Bifm Economic Review 2nd Quarter 2008 Economic ReviewSummary stable even as food and fuel prices have rocketed (see Figure 1). helps to contain price increases. For oil, by contrast, the scope for increasing supply asof Economic These inflationary pressures are almost prices rise is limited in the short-term, andDevelopments price stabilisation is much more dependent entirely driven by international developments. upon reducing demand; although demand Food prices have been rising around the for oil has fallen in the major industrialisedDr Keith Jefferis world, especially for dairy products, cereals countries during 2007 and 2008, demand and oils & fats whose prices have more than from the major developing countries has doubled in international markets over theChairman of past two years (see Figure 2). The overall continued to grow.Bifm Investment Food Price Index published by the UN Food and Agriculture Organisation has risen by The international origin of these inflationary pressures means that almost all countriesCommittee two-thirds over this period. This inevitably feeds through to domestic prices in a food- are affected in similar ways. In the major industrialised economies, inflation has alsoI importing nation. The only positive news risen sharply, albeit from lower levels, and is is that international food prices appear to set to reach the highest levels since 1991. have peaked, with a slight price decline in Inflation in South Africa has more or less ntroduction all commodity groups except meat between doubled over the past year, and inflation inThe past quarter has been one of almost March and May 2008. Even if prices do not many developing countries is at the highestuniformly bad economic news. Domestically, fall much, price stabilisation will at least rate for several years.there has been rapidly rising inflation, two mean that the impact on inflation will begininterest rate hikes, and setbacks for two What are the prospects for inflation in to reduce.major development projects. To the extent Botswana over the next year or so? In thethat there is any good news, it is that International fuel prices have also risen short-term, inflationary trends will continueBotswana is not alone; internationally, it is steadily, doubling over the year to June. to be dominated by fuel prices. Domestica similar story, with rising inflation almost In contrast to food prices, there is no sign pump prices have risen by less thaneverywhere, tighter monetary policy, and of an end to the upward movement in oil international oil prices, and even if oil pricesa slowdown in economic growth. In this prices. One difference between the two stabilise, domestic prices will still have toissue, we take a closer look at recent commodities is that higher food prices are rise further (see Figure 3). In all likelihood,economic developments, and the extent to quite effective at generating additional inflation will rise by at least another 2%,international economic developments are supply as farmers plant more crops, and this and will peak between 14% and 15% inimpacting on Botswana. Figure 1: Food & Fuel Price InflationInflationInflation has continued to rise rapidly inrecent months, and is up from 8.2% at theend of 2007 to 12.1% in May 2008. Theincrease is almost entirely driven by higherinternational food and fuel prices. Foodprice inflation reached 18.5% in May, whileinflation for the component of the CPI thatcomprises mostly fuel prices reached 42%.Indeed, apart from these items, inflationhas been quite well behaved; inflationexcluding food and fuel was only 5.2% in Source: CSO, EconsultMay – a rate that has remained remarkably
2 Economic Reviewthe third quarter of the year, on the basis of This duty has been imposed under the infant 15% on items such as printers, cellphones,events that have already occurred. However, industry provisions of SACU to protect a digital cameras, blank CDs etc. The apparentif international oil prices rise further, then new local UHT milk producer. Whether the intention is to establish a fund for musiciansBotswana’s inflation could move even new producer really needs 40% protection who may be disadvantaged by the illegalhigher. is a moot point, but the downside is that the copying of their music. A noble objective,On the bright side, as mentioned above, price of a key consumption item – especially one might think. However, the levy is wide-inflation continues to be focused on the for the poor – will be artificially increased, ranging and completely disproportionate tospecific areas of food and fuel, and apart adding further to inflation and poverty. In the matter at hand. Many of these items,from these commodity groups inflation addition, the 40% tariff is in contravention but especially computers, are essentialremains very low; there is no sign yet of of Botswana’s commitments to the World items of business equipment, especiallythe second-round effects