2008 Q1: Features on the New Monetary Policy Framework and Power Supply Issues
Bifm Economic Review 1st Quarter 2008 Economic ReviewSummary impact of economic slowdown in the major developed economies as a result of the growth of 12%, is particularly significant, as the sector had been struggling for severalof Economic credit crunch and the associated crisis in the financial sector, which could affect export years. Export data suggest that the textiles sector has been growing rapidly, but apartDevelopments performance. from this it is unfortunately not possible to distinguish which particular component of Economic GrowthDr Keith Jefferis The economic growth data released along the manufacturing sector has done well, as the CSO classes 75% of manufacturing with the 20087 Budget, covering theChairman of output simply as “other manufacturing” period July 2006 to June 2007, confirmed (i.e. not meat, beverages or textiles).Bifm Investment earlier indications that there had been a strong growth recovery in late 2006 Although economic growth has beenCommittee impressive, this has not translated into and early 2007. Overall GDP growth rose strong employment growth. Total formal from (a revised) 0.6% in the previous year sector employment rose by only 2.4%I (2005/6) to 6.2% in 2006/07. The growth between March 2006 and March 2007, recovery in the non-mining private sector spread more or less equally across the was particularly impressive; after several ntroduction private sector and government. This result years of a downward growth trend, growth is disappointing, as the rapid growth ofIn common with much of the rest of the picked up from (a revised) 5.7% to 9.7%. the private sector noted above would beworld, Botswana experienced a mixed set The recovery in growth was broad-based, expected to lead to much faster job growth.of economic developments during the first with transport and communications, trade, But there appears to be inconsistencyquarter of 2008. While the most recent manufacturing and construction the fastest between the employment data and thegrowth data and related indicators show growing sectors, and all showing much GDP growth data, which could make onethat the economy performed strongly faster growth than in the previous year. (or both) of the data series unreliable.through 2007, recent months have been Although this is only one year of data, these For instance, employment in the fastestless positive. Inflation has risen sharply, growth results show that some economic growing economic sector – transport andand shows signs of increasing further over diversification has taken place, which is communications – supposedly contractedthe next few months before beginning to in turn consistent with the picture that by 5.1%, even though the sector grew byfall towards the end of the year. Botswana has been emerging recently of successful 20%, and employment in the non-miningalso faces uncertainty due to power supply export diversification. The revival of the private sector as a whole only grew byproblems in Southern Africa, and the manufacturing sector, which achieved 2.2%, even though output grew by 9.7%. Figure 1: Economic Growth (%) Figure 2: Economic Growth by Sector (%) Source: CSO, Econsult Source: CSO
2 Economic ReviewHopefully the CSO will be able to improveconsistency between various different data Figure 3: Business Growth Indicators (Quarterly)sources in future.The published growth data only cover theperiod to June 2007, so for the most recentnine months we have to rely on othereconomic indicators. These suggest thatthe growth recovery has continued, withdata on the real growth of business credit,electricity consumption and governmentspending all indicating that growthcontinued to be strong through the secondhalf of 2007.Nevertheless there are a number of risks Source: BPC, BoB, Econsultto growth going forward. The impact ofthe problems facing the financial sectors is vulnerable to fluctuations in global would require eventual adjustment to lowerin developed economies is likely, even on economic growth. Furthermore, Botswana’s export earnings and government revenues.the most optimistic forecasts, to lead to a exports are primarily to the major developed A second risk to growth is the ongoingperiod of slower global economic growth economies that are unlikely to grow rapidly. power supply crisis in southern Africa. Thisthrough 2008 and into 2009. The IMF has The United States is the largest market for is discussed further in a feature later inrevised down its global growth forecast for two of Botswana’s three biggest exports this Review.2008 to 3.7%, with only a slight recovery (diamonds and textiles). Taking account ofto 3.8% in 2009. But what is striking is the ultimate destination of diamonds in the Inflationthe contrast between projected growth world market, nearly 70% of Botswana’s The first quarter of 2008 provided morein the major developed economies (only exports go directly or indirectly to the USA, bad news on inflation, which rose sharply1.3% in both 2008 and 2009) and that in Europe and Japan, which are all facing a from 8.2% at the end of 2007 to 9.8%emerging and developing countries (6.7%). severe growth slowdown, if not recession. in March 2008. This was largely driven byIt is encouraging that developing countries Perhaps reflecting the impact of the slowing higher food