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Bifm Economic Review 4th Quarter 2008 Economic Review The Impact of the Global Financial and Economic Crisis on Botswana. Dr. Keith Jefferis Chairman of Bifm Investment CommitteeIntroductionThe final quarter of 2008 was a period of deepening crisis Figure 1: Global Economic Growth Forecastsas global financial and economic conditions deteriorated 6sharply. In September and October, financial systems in annualised real GDP growth, qoq, %several major economies came close to collapse, which 4was only prevented by unprecedented interventions and 2rescue packages provided by governments and centralbanks. But as the year came to an end, it became apparent 0that what had started as a financial crisis had developed -2into a major economic crisis, with growth rates collapsingaround the world as many major economies entered -4recession. While Botswana has been largely immune to -6the direct effects of the global financial crisis, it has become 1Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09increasingly apparent that the global economic crisis will Emerging markets USA Worldhave a major negative impact on the country. In this edition Source: JP Morganof the Economic Review, we discuss these developmentsand their impact on Botswanas economic prospects and The immediate trigger for the downturn was the financialpolicy challenges for 2009. We begin by outlining key crisis that had been building throughout 2007 and 2008,international economic developments, and then analyse leading to a sharp tightening of financial conditions andtheir likely impact on Botswana and the macroeconomic a "credit crunch", plus the impact of the jump inpolicy options open to the government. commodity prices in the first half of 2008. Subsequent developments have compounded the impact of the initialThe Global Economy financial crisis and the loss of real income as oil prices in particular reached unprecedented levels. Developments inDuring the fourth quarter of 2008, the global economy the USA, the worlds largest economy, provide anexperienced a deep and synchronised downturn in illustration of what has happened in many other countries.economic activity. While a mild slowdown in growth had In the US, the malaise in the housing sector following thebeen apparent earlier in the year, the extent to which sub-prime crisis spread to consumer spending moreeconomic conditions deteriorated towards the end of the generally; households have been affected by a negativeyear was unexpected and almost unprecedented. The shock to their wealth as the value of housing and financialdownturn was led by the USA, where real economic activity assets has collapsed, compounded by the reducedis estimated have to contracted at an annual rate of 6% availability of credit and fears of rising unemployment. Asin the 4th quarter of 2008 (see Figure 1). This is reinforced a result, consumer confidence has fallen to the lowestby similar economic contractions in the euro area, Japan levels ever recorded, and savings have been rising toand the UK, with these four economies in recession together compensate. The outcome of this has been a reduction infor the first time since the early 1980s. As a group, consumption spending, which is the largest singledeveloped countries are experiencing their worst recession contributor to aggregate demand in the USA. This hasin the sixty years since the end of World War II. While been followed by a reduction in expenditure by firms asgrowth remains higher in emerging markets, they have inventories have been reduced and capital investment cutalso been badly hit by the slowdown and growth has fallen back due to both credit constraints and reduced productjust as sharply as in developed markets. demand. Firms have also retrenched workers, which
2 Economic Reviewcompounds the problem of weak consumer spending. The years have been predominantly V-shaped, whereas ofthird major component of demand, net exports, has also course the 1930s depression was L-shaped.fallen as the global economy has slowed. Hence all major It is likely that the key to global economic recovery willcontributors to growth, with the exception of government be the resumption of growth in US consumer spending;spending , have weakened. This leaves governments notjust as the ultimate guarantors (and sometimes owners) Figure 2: US GDP growthof the financial system, but also as "spenders of last 8%resort", as shown by the reliance on fiscal spendingpackages in the recovery plans of many countries. 6% 4%While there are many similarities and general trends, theimpact of the economic slowdown varies across economic 2%sectors and countries. In the USA, the industries that havebeen most severely affected - in addition to the financial 0%sector - are those involving large consumer spending -2%commitments and dependence on access to credit, suchas housing and automobiles; spending on new homes and -4% Recessionscars has dropped by between one-third and one-half on 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009in 2008. Also badly affected are industries providing capitalgoods, as corporate investment spending has in manycases been drastically cut back. A third area of vulnerability this would boost growth in the US which will in turn helpis industries providing luxury goods (such as jewellery) or to stimulate growth in the rest of the world. The