that would result Trade Organisation (WTO), under which the in service industries which Botswana isfrom inflation spreading more widely in maximum permitted tariff is 20%. trying to promote through entities suchthe economy. This may be just a question In a further strange policy move that will add as the IFSC. For a country that is alreadyof time, however; higher fuel costs will to inflation and undermine competitiveness, challenged with regard to internationaleventually affect many other prices, and the Ministry of Trade and Industry has competitiveness, and is suffering from anthere will undoubtedly be pressure for wage imposed an additional tax on computers inflation problem, this policy measure isincreases as a result of higher food and and related items under the Copyright completely counterproductive, and the taxother prices. If second-round effects can and Neighbouring Rights Act. The tax on should either be removed or drasticallybe contained, then inflation will fall rapidly computers is 10%, and ranges from 5% to reduced.once fuel prices stop rising. However, ifsecond-round effects take hold, then it will Figure 2: International Food Pricestake much longer to bring down inflation.Apart from monetary policy (discussedbelow), what can be done to minimisethe impact of inflation? One area thatneeds to be considered is trade policy.Countries such as Kenya and Mauritiushave countered the impact of importedinflation by cutting import duties on fooditems. Botswana could lobby for similarmoves by the Southern African CustomsUnion (SACU), using the channels that areopen to all members under the 2002 SACU * to April Source: UN FAOAgreement. The SACU tariff structure isunnecessarily complex, and in general thetariffs are too high; the need to bring down Figure 3: Fuel & Crude Oil Pricesfood prices provides a good opportunityfor the reduction and rationalisation oftariffs, and as well for Botswana and thesmaller SACU members to use the availablemechanisms to influence the tariff structurein a way that suits their interests.Instead, Botswana has scored something ofan own goal by imposing an additional 40%import duty on UHT milk, which has pushedup the price of imported UHT milk by asimilar amount – on top of steep rises in milk Source: DEAprices which have occurred internationally.
3 Economic ReviewMonetary Policy Figure 4: Bank RateIn response to rising inflation, the Bank ofBotswana has raised interest rates twicein quick succession, by a total of 1%. Thistakes the Bank Rate (the BoB’s benchmarklending rate) to 15.5%, and the commercialbank prime rate to 17%. This marksthe highest ever level of interest rates inBotswana – even when inflation previouslyreached high levels of 14.2% in 2006 and17.6% in 1992, the Bank Rate had neverexceeded 15.25% (see Figure 4). Source: IMF, BoBAs discussed above, virtually all of theinflation being experienced by Botswana is rates can be effective in reducing demand In order to assess whether higher interestimported from international sources, and as and containing inflation, and this is one rates are likely to be effective at bringingsuch interest rate policy can have no direct reason why many central banks around the down inflation, empirical evidence is neededeffect on inflation. The intention, however, world have been increasing interest rates based on analysis of the sources of inflationis to prevent inflation from moving beyond in response to recent increases in inflation. and what economists call “the transmissionfood and fuel to become more generalised It is sometimes argued, however, that this mechanism of monetary policy”. The Bankin the economy. As we have noted, inflation is not relevant in Botswana, because only of Botswana’s monetary policy decisions areother than for food and fuel has remained a small portion of inflation is determined based on its own modelling of inflation andrelatively low, at just over 5%. Monetary locally – rather than by import prices or the transmission mechanism. However, thepolicy, through higher interest rates, is exchange rates – and hence monetary results of this work has not been published,intended to prevent this from rising. This policy is unlikely to be effective. Monetary and greater transparency regarding thechannel works through reducing the level policy is much more effective when high modelling results, inflation forecasts andof demand in the economy, by increasing inflation is caused by domestic demand empirical analysis of impact of interestthe cost of borrowing and hence reducing pressures, which is not the case at present. rates on inflation would help to enhancecredit growth. When inflation is imported, interest rates the credibility of monetary policy, andTo what extent is this likely to be effective? can only influence inflation by moderating convince the sceptics that there is a soundThis is difficult to answer definitively. second round effects, and cannot affect the