and fuel prices; over the pastappear likely to sustain high growth even of growth in the USA, Botswana’s diamond 12 months, food prices rose by 18%, whilewith a slowdown in the industrialised exports in the last three months of 2008 those for “operation of personal transport”countries, an indication of the “decoupling” were 27% lower than in the same period (which is mostly petrol and diesel costs) roseof growth that has been much talked about. in 2006. While there is no immediate by 22.5%. These price increases, combinedFor Africa, forecasts of continued growth of problem from this – the foreign exchange with their high weights in the CPI basket,well over 6% are particularly welcome. reserves are maintained at high levels led transport and food costs together toBotswana, however, is in a difficult situation. specifically to cope with such situations – contribute 6.8% to the overall inflation rateAs an export-dependent economy, Botswana a deep or prolonged recession in the US of 9.8% in the year to March. Underlying Figure 4: Global Growth Forecast, 2008 (%) Figure 5: Inflation: Botswana vs. Trading Partners Source: IMF Source: CSO, Econsult
3 Economic Reviewthese price increases were higher prices these will eventually feed through to retail with many filing stations – such as the urbanin international markets; for instance the prices. Despite the substantial increases areas where the majority of the populationprices for the key food grains wheat, rice in petrol and diesel prices on April 15th, lives - this is likely to result in lower prices forand maize were up 108%, 103% and 66% Botswana fuel prices still lag international consumers, and make a small contributionrespectively in the year to March, and the prices by a considerable margin, and further to keeping inflation in check.price of crude oil was up 50% over the large price increases are likely.same period. The likelihood of further increases in While there is little that can be done about fuel and food prices means that inflationThe upsurge in inflation is not unique the rising cost of fuel imports, one policy will probably keep rising for a few moreto Botswana, and inflation is generally response that could help would be to months. Our current forecast is for inflationrising around the world. South Africa has liberalise domestic fuel prices. At present,experienced a similar increase in inflation, to rise from current levels to peak around fuel prices are rigidly controlled by thewhich of course feeds through to Botswana 12%, before declining from October government, in an outdated system thatthrough import price rises. The only good onwards; however inflation is likely to prevents competition from playing a rolenews on inflation is that because it is being remain in double digits for the foreseeable in making the industry more efficient andexperienced worldwide, there has been little bringing prices down. As an initial reform, it future. Of course this forecast is subjectchange in Botswana’s relative position with would be a straightforward move to change to much uncertainty given the difficultiesregard to inflation, and hence there is little in predicting what is likely to happen to the regulated fixed price into a maximumimpact on international competitiveness. fuel prices and the extent of second-round price, thereby allowing fuel retailers toInflation prospects for the remainder of the charge lower prices if they wished to do so effects; much will depend on what happensyear are not particularly good, however. to attract more customers. This would enable to other regulated prices such as publicInternational oil prices keep on rising, and price competition to operate, and in areas transport fares and electricity tariffs. Figure 6: Fuel and Crude Oil Prices Figure 7: Inflation Source: DEA, US EIA, Econsult Source: CSOFeature: take some time so see how much difference the changes make in practice. slightly in recent years following the introduction of the crawling exchangeThe New rate peg, which allows the Botswana The key features of the old monetary policy inflation target to be slightly higher than framework included:Monetary • short-term (annual) inflation objective, a international inflation; • he main monetary policy instrument tPolicy Framework and a medium-term inflation objective, based on expected inflation rates of was short-term interest rates (Bank Rate/ BOBC rate); major trading partners; the attainment • the intermediate target was the rate of The Bank of Botswana (BoB) presented its of the inflation objective would therefore growth of bank credit;2008 Monetary Policy Statement (MPS) onFebruary 25th. The MPS introduced some result in the maintenance of inter- • monetary policy changes were determined potentially far-reaching changes to the national competitiveness (by matching on the basis of the actual rate of inflationmonetary policy framework, although it will international inflation); this was changed vis a vis the objective, and the rate of