pre-discretionary spending (such as tourism), where expenditure requisites for recovery in US consumer spending include:can easily be postponed, while consumer necessities suchas food and clothing have held up much better. - The resumption of credit flows; - A macroeconomic stimulus from fiscal tax and/orWhile many emerging markets have not directly experienced spending packages and looser monetary policy;financial sector problems or housing market collapses, - Growth in real incomes;they have not escaped unscathed. Most emerging markets - A reduction in uncertainty and improved consumerare highly dependent upon exports, so economic slowdown confidence.in developed economies has reduced demand as the growthof world trade has slowed. There have also been sharp The unblocking of credit markets is essential for recoveryreductions in commodity prices as the earlier bubble has in the housing and motor vehicle markets as well as forburst. While this will play an important part in boosting companies. There are some signs of an easing of creditreal incomes and restoring demand and growth in much conditions and resumption of credit flows to consumersof the developed world, the reliance of many emerging and businesses, but the process is very slow. While manymarkets, especially in Africa, on commodity exports will banks have received capital injections from governmentsis already causing problems for many countries as export and shareholders, this is not in itself sufficient to get creditearnings decline. The credit crunch, combined with flowing again, as in many cases financial institutions haveincreased risk aversion, has made finance more difficult suffered such large losses - and may still face further lossesto come by for countries dependent upon inflows of short- - that their priority is to recapitalise and rebuild theirterm capital or foreign direct investment, especially for balance sheets rather than rapidly increase lending. Thismining projects as lower commodity prices have project problem is compounded by fear, and a desire to avoideconomics unfavourable. unnecessary risks.International Prospects for 2009 Much emphasis is being placed on the impact of fiscal stimulus packages, comprising additional public spendingAs the crisis has deepened, many analysts have become and/or tax reductions, most notably in the US but also inmore pessimistic about how deep and prolonged the many other developed and developing economies. In mostrecession will be. We can distinguish between a "V-shaped" developed economies these packages are likely to berecession - which is deep and painful but short-lived and equivalent to 1-2% of GDP in 2009, rising to an estimatedfollowed by a robust recovery - or an "L-shaped" recession, 5-7% in India and China. These can potentially make awhich is prolonged with weak and slow recovery. As Figure significant contribution to recovery, although they are not2 shows, previous US recessions over the past three decades without problems. Increasing public spending in a hurry
3 Economic Reviewruns the risk of poor project selection and management, Implications for Botswanaleading to waste and inefficiency, although tax cuts maysimply result in increased saving by households rather than While almost all countries of the world will be negativelyspending; while additional saving makes sense from an affected by the crisis, the type and scale of impact willindividual point of view, especially when household assets vary. In most developed countries, as discussed above, thehave fallen in value, it does nothing to help pull an economy crisis originated in a combination of financial sector distress,out of a recession (Keynes famous "paradox of thrift"). the credit crunch, and rising oil prices. These factors haveExpansionary fiscal policy also leads to increased public been less important in most emerging markets, where thedebt levels and/or monetary expansion, both of which main impact has come from the slowdown in internationalstore up future problems. trade as developed countries enter recession. Like many other developing countries, Botswana is highly trade-However, fiscal expansion will help to boost real household dependent, integrated into the regional and worldincomes which should ultimately lead to increased spending, economies, and the reduction in global trade and economiceven if not by the full amount. The income effect will also growth is already having a negative impact on demandbe supported by lower commodity prices, especially lower for Botswanas exports.oil and fuel prices; recent declines have already reversedsome of the negative effects experienced last year as higher While exports have become more diversified in recentoil prices reduced spending power in oil-importing nations. years, this does not enable the country to escape theNevertheless, this will be offset to some degree by the impact of a widespread downturn in global demand. Thenegative impact of further falls in house prices, and until global recession will affect demand for exports across thethese bottom out it is unlikely that spending will rise board, including all three of the countrys major exportssignificantly. - diamonds, copper-nickel, and tourism. Diamond exports have already suffered through reduced export quantitiesThe final component of the recovery is increased consumer towards the end of 2008, while the prices received forconfidence. So