex was up by 36%. The decline in the significantly and the existing credit market may in turn lead to higher interest rates. AsBSE DCI coincided with the decline in stock problems would intensify. In this scenario, a in 2007, there will be continued pressuremarkets around the world, especially the global slowdown could persist well beyond from high food and oil prices, and domesticmajor developed markets. However, it does the end of 2008. fuel prices are likely to be the main driver of
4 Economic Review Figure 4: Petrol and Crude Oil Prices Figure 5: Inflation f’cast Petrol (lagged 4 months) Crude Oil Source: Econsult , Dept. of Energy Affairs, US EIA Source: BoB, EconsultBotswana inflation in the coming months. South Africa, the source of around 70% of is likely to change in 2008. Expect a muchFuel prices are adjusted on a monthly basis Botswana’s electricity. A new supply contract more hawkish tone in the Monetary Policyto reflect the cost of crude oil on international between South Africa’s Eskom and the Statement to be released in February, andmarkets as well as refining and transportation Botswana Power Corporation (BPC) came into increases in interest rates in the first half ofcosts. Domestic price changes therefore effect on 1 January 2008, and is much less the year, even though with inflation beingreflect international crude price changes, favourable to Botswana than the previous primarily driven from outside of Botswana,albeit with a lag and an element of contract, both in terms of prices and stability the potency of monetary policy is limited.stabilisation. As Figure 4 shows, domestic of supply – the result of which is that Botswanapetrol prices generally reflect international is now much more exposed to both tariff The changed electricity supply situation iscrude prices with a lag of around 4 months. increases and supply disruptions from South not just a price threat, but could hinderAs a result, the recent sharp increase in Africa than it had been previously. In addition, investment and growth as well. With theinternational oil prices from $70 to $100 a BPC needs to generate funds to contribute to virtual certainty that Botswana will increasinglybarrel towards the end of 2007 has not yet the financing of new domestic generating experience interruptions in supplies frombeen reflected in domestic pump prices. capacity. Substantial electricity price increases South Africa over the next five years, andWhile crude prices went up by 58% during are likely in 2008, and although electricity costs with no new domestic supply capacity due2007, domestic pump prices only rose by only have a weight of 1.5% in the CPI basket, online before 2011, the problem is serious,20%, even with December’s substantial price they feed through widely to other prices and especially for the energy-intensive mininghike. Should crude prices remain at current will push up inflation further. sector that is the bedrock of the economy.levels, domestic fuel prices would have to To date, little public information has beenrise from the current level of P5.60 a litre The combination of these developments provided by BPC on these problems and how(for petrol in Gaborone) to nearly P7 to fully means that inflation will continue to rise from they are going to be addressed, and a morereflect this – a further increase of 20% or the December level of 8.1%, and could easily informative approach by BPC and themore. Fuel has a weight of around 7% in reach double digits by mid-year if international oil and food prices remain high and there Government would help the private sectorthe new CPI basket, so this alone would are substantial increases in BHC and BPC to plan appropriately.nearly 1.5% directly to inflation, which wouldbe compounded by the impact on higher tariffs. On the positive side, it is unlikely that Botswana’s financial markets should remaintransport costs, public transport fares etc. oil prices will rise much further from current relatively immune from the turmoil in global levels – in the absence of higher levels of financial markets in 2008. More reasonableOther possible inflation shocks could come geopolitical instability in the Middle East –from domestic electricity prices and Botswana valuations on domestic stocks should as a slowdown in global growth will put encourage a resumption of buying activityHousing Corporation (BHC) rentals. The latter downward pressure on oil prices. Hence it ishave not been adjusted for four years, and and the DCI should bottom out in the first possible that the direct impact of oil pricesBHC has been lobbying Government to approve quarter. In the bond markets, expectations on inflation will be short-lived, although thea rental increase – although the magnitude of are high that Government will announce a indirect impact via other costs could beany such increase should be small given that programme of regular bond issues to coincide longer-term.private sector housing rentals have been largely with the maturity of the BW002 bond on 1ststagnant over this period, and BHC rentals are Although the BoB maintained unchanged March. This would help to boost liquidity insupposedly market-related. Perhaps a more interest rates at the last meeting of the the bond market and support the yield curve,serious threat arises from increases in electricity Monetary Policy Committee in 2008, despite which in turn provides a foundation for bondtariffs. Electricity prices are rising steeply in rising inflation and credit growth, this situation issues by the private and parastatal sectors.