4 Economic Review credit growth vis a vis the intermediate way as in the past - will be a crucial countries all have floating exchange rates. target, as well as the growth rate of determinant of policy; hence the quality In addition, fiscal policy is not managed government spending and an assessment of the inflation forecast becomes crucial, so as to minimise its inflationary impact. of real economic activity. and this in term depends on the quality Furthermore, there is no clear mandate for of the Bank’s medium-term inflation BoB to pursue price stability above all otherThe changes introduced in the 2008 MPS forecasting model; objectives (whether a statutory objective orinclude: • hile short-term inflation modelling w a statement of government policy), and BoB• ropping the annual inflation objective, d and forecasting is quite easy, being cannot at present be held fully accountable and henceforth focusing only on the primarily momentum driven, medium- for achieving the target. medium term objective; term forecasting is much more difficult;• ropping the intermediate credit growth d Inflation targeting has generally been it depends upon both high quality target; quite successful in achieving low inflation• onetary policy changes will be m modelling (i.e. a model which can be shown to perform well in forecasting on across a wide range of countries, although determined on the basis of the deviation the basis of historical data) and the ability the current environment of cost-driven between forecast medium-term inflation to accurately forecast a range of real increases in global inflation will provide and the medium-term objective, i.e. policy activity variables (e.g. the rate of future inflation targeting regimes with a severe will be adjusted in order to bring the economic growth, the level of capacity test. However, it has generally been adopted medium-term inflation forecast in line utilisation in the economy, productivity by medium or large economies, and there with the inflation objective; growth, government spending, and real is limited experience of its use in small• here will be less focus on meeting short- t and nominal economic shocks); it also open economies such as Botswana where term objectives for inflation and credit depends on the quality of the statistical inflation is primarily imported and hence growth. data on which model is estimated; determined by external factors.What are the implications of these changes? • he model should also be capable of t As noted above, the 2008 monetary policyThe overall impact should be positive. The producing a range of forecasts underprevious focus on short-term objectives changes in Botswana can be seen as a different scenarios, with different “halfway house” towards the adoption ofwas problematic, in that monetary policy probabilities attached;changes work with a fairly long lag (typically full inflation targeting. Whether it works • he credibility of monetary policy actions t12-24 months) and hence any changes depends crucially on the performance of the would be enhanced if BoB publishes itsmade in response to current inflation (in inflation forecasting model and its modelling inflation forecasts, and in due courserelation to the annual target) would not of the monetary transmission mechanism, details of the model itself.have had an effect within the desired time which will become apparent over the nextframe. So moving towards a medium term The changes represent a partial move 2-3 years. However, the adoption of FFITtarget makes sense in terms of the time towards the adoption of inflation targeting. would depend on much more than this,lags involved in the impact of monetary In particular, the adoption of a medium as it would require reform of the Bank ofpolicy. There have also been concerns term inflation target/objective, and the use Botswana Act, and an explicit commitmentover the usefulness of credit growth as of a model and medium-term forecasts to to the framework from government. Itan intermediate target, its responsiveness determine policy changes, are a common would also require a move towards muchto changes in monetary policy and its feature of inflation targeting regimes. greater exchange rate flexibility, with eitherlinks to inflation - i.e. whether it actually However, there are key differences which a market-determined floating exchangefunctioned as an intermediate target as mean that the new monetary policy rate, or at the very least an acceptance thatintended. The new framework should also in the event of conflict between exchange framework is some way from being a fully-enable a more measured monetary policy rate and inflation objectives, the latter fledged inflation targeting (FFIT) regime.response to short-term changes in inflation. would take precedence. A more flexible One of the most crucial aspects of FFIT isIt is also more in keeping with international exchange rate policy would in turn require that the inflation target must dominatepractice. a new mechanism for building up foreign all other macroeconomic policy objectives,For the changes in monetary policy to be including exchange rate or fiscal policy exchange reserves and saving mineraleffective, however, there are several key objectives. Botswana of course maintains revenues, and would also run the riskrequirements: a pegged exchange rate, determined by that the exchange rate would appreciate,• he divergence between the medium- t government, and BoB does not have control leading to competitiveness problems of the term inflation forecast and the medium- over this important component of monetary kind that emerged prior to the devaluations term inflation objective – set in the same policy and determinant of inflation. FFIT of 2004 and 2005.