far there is little sign of any improvement, copper and nickel have fallen by 70% - 80% from theirwith confidence surveys showing readings at rock-bottom peaks. Tourism is yet to seriously feel the pinch, given thatlevels. Consumer spending over the important Christmas much of the industry works on quite a long booking cycle,season fell in most major economies, and with a steady but will inevitably do so during 2009. All three industriesflow of corporate bankruptcies and retrenchments, will suffer reduced earnings, and are likely to retrenchunemployment is expected to continue rising for several staff.more months. Continued negative sentiment will meanthat any recovery in consumer spending, even with a fiscal While the impact on exports may be broad-based, theboost behind it, is likely to be weak and sluggish through 2009. main concern is what the consequences will be of a downturn in the demand for diamonds. This is becauseMore generally, there is little sign that the deterioration diamonds remain Botswanas largest export, accountingin economic conditions is bottoming out. The flow of for over half of total earnings from exports of goods andeconomic and financial news remains almost uniformly services, and account for nearly 40% of governmentbad and below expectations, which as a result continue revenues. As a result, problems with diamond exportsto be revised downwards. Only once economic and financialdevelopments start exceeding expectations will confidence affect not just the industry but have macroeconomicreturn. consequences, which may in turn call for macroeconomic policy responses.Over the past three months, general views on the likelydepth and duration of the recession have shifted towards Diamonds"bad for long". It is widely expected that recession - i.e.negative economic growth - in developed economies will The global economic and financial crisis has had a dramaticcontinue at least until the middle of 2009, with the first impact on the global diamond industry. After a buoyantquarter of the year being particularly bad. While there start to the year, the industry suffered severe problems inmay be some recovery towards the end of the year, this the second half of 2008 as a result of the combination ofis likely to be weak; taking 2009 as a whole, the world restricted credit availability and reduced demandeconomy is likely to experience negative growth, which for the industrys final product, diamond jewellery.would be the first time that this has happened-over a fullyear-for over 60 years. More robust recovery in world economic The global diamond industry takes the form of a pipelinegrowth is unlikely before 2010, and quite possibly 2011. whereby diamonds flow from mining companies, through
4 Economic Reviewsales channels for rough diamonds, to cutters and polishers, Figure 4: World retail Diamond Demand 2006wholesalers, jewellery manufacturers, and the retail market(see Figure 3). This value of diamond stocks in this pipeline Other Gulf 6%is extremely high, and is largely financed by short-term 5%bank credit. With weakness in the retail market in the Chinasecond half of 2008, the flow of diamonds through the 5%pipeline slowed, resulting in a build-up of stocks. At thesame time, due to the credit crunch the banks became Indialess willing to provide credit, and furthermore were 8%concerned that with prices under pressure, the value of USAthe diamonds held as collateral for short-term credit was 45%declining. The combination of reduced credit, rising stocksand falling demand meant that by the end of the year,the pipeline could not absorb any new supplies of rough Europediamonds from mining companies such as Debswana. The 19%result was that global sales of rough diamonds collapsedin the 4th quarter of 2008, and Botswanas diamondexports fell to virtually zero. Japan Source: BMO Capital Markets 12% Figure 3: Diamond Pipeline fall of all reported retail categories. These figures would Mining Rough sales Cutting & polishing Wholesalers Retail put jewellery in the same category as new housing and automobile sales, which are down by similar amounts. With this starting point, what kind of recovery can be expected? As noted above, general economic recovery in the USA and other developed markets is likely to be slow Debswana DTC Sightholders Traders Consumers and weak, with healthy growth only taking place in 2010 or 2011. Beyond the general recovery, what is importantThis situation is likely to be temporary, and diamond sales for Botswanas diamond exports is the sequencing ofwill resume once stock levels have fallen. What is unclear, recovery in different sectors. In contrast to some of thehowever, is at what level sales will resume, but with other hard-hit sectors, jewellery purchases are lessreduced credit availability, lower retail demand and de- dependent on credit finance, so the sector is much lessstocking in the diamond pipeline, exports will undoubtedly dependent - at least directly - upon improvements in creditbe lower than in recent years, and in 2009, exports are availability than is, say, the motor industry. However, whenlikely to be particularly weak. times are hard, purchases of luxuries can easily be postponed, and it is quite plausible that jewellery salesThe world market for cut and polished diamonds is will only really recover once economic recovery is welldominated by the USA and by developed country markets under