basis for higher interest rates in the currentCertainly, it is widely accepted that interest direct causes of inflation. inflationary environment.Economic Growth 3.6% in South Africa – all 1-2% lower than in 2007. The main causes of slower To what extent has this growth slowdown had an impact on Botswana? So far, the growth are the fallout from the US sub- impact seems to be limited. The latest GDP prime and financial sector crisis, resulting in growth data only go as far as SeptemberThe international economy is suffering from 2007, but show that, at least up until then,a slowdown in growth as well as sharply risk aversion and reduced credit availability, growth was powering ahead. In the year tohigher inflation. While the world economy compounded by the impact of higher food September, total GDP grew by 5.9%, andis not (yet?) in recession, growth is falling and oil prices. The latter has resulted in a the non-mining private sector by a strikingalmost everywhere. The USA is amongst the massive shift of wealth and purchasing 11.1%, with particularly rapid growth inworst affected countries, with close to zero power from oil importing nations to oil the manufacturing, trade, hotels & tourism,growth, and other developed economies exporters, with an associated loss of real and transport & communications sectorsalso experiencing growth down to around income amongst the oil importers that has (see Figure 5).1%. In major developing economies, growth inevitably caused growth to slow, especially However, export data – which are moreis also falling, but remains more robust, as the additional earnings received by oil up to date - tell a less encouraging story.with 2008 GDP growth projections of 9.5% importers have largely been saved rather Total exports in the last quarter of 2007 andin China, 7.4% in India, 4.8% in Brazil and than spent. the first quarter of 2008 were down 12%
4 Economic Reviewcompared to a year earlier, with particularly 17%). The reduction in these exports, which growth slowdown may be biting, and doessharp falls in exports of beef (down 44%), almost entirely go to developed country not augur well for export led growth overand textiles and diamonds (both down markets, suggest that the effects of the the next couple of years (see Figure 6). Figure 5: Real GDP growth (annual) Figure 6: Change in Exports 6 months to March 2008 Source: CSO, Econsult Source: CSO, BobFinancial Markets overall credit growth, demand for mortgage finance reportedly remains robust. However, the decline in the BSE index largely reflects local developments. A year ago, there was widespread agreement that the While the Botswana Stock Exchange (BSE) stocks of commercial banks, which accountA major characteristic of the economic has experienced a period of decline since the third quarter of last year, there are only for the majority of BSE capitalisation, werecrisis affecting developed countries is the overvalued, with price-earnings (P/E) ratios superficial similarities with the declines incredit crunch – the reduced availability of up around 30, and a P/E ratio for the stock markets around the world. The BSEcredit from banks and financial markets, market as a whole of 19. Since that time, domestic index (DCI) fell from a peak ofand rising spreads which mean that riskier 9866 in August 2007 to 6908 in May 2008, the decline in the value of bank stocks – ofprojects and borrowers have to pay higher a drop of around 30%. The MSCI World up to 50% - has been the main driver ofinterest rates – if they can get credit at all. index (representing movements across all the falling stock market index. Bank stocks major developed and developing country now have P/E ratios of less than 20, and theThere appears to be no equivalent credit stock markets) fell by 18% from its peak market a P/E ratio of 12.9. This has beencrunch in Botswana, where the financial over a similar period, and almost all stock associated with declining bank profitability,markets are relatively insulated from global which has largely domestic rather than markets around the world have experiencedfinancial developments. Domestic financial sharp falls. international causes.markets remain very liquid, and creditgrowth has been robust; total bank credit Figure 7: Growth of Bank Creditgrew by 28% in the year to March, thefastest growth since 1999 (see Figure 7).Growth has been particularly rapid in creditto the private business sector, which was upby 35%.Looking specifically at mortgage markets,which have been at the forefront of financialsector problems in the major developedeconomies, in Botswana it appears to be“business as usual”. Total mortgage lendingby the commercial banks and the BotswanaBuilding Society rose by 12.3% in the year Source: BPC, BoBto March 2008, and although lower than