5 Economic ReviewFeature: required, and is usually reached in winter) reached around 500MW in 2007. grow at almost 10% a year, while mining demand includes the impact of anticipated new projects, giving total demand growthPower Supply As Figure 9 shows, electricity demand and of around 11% a year and a capacity consumption are very closely related to requirement of 750MW by 2011. The powerIssues the level of economic activity. In the non- mining sector of the economy, growth of 1% translates to approximately a 1.6% supply shortfall (the difference between projected demand and anticipated supplies from Morupule and Eskom) therefore rises increase in electricity consumption. If thisOne of the major economic developments from around 100MW in 2008 to some relationship is maintained, a shortfall inin the first quarter of 2008 has been the 500MW in 2011. electricity supplies could have a majoremergence of serious electricity supply negative impact on growth: a 10% cut in Various strategies are in place to meetproblems in South Africa and their spill-over power supplies would lead to a fall of 6-7% this shortfall. Imports of up to 60MWinto Botswana, leading to serious supply in non-mining GDP. from Cabora Bassa in Mozambique, viainterruptions in late January and early Zimbabwe, are supplementing suppliesFebruary. This reflects the reduced level of Over the next few years it is likely that the (although they were not available duringfirm supplies from South Africa under the electricity supply situation will become the crisis period in January and Februarynew Eskom/Botswana Power Corporation much tighter, due to a combination of due to problems with transmission links in(BPC) contract from January 1, 2008 as well supply shortfalls and rising demand. There Zimbabwe). There is also a tentative schemeas the shared impact of load shedding in are a number of large mining projects, to re-open the mothballed Bulawayo powerSouth Africa. The impact on Botswana has notably the Tati Nickel Activox refinery station in Zimbabwe, using coal frombeen considerable, with lost production, near Francistown, which will lead to Botswana, which could provide Botswanareduced productivity and additional costs sharply increased electricity demand over with a further 45MW of power. However,facing many businesses. Unlike South the period to 2012. Unless significant this is progressing slowly, with no firmAfrica, however, there are no reports of demand-management measures - including indication of when this power will bemining production being adversely affected higher prices - are put in place, it is also available. Clearly, power supplies originatingin Botswana. likely demand from the non-mining sector, from or transiting through Zimbabwe are including households, will continue to growFigure 8 shows Botswana’s sources of unreliable. steadily; as noted above, this has beenelectricity used in recent years. Around increasing at around 9% a year. BPC is also about to commence a major80% of electricity is imported, with 70% expansion of the Morupule coal-fired powerfrom Eskom. Domestic supply (from BPC’s On the supply side, the most important station. Morupule B will have a capacityMorupule power station) accounts for pending development is the reduction in of 600MW (compared to 120MW for thearound 20%. Morupule supply has been “firm supply” from Eskom under the new existing plant), so when commissioned willdeclining slowly, presumably reflecting the Eskom/BPC contract; this was 410MW in meet almost all domestic requirements.aging of the power station and the resulting 2007, and has been reduced to 350MW Although it is the stated intention to generate in 2008 and 2009, and will fall further tomaintenance needs. On the demand side, first power from Morupule B by 2010, 250MW in 2010 and 150MW in 2011.mining accounts for around one-third of this appears optimistic, and a more likelytotal consumption. Over the past decade, Figure 10 shows recent and forecast peak scenario is that Morupule B will only bemining demand has been increasing at demand. Peak demand determines the level online in 2011 at the earliest. The mucharound 5% a year, and non-mining demand of installed capacity (or firm import supply larger Mmamabula project, which willat 9% a year. Peak demand (which is the commitments) needed. The chart assumes provide 2400MW, mostly for export, willkey determinant of the generation capacity that non-mining demand will continue to only come online in 2013. Figure 8: Sources of Electricity Figure 9: Growth of Non-mining Electricity Consumption and GDP Source: CSO, BPC, Econsult