way. It is quite plausible that the recovery of spendingmore generally; while emerging markets such as China on jewellery and other luxuries will only follow the recoveryand India are growing rapidly, they still account for less of spending on other big-ticket items such as housing andthan a quarter of final demand at present. Hence the automobiles. In the meantime, it is likely that world retailprospects for diamonds depend crucially on economic diamond demand will be 10-15% lower for the foreseeabledevelopments in major developed markets [see Figure 4]. future, which it has been estimated will translate to 50% lower demand for rough diamonds in the short run as theIn the USA, short-term prospects are not good. Diamond industry de-stocks and adjusts to credit constraints. Assales during the all-important Christmas season, which Figure 5 shows, in the previous similar recession of theaccounts for a large proportion of annual turnover, appear early 1980s, it took seven years before rough diamondto have been poor. Several jewellery store chains reported sales recovered to pre-crisis levels. The likelihood is thatsales declines in the region of 15-25% compared to 2007. Botswanas diamond exports will face market weaknessAccording to Mastercard, total retail sales in the US over - resulting in lower prices and reduced volumes - not justthe period from November 1 to December 24 were down in the short-term but into the medium-term.2-4% compared to a year earlier, but sales of luxury items- which includes jewellery - were down 34% - the largest
5 Economic Review Box: The 1981 Recession and Diamond CrisisThe last occasion that Botswana experienced a serious The adjustment measures included:macroeconomic crisis was in 1981-82, when circumstances (i) the devaluation of the Pula, by 10%were similar to the present: an international recession, (ii) a freeze on public sector wages and salaries (which,coupled with a dramatic reduction in diamond sales. As given the policy in place at the time, effectivelyFigure 2 shows, US GDP contracted by 2% in 1982, similar meant an economy-wide wage freeze);to the current forecast for 2009. The international diamond (iii) tighter monetary policy (the Bank Rate rose frommarket was hard hit: sales through De Beers Central Selling 8.5% to 12%);Organisation (CSO), which at that time dominated the (iv) direct controls by BoB on credit extension by theworld market, fell by more than 50%, from $2.7 billion commercial banks;in 1980 to only $1.3 billion in 1982. The demand for large, (v) the introduction of a sales tax;valuable stones for the upper end of the jewellery market (vi) restrained growth in government spending.was particularly weak. Former President Masire described the principles that were Figure 5: CSO diamond sales, 1976 - 1987 followed in implementing these adjustment measures in 1 3.5 his biography . 3 (i) spread the burden of adjustment as fairly as possible; 2.5 (ii) be transparent and consult widely if difficult decisions have to be taken, so that the facts are known and US$ billion 2 the reasons understood; 1.5 (iii) use accumulated reserves as a buffer; 1 (iv) do not delay or avoid adjustments if they are necessary. 0.5 In adopting these principles, the government had learned 0 from the experience of other countries which had hoped that their problems would go away, when delays in taking 76 77 78 79 80 81 82 83 84 85 86 87 action actually created more problems and ultimately the 19 19 19 19 19 19 19 19 19 19 19 19 need for more severe measures. Source: Bank of BotswanaBotswanas diamond exports were hard hit; there were The outcome of the crisis was, in the end, not as bad asno diamond exports at all for several months in late 1981 had been initially feared. This was largely because in 1982and early 1982, and there was a sharp reduction in the cavalry arrived, in the form of the opening of thegovernment revenues from diamonds. De Beers reduced Jwaneng mine, and despite the weakness of thesales offtake quotas for producers selling through the international market, Botswana was permitted to increaseCSO, and many producers, including Debswana, were its diamond sales through the CSO. Hence the reductionforced to stockpile part of their production. in diamond exports and government revenues was fairly short-lived, and by 1983 both were growing at a healthyAs the crisis unfolded it was not at all clear how long it rate. GDP growth was not affected, because even duringwould last, and the Botswana Government introduced a the crisis diamond production was not reduced, and surpluspackage of adjustment measures aimed at maintaining stones were simply stockpiled, and when Jwaneng openedmacroeconomic stability in an environment where national output rose sharply.income (represented by export earnings) and governmentresources (derived from taxation of minerals) had been Because the opening of Jwaneng transformed the situation,sharply reduced. Essentially these measures aimed at it is difficult to say how much the adjustment packagecurbing national consumption to maintain a balance with contributed towards maintaining macroeconomic stability,(reduced) income, and ensuring that neither the although it undoubtedly played a positive role. Withoutgovernment nor the country incurred unsustainable deficits. the contribution of Jwaneng, the impact of the crisis on Botswana woul undoubtedly have been much more severe.