5 Economic ReviewFeature: on the basis that this represents the average The Need to Adjust level of government revenues expected This point was made strongly in a recent IMFFiscal during the remainder of NDP 9, leading to publication, which considered the impact a balanced (and therefore sustainable) of declining diamond production and theSustainability budget. move underground on the government. TheIssues in NDP10 However, the long-term prospects are for much lower levels of government revenues anticipated dramatic decline in diamond revenues between 2021 and 2029 is shown as a proportion of GDP. Current and recent in Figure 6. This shows that diamond revenues revenues are high due to the exceptionally will grow at a healthy rate over the nextIntroduction high profitability of the diamond industry decade, after which time they will decline and the high rate at which those profits are sharply as production goes underground,Government is currently in the process of and in just over 20 years from now, by 2029, taxed. In the medium term, production andpreparing National Development Plan 10 will fall to zero as known diamond reserves profits at these mines will decline as(NDP 10), which will run from the 2009/10 are depleted. production moves underground and costsfinancial year until 2015/16. NDP10 will cover rise. While some new diamond mines arean important period in Botswana’s economic The implications of this are clear: (i) efforts expected to open, these will be much smallerdevelopment, and will have to address issues to diversify the economy must be intensified, than the existing mines, have a relatively and (ii) the government budget must beof high unemployment, slow economic short life, and are unlikely to be nearly asdiversification, high levels of dependency placed on a sustainable adjustment path to profitable as the Debswana mines. a much lower revenue level. The earlier thisupon government, and budget sustainability. Furthermore, as the economy diversifies – adjustment begins, the less traumatic andIn this feature we address this latter issue, in whether into other mining activities or into drastic it will be. But even a smoothparticular the fiscal issues that NDP 10 will non-mining activities – tax revenues will adjustment requires considerable cuts, withneed to address to ensure smooth adjustment decline in relation to the size of the economy budgeted expenditure falling by up to 1%to lower mineral revenues in future. as enterprises taxed at more “normal” rates of GDP each year for the next 15 years.Revenue Prospects become more important. In the long term, the government’s tax and other revenues However, the current starting point of theIn recent years the government budget adjustment process is not as bad as it could will most likely decline to around the averageoutturn and trends have been mixed. A few have been, because government spending in sub-Saharan Africa of 25%-30% of GDP.years back the budget was in deficit, for the This will require a major (downward) (i) For instance, in South Africa government revenues account forfirst time in many years, due to rapidly rising 26% of GDP adjustment in the level of governmentexpenditure and weak revenues, and there (i) IMF (2007) Botswana: Selected Issues and Statistical Appendix. spending, which will have to grow morewere genuine concerns that budget trends The projections are based on data from the Ministry of Mineral slowly than the economy as a whole. Resources and Water Affairs and Debswana.were unsustainable. As a result expenditurehad to be restrained, and a new Fiscal Rule Figure 6: Projected Revenues from Diamondswas introduced in the Mid-term Review of 7000NDP 9. The current budget position is more 6000favourable, due to improved revenues andreduced spending, and in the last two 5000financial years (2005/06 and 2006/07) therehave been significant surpluses. However, 4000reduced spending has been due more to an Diamond revenueinability to spend available resources than to in millions of dollars 3000a budgeted reduction in spending, and shouldnot therefore be seen as a planned outcome. 2000 Mining goes underground beforeWhile the immediate budget position is Recycling of existing waste resources are totally (higher production of lower- depletedreasonably favourable, the position is much 1000 quality diamonds as underlined by a lower priceless positive in the medium and long term. trend)The Fiscal Rule introduced in the Mid-Term 0 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029Review of NDP 9 specifies that government Source: IMF, 2007expenditure should be set at 40% of GDP,