6 Economic ReviewTo meet the shortfall that is likely to resultin 2009 and 2010, BPC has tendered for Figure 10: Electricity Demand and Supply Projectionsup to 240MW of short-term generatingcapacity. This is a common response tosupply deficits, and was used extensively inEast Africa (Kenya, Uganda and Tanzania)in 2006 in response to shortfalls in hydropower generation due to drought; such“emergency capacity” can be put in placefairly quickly, and is typically diesel powered.The solution adopted in Botswana is likelyto be either diesel-powered generation, orpossibly gas-fired generation using coal-bed methane.One way or another it is likely that therequired power will be made available and Source: Econsultthat Botswana will escape severe shortagesin 2009 and 2010. The problem, however,will be the cost. Indicative costs of new Table 1: Approximate Cost of Electricity from Different Sources (New Capacity)generation capacity from different power Source Cost (US cents per kWh) Cost (thebe per kWh)sources are shown in Table 1. Large-scale hydro 2-4 12 – 25As the table shows, the cost of emergency Large-scale coal 6–8 40 - 50capacity from small-scale gas or diesel Small-scale diesel 25 – 35 160 - 230plants is many times higher than that ofhydro or coal-fired power, which have beenthe main sources of power in the region up generation. These subsidies could be very settlements. At a larger scale, however, thereto now. Current tariff levels in Botswana expensive: depending on the exact amount is little experience internationally of powervary between 40 – 46 thebe/kwh (approx. of emergency power required, and the price stations based on solar energy to provide6 – 7 US c) for domestic and small business of gas or diesel, the subsidies could amount electricity to the grid, although there are aconsumers, with lower tariffs for large to P3 billion a year – equivalent to somescale business and mining users. Clearly, few experimental plants in Europe, the USA 10% of government spending and 3% orcurrent tariff levels are nowhere near and Australia producing up to 20MW. With more of GDP.enough to cover the cost of emergency current technology, capital costs are highpower generation, and are unlikely to While steep price increases will no doubt and solar is still relatively expensive whencover the costs of new coal-fired power be unpopular, the experiences of other compared to coal or hydro power.generation. Although Botswana electricity countries indicates that when faced with a choice, consumers prefer tariff increases to However, the economics of power generationtariffs have not been as low as in SouthAfrica, they are still relatively low by world interruptions in supply. are changing in a direction that is likely to– or even African – standards. Substantial In the discussion of potential sources favour solar energy: coal input costs aretariff increases – in the region of 50% of power to meet rising needs, in both rising (following higher oil and gas prices);or more, over and above inflation – are Botswana and elsewhere in the southern environmental factors weigh against coalprobably necessary to finance the true costs African region, little has been said about the with its high carbon dioxide emissions,of Botswana’s new generating capacity. potential of solar power. Clearly Botswana and changes taking place in solar energyBPC has just been granted a 10% - 14% has one of the main inputs – ample supplies technology are bringing down costs. Thetariff increase by government, but further of sunshine – and there have been some development of carbon-offset tradingtariff increases will be necessary over the small scale attempts to use solar as a means mechanisms under the Kyoto Protocol,next 2-3 years to enable BPC to pay for of providing electricity and water heating in where carbon credits can be sold, wouldnew capacity, to provide an incentive for off-grid areas. For rural electrification, whereindependent power producers (IPPs), and provide additional revenue to solar power grid infrastructure costs are high and powerto provide appropriate signals to consumers usage low, domestic solar installations producers. In the medium-to-long term,to use power more efficiently. Even with using photovoltaic technology are already large-scale solar power may well prove ansuch increases, subsidies will be necessary more cost-effective than the provision of attractive alternative (or complement) toto cover the cost of emergency power grid power to smaller and more isolated coal-fired power generation in Botswana. Bifm Botswana Limited Asset 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