6 Economic ReviewIt took seven years for the international diamond market duration of the international recession is likely to beto recover; only in 1987 did CSO sales pass the level that greater. On the positive side, however, Botswana hasachieved in 1980, and it was only at this time that used the intervening period to build up a sizeable cushionBotswanas accumulated stockpile of diamonds could be of financial resources (in the form of the foreign exchangefinally sold off. reserves and governments savings at BoB) that can be used as a buffer to support the adjustment process. InThe current situation has some similarities with 1981-2, terms of possible adjustment measures, the range ofbut some important differences. Most obviously, there is policies available to government is somewhat reducedno Jwaneng waiting in the wings to rescue the situation; compared to 1982, when the economy was much smallerwhereas in 1981-2 the reduction in diamond exports and and the government had more direct controls; for instance,mineral revenues was fairly short-lived, this time it is likely credit controls and a wage freeze are no longer part ofto last for several years, especially as the depth and the policy armoury. 1 Q K J Masire, "Very Brave or Very Foolish", (edited by S R Lewis Jr)Macroeconomic ImplicationsThe immediate impact of the halting of diamond exports Figure 6: Projected Budget Balance and Trade Balanceis that approximately P1.5 - 2 billion has to be drawn from 10%the foreign exchange reserves each month to maintainimport levels. With total reserves of around P70 billion 5%this is not a problem in the short term. Government is % of GDP 0%losing around P1 billion a month in mineral revenues, butwith accumulated savings of some P30 billion, this too -5%can be accommodated in the short term. -10%Diamond exports will eventually resume, but are unlikelyto return to pre-crisis levels in the near future. While -15% 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13forecasts are still hedged with a great deal of uncertainty, Budget Trade Source: Econsultwe estimate that taking account of lower prices andreduced export volumes, diamond export earnings will fallsignificantly, by one-third to one-half, in 2009/10. GDP growth is likely to fall sharply and could well beFurthermore, we estimate that it will take five years for negative, although this primarily depends on the degreediamond exports to fully recover. Lower diamond exports to which production is cut back at the diamond mines, orwill be compounded by declines in exports of other major how much production is maintained and any surplus iscommodities such as copper-nickel. This reduction in stockpiled. If sales do fall by 30-40% in 2009 (or perhapsexports is equivalent to around 10-15% of GDP. In the even more), it is likely that Debswana will have to cut backmeantime, unless measures are taken to restrain imports, on production in order to contain costs. There has alreadythe country will experience substantial balance of trade been discussion of closing two of the smaller mines, anddeficits, which will have to be financed by drawing this would be a prudent strategy; while in principle all thedown the foreign exchange reserves (see figure 6). mines could be kept open and production maintained at recent levels, and the surplus stockpiled, this would causeThe above figures would also translate into a decline of government mineral revenues to fall even further. While15-20% in total government revenues. Lower mineral keeping all of the Debswana mines open would benefitrevenues are likely to be compounded by slower growth Debswana employees and suppliers, it would disadvantagein other important revenue sources. SACU revenues are other citizens, and would thus be inconsistent the principlelikely to decline as South African import growth slows; of equitable burden-sharing.earnings from the foreign exchange reserves will fall dueto both declining returns in international markets and the The credit rating agencies, Moodys and Standard & Poorsdrawdown of reserves; and other revenue sources (such both released their 2008 reviews of Botswana in December,as VAT and income tax) will be hit as economic growth slows. and included forecasts of real GDP growth for 2008/9 andDepending on how government spending is adjusted, large 2009/10, taking account of the impact of the global crisis.budget deficits are likely (see Figure 6). Moodys are slightly more optimistic, seeing growth fall sharply, but remaining positive. S&P consider that the