6 Economic Reviewhas recently been significantly below primarily as a resource to build up a capital infrastructure in increasingly remote ruralbudgeted levels due to underspending and asset that can provide long-term annuity areas. At the same time, allocations tolack of implementation capacity. Although income. The basis for this is already in place, recurrent spending may be insufficient toexpenditure has been budgeted at 40% of in the form of the Government Investment maintain existing infrastructure. Roads are aGDP following the Fiscal Rule, actual spending Account (GIA) at the Bank of Botswana, and case in point: a combination of poorwas only around 31-32% of GDP in the the Pula Fund component of the foreign management and insufficient resources2005/06 and 2006/07 fiscal years. But the exchange reserves. However, the balance in means that maintenance of the existinglong term need for much lower spending these accounts, especially the GIA, would infrastructure is inadequate, while resourcesmeans that the emphasis now and during need to rise sharply if the resulting annuity are being devoted to building new roads inNDP 10 should not be on ramping up income is to be meaningful. areas with very low traffic volumes. This isgovernment spending to match revenues, There will also need to be a change in unlikely to represent rational allocation andbut to make government expenditure more budgetary principles, with allocations from management of scarce resources. Henceefficient and focused on long-term mineral revenues to long-term savings made NDP 10 needs to ensure greater efficiencysustainability. actively before spending decisions are made, in the use of public financial resources, rather than as a passive residual depending especially as the availability of such resourcesBudgetary Principles for NDP 10 on budget outcomes, as at present. It also will decline in coming years.In the short-to-medium term this means the means that the Government’s accumulatedGovernment should be spending less than it savings (balances at BoB) and the nation’s Key initiatives could include: re-introducingis earning, and accumulating the balance – savings (the foreign exchange reserves) should effective project appraisal techniques andi.e., returning to the days of significant budget be viewed as a resource to facilitate and reducing the number of politically drivensurpluses. This has two benefits. First, it cushion the adjustment process rather than development projects; introducing properfacilitates the smooth adjustment of as a resource to finance a higher level of project management skills in the public sector,expenditure levels to lower revenues in the spending in the short term. including parastatals; taking better accountlong term. Second, it means that government of the recurrent expenditure implications and A second important fiscal issue to be(and the nation) can accumulate significant resource needs stemming from development addressed in NDP10 relates to the balancesavings balances that can be used to finance projects; improving productivity and efficiency between recurrent and developmentfuture expenditure and supplement other in the public sector workforce, if necessary spending. The NDP 9 MTR specified a targetsources of revenue as mineral revenues of 30% of total spending allocated to by downsizing, and terminating ineffectivedecline. Essentially this means building up development spending, in order to boost the activities; transferring activities to the privatereserves (both government savings and overall national investment rate. Looking sector and contracting out under perform-national foreign exchange reserves) that can further ahead, this may not be appropriate. ance related management arrangements;be used as a capital fund that will generate Many public sector investment projects are and making better use of international besta permanent future income flow without arguably yielding very low economic (and practice techniques in public sector resourceconsuming the capital base of the fund. This social) returns, especially those involving the allocation and expenditure decisions in bothinvolves treating current mineral revenues provision of very expensive physical the recurrent and development budgets. Bifm Bots wana Limited Asset Management. Property Management. Private Eq uity. Corporate Advisory Services. Private Bag BR 185, Broadhurst, Botswana Tel: +(267) 395 1564. Fax: +(267) 390 0358. Web site: www.bifm.co.bw