5 Economic ReviewThreats on the Figure 8: Business Confidence IndexHorizon? (% of firms rating current business conditions satisfactory)Although Botswana’s growth does notseem to have been badly affected by theinternational economic slowdown, andcredit is still readily available, the situationmay not last. There have been a coupleof high-profile corporate failures in thetransport sector (Lobtrans and AfricanExpress), which may make the banks morereluctant to provide corporate credit, orimpose tighter terms and conditions whichwould restrict credit availability.More generally, growth prospects for 2008 Source: BoBare uncertain, despite strong economicgrowth in the second half of 2007. Growthis likely to be negatively affected by the costs for the project – up from an initial promoted by CIC Energy and Internationalglobal economic slowdown (through $350m to an estimated $1500m - meant Power. Following similar concerns aboutreduced demand for exports) and the that the project was no longer viable. These rising construction and equipment costs,regional electricity shortage (discussed in rising costs reflected higher construction, it was announced in late June that it haddetail in the previous issue of this Economic equipment and project management costs. not proved possible to reach agreement onReview), although strong government The regional power shortage was also an the sharing of risks between the variousspending domestically should help to important contributory factor to the decision project stakeholders. Reading between thesupport growth rates. Views in the private to postpone; the Activox refinery would have lines, it appears that the preferred suppliersector are mixed: the Bank of Botswana’s been Botswana’s largest single consumer of power station equipment (Siemens ofBusiness Expectations Survey conducted of power, and given the shortfall in power Germany) and the main off-taker (Eskomin March 2008 reported that businesses supplies projected for Botswana over the of South Africa) were unwilling to shoulderexpected an average growth rate of 5.9% next four years or so, Tati Nickel could not sufficient financial risks (besides contractingin 2007/08 (compared to 6.1% in 2006/07, be assured of receiving the required power as supplier and purchaser, respectively),the most recent actual data), rising to 6.4% to commission the project on time, with the resulting in risk levels that the projectin 2008/09. At the same time, business resulting delays reducing project viability promoters (CIC and International Power)confidence levels have fallen slightly, with even further. Falling nickel prices, - down tothe overall percentage of firms rating current and other funders were unwilling or unable $22 000 a tonne at the end of May 2008, to take on themselves. Besides risingbusiness conditions satisfactory falling to from a peak of $54 000 a year earlier – also costs, the project has also fallen victim to70%, from 71% in September 2007 (see contributed to the demise of the project. tightening credit conditions in internationalFigure 8). Perhaps more telling is that the Contrary to some reports, however, the Tati markets. While there may still be a powerproportion of firms who are optimistic Nickel mine itself is not threatened; it will station built at Mmamabula, it is likely to beabout business conditions in 12 monthstime fell from 85% to 73%. keep on producing concentrates which are much smaller than the 2x2400MW project then smelted into copper/nickel matte at that has been discussed up to now. ThereThe impact of deteriorating economic BCL in Selebi-Phikwe. There remain good may also still be potential for developmentconditions has already had a negative on prospects of an expansion of the Phoenix of the coal mine for coal exports and/or atwo of the major development projects open pit, and also for a re-opening of coal-to-liquids project, but coming on topthat were expected to boost growth in the nearby Selkirk underground mine.coming years. In May it was announced of May’s cancellation of the Activox refinery, However, the postponement of the project the problems at Mmamabula are indeedthat the Activox Nickel Refinery Project may prompt a review of the tax concessionsbeing built near Francistown by Tati Nickel, unwelcome news. Both projects had been that were granted to Tati Nickel to supporta subsidiary of Russia’s Norilsk Nickel, had seen as major contributors to Botswana’s the Activox project, which would appear tobeen indefinitely postponed. The refinery efforts to diversify the economy through be no longer justified.was intended to process nickel and copper value addition to minerals producedconcentrates from Tati Nickel’s nearby The second major mining-related project in the country, a task that will becomePhoenix Mine into finished metal. However, to experience severe problems has been more difficult as international economicNorilsk decided that rapidly rising capital the Mmamabula Energy Project being conditions deteriorate. 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 thegate100092