7 Economic Reviewgrowth shock will be greater, and that there will be two and polishing operations will be adversely affected due toyears of negative growth, before a modest recovery in the drop in demand for their products, and it has already2010/11. been announced by De Beers that the transfer of diamond aggregation operations from London to Gaborone hasTable 1: Economic Growth Forecasts been postponed. Outside of mining, it is likely that tourism will be adversely affected, as well as perhaps other important export industries such as textiles. Domestically, construction isUndoubtedly there will be a reduction in GDP growth from likely to be impacted by reduced government spendingthe 3.3% recorded in 2007/08. Our own projections are on development projects. As for employment, there havemore in line with the S&P forecasts, i.e. that Botswana is already been redundancies announced in the mining sector;likely to experience negative economic growth through more are likely, as are retrenchments in the other sectorsto 2010. Furthermore, the main risks are to the downside, mentioned above, although quantifying the likely negativei.e. that growth will be lower than the figures indicated effect on employment is very difficult.here. Compared with trend GDP growth of 4-5%, thismeans that the negative impact of the crisis on the economy There has been much speculation regarding howwill be equivalent to some 10% of GDP (see Figure 7). Botswanas foreign exchange reserves have been or mayWhile this may seem large, it is similar to the fall in GDP be affected by the crisis. There is no evidence that financialgrowth rates being experienced by many other countries. assets making up the reserves were negatively affected by the turmoil in global financial markets in September and Figure 7:Real GDP - Trend & Forecast October. However, the likelihood of sharp falls in export 125 earnings, it will be necessary to draw down on accumulated reserves. Forecasts of the likely declines are inevitably 120 speculative, and depend on the governments policy 115 response, which is discussed further below. However, on Index, 2007/08 = 100 Forecast 110 the basis of a projected 40% decline in diamond exports, Trend and a modest restraint in fiscal policy, we project that the 105 foreign exchange reserves could fall by more than half 100 over the next five years. Net government savings balances 95 are also likely to decline by a similar amount. 90 While most of the economic news is bad, there are two 8 9 0 1 2 /0 /0 /1 /1 /1 07 08 09 10 11 positive outcomes of the crisis. The first is that inflationary 20 20 20 20 20 Source: calculations based on data from Bank of Botswana pressures are abating rapidly, both globally and domestically; inflation is likely to fall sharply during theThere has been much public discussion regarding which first half of 2009, and could be within the Bank ofsectors of the economy are likely to be hardest hit by the Botswanas 3-6% inflation objective by the middle of thecrisis. As noted above, mining has already been badly year, driven by declining fuel prices. This should enableaffected, with sharp falls in the volume of diamond exports further reductions in interest rates. Second, reducedand in revenues from copper-nickel. All of Botswanas economic growth in the southern African region will easemining companies are negatively affected, with the pressure on power supplies, and the precarious situationexception of Mupane gold mine, as gold has been the one in Botswana will be eased by the closure of one or moremineral that has benefitted from the crisis due to its "safe of Debswanas mines.haven" status. The most vulnerable mines are the newsmall mines run by African Copper and Diamonex, which Policy Responseshave been hit by lower prices just as they were scaling upproduction. Elsewhere in the mining sector, it is likely that As noted in the Box, the macroeconomic policy responseprospecting and exploration work will be scaled back, and to the 1982-2 crisis involved fiscal, monetary and exchangeprojects that were considered likely to lead to new mines rate policy, as well as direct controls on credit and wages.in the new few years - such as Discoverys copper project The economic policy environment is quite different now,and A-Caps uranium project, as well as two new diamond however. Government no longer has the power tomines - are likely to be deferred due to low prices and implement wage and credit controls. Monetary andfunding constraints. Newly-established diamond-cutting exchange rate policy have also changed. The adoption of the crawling peg exchange rate regime appears to have
8 Economic Reviewruled out step devaluations, and although a reduction in to lower income levels is required.the value of the pula would be appropriate in presentcircumstances - primarily to restrain imports in line with With this in mind, using fiscal policy to stimulate thereduced exports - this is more likely to be done through economy, or even maintaining a "business as usual"an acceleration in the rate of crawl rather than a devaluation approach, runs the risk of large budget deficits and balanceas in 2004 and 2005. As for monetary policy, this is now of payments deficits for a number of years, which wouldmuch more closely focused on controlling inflation rather lead to a rapid depletion of the foreign exchange reserves.than influencing the level of economic activity; given thediminished inflation risk in the recession, it is more likely At this point we should note that government savings andthat interest rates will be reduced, rather than increased the foreign exchange reserves have two purposes: to actas in 1981-2. as a buffer against short-term fluctuations in economic activity and earnings, and as a "fund for futureMuch of the burden of macroeconomic adjustment in generations", a financial asset intended to compensateresponse to the current crisis will therefore fall on fiscal for the depletion of mineral assets and generate incomepolicy. In doing so, the policy response has to accommodate for the future. It is important not to use all of the reservestwo, possibly conflicting, objectives. First, policy can attempt for the first purpose, leaving nothing for the second.to reduce the adverse impact of the crisis on the economy,though a combination of using accumulated reserves as This does not mean that Botswana is gaining no benefita buffer and using fiscal policy to stimulate the economy, from the reserves. The do provide room for manoeuvre.in a similar fashion to policy packages being undertaken For instance, even if export earnings and governmentin other countries. Second, policy should focus on revenues fall sharply in 2009, it will not be necessary tomaintaining macroeconomic stability, which means ensuring cut back on imports or government spending by the samethat domestic and external balances (the government amount, because of the cushion provided by the reserves,budget balance and the balance of payments) are which can certainly be partially drawn down to financesustainable. The two objectives may be in conflict because, deficits. However, this does not mean that the reservesfor instance, providing a fiscal boost to the economy could can be fully depleted in order to indefinitely financelead to an unsustainable budget deficit, depletion of consumption levels far in excess of the countrys income-reserves, accumulation of debt or future inflation. Achieving earning ability.an appropriate balance between buffering and adjustmentis the key. While a fiscal stimulus is likely to be unsustainable, government should as far as possible try to avoid makingIf the crisis were expected to be short-lived, the focus drastic cuts in spending that would destabilise the economycould be primarily on "buffering" and using accumulated still further. But some spending cuts are likely: ourreserves to counter the negative impact of the recession. projections suggest that with government spendingHowever, it would be risky to assume that the crisis is growing at "pre-crisis" rates, the budget deficit wouldgoing to be over within, say 12-18 months, which is the quickly surpass 10% of GDP, which is very large and quiteperiod for which a "business as usual" scenario could be possibly unsustainable. Modest cuts, to keep theeasily maintained. It is much more likely that it will be a deficit within say 6% of GDP, should be targeted.multi-year affair, with diamond exports taking perhapsfive years to recover to early 2008 levels in real terms The level of spending cuts that will be necessary to maintain(reflecting stuttering recovery in the world economy, and fiscal sustainability depends very much on the degree ofthe diamond sector lagging behind recovery in other the downturn in diamond exports and mineral revenues.sectors. If the decline in exports is limited to, say, 35% for two years, with recovery beginning in late 2010, then it shouldBotswana could, in principle, undertake a fiscal stimulus be possible to manage with some fairly modest cuts inpackage financed by accumulated government savings or government spending. The danger is that the decline inby additional government borrowing; after all, the economy earnings is larger, say more than 50%, in which caseis awash with liquidity and the private sector is undoubtedly deeper cuts would be necessary.willing to hold more government bonds. However, budget Controlling the government budget will be the key todata suggest that there is little scope to do this in a maintaining macroeconomic stability during the crisis.sustainable manner. Such a policy would lead to large The following principles would be appropriate:budget deficits and sharp deterioration in governmentsfinancial position, which would be difficult, if not • Setting a firm ceiling on the government budget, whichimpossible, to restore. It would also lead to rapid drawdown is likely to involve modest spending cuts;of the foreign exchange reserves. The ability to borrow • Reviewing government policies and programmes anddoes not change the situation: governments net financial their expenditure implicationsposition and the impact on the reserves is the same whether - weeding out unnecessary and unproductiveexpenditure is funded from savings or borrowing. To spending;maintain macroeconomic stability, some kind of adjustment - prioritisation of projects and programmes,
9 Economic Review so that the focus can be on high priority items; It should also be noted that contrary to popular perceptions, - focusing government spending on economically much has been done to reduce Botswanas dependence productive projects which will help the economy upon diamonds over the past two decades. For instance, to withstand the recession and contribute to while mineral revenues accounted for well over 55% of economic diversification; total government revenues as recently as the late 1990s,• Postponing non-essential development programmes; the figure is now under 40%. Similarly, the balance of• Critically evaluating projects with a very high import payments is much less dependent upon diamond exports component; than it was: in the early 1990s, non-diamond exports• Freezing new posts in the public sector; managed to pay for less than 30% of Botswanas imports• A continued focus on improving productivity and of goods and services, whereas by 2007, the figure had efficiency in the public sector; risen to nearly 60% (see Figure 8). Hence the impact of• Preparing contingency plans to be implemented in the a dramatic downturn in diamond exports on the economy event that the international crisis proves deeper or is likely to be less at the current time than it would have more long-lasting than currently anticipated (especially been a decade ago. The severity of the impact reflects not with regards to diamond exports); so much a failure to diversify away from diamonds, but• Postponing the introduction of NDP10 until the the fact that several of the industries that have been longer-term implications of the crisis are clearer. instrumental in that diversification are also being badly affected by the global recession.Conclusion Figure 8: Proportion of imports covered byIn the last edition of the Economic Review (2008Q3) we non-diamond exports (goods and services)argued that while "Botswanas financial sector has so far 60%been immune from the problems facing stock markets and 50%banking systems in other countries", the "main threat lies US$ billionin the potential impact of prolonged global economic 40%slowdown on the mining industry". We also noted that 30%"the next three to six months will be crucial in determining 20%how the impact of the global crisis on Botswana will play 10%out". In the event, developments over the past threemonths have been far worse than anticipated, and the 0%impact on Botswana - as in most countries of the world 07 06 92 93 94 95 96 97 98 99 00 01 02 03 04 05 20 20 19 19 19 19 19 19 19 19 20 20 20 20 20 20- will be severe, with lower economic growth, reduced Source: Econsultexports and government revenues, and risingunemployment. While in many respects the economic prospects for 2009 are not good, the situation is not all bleak. The long-termWhile Botswana will undoubtedly be stressed in the current prospects for diamonds remain good, with falling worldglobal economic climate, the dangers should not be diamond supplies providing support for prices once demandexaggerated, and Botswana is in a much stronger position recovers. As noted above, inflation is falling sharply, duethan many other mineral-producing economies. Nigeria, in large part to the impact of the global recession, andAngola and Zambia are all likely to experience larger regional power shortages should become slightly lessdeclines in export earnings than Botswana, and also have acute. In addition, government budget constraints willsmaller reserves to help see them through the crisis. hopefully force some long-overdue pruning of waste inBotswanas accumulated foreign exchange reserves and government spending, along with the prioritisation ofgovernment assets provide a cushion that will enable a projects and programmes. The crisis also reinforces thegradual adjustment to these adverse circumstances, rather point made in earlier editions of this Review that in goodthan a panic response. The foreign exchange reserves times, government should be saving much more to putamount to some 24 months of import cover, whilst at the the economy in a stronger position when diamondsend of 1980, going into the previous crisis, reserve cover eventually run out, and should not be embarking on newwas only around 6 months. spending programmes (or keeping old ones going) with unknown or insufficient economic or social benefits. Bifm Botswana Limited Asset Management, Property Management, Private Equity, Corporate Advisory Services.Dynamic Wealth Management Private Bag BR 185, Broadhurst, Botswana, Tel: +(267) 395 1564, Fax: +(267) 390 0358, www.bifm.co.bw