2010 Q3: Feature on IMF Article IV Report


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2010 Q3: Feature on IMF Article IV Report

  1. 1. Bifm Economic Review 3rd Quarter 2010 Economic Review Dr. Keith Jefferis Chairman of Bifm Investment CommitteeINTRODUCTION Annual GDP GrowthThe third quarter of 2010 marked a continuation of the 30%recovery from the global economic crisis of 2008-09. Recovery Source: CSO, Econsult 20%in Botswana’s most important industry – diamond mining –has been stronger than earlier expectations, with the global 10%diamond market increasingly robust. This has had a positive 0%impact on the trade balance and the government budget, andhas helped to stabilise some of the adverse macroeconomic -10%developments that were in full swing a year ago. But in many -20%respects, economic conditions remain challenging and farfrom the “pre-crisis normal”. At the same time the economy is -30%going through a period of transition, from “recovery” mode to 2005 2006 2007 2008 2009 2010“adjustment” mode. With recovery from the crisis well under Mining Non-mining private sector GDPway, the priority is now changing to adjustment, and dealingwith the structural challenges that need to be addressed toensure sustainable growth. Another note of caution stems from the performance of the rest of the economy. Annual growth (of value added) in the non-ECONOMIC GROWTH mining private sector declined to 4.5% in the second quarter, theOverall GDP growth in the year to June 2010 rose for the second lowest rate for almost five years. The general pattern of growthquarter running, reaching 9.2% - the highest growth rate for so far in 2010 is therefore largely as anticipated, combining afive years - driven by the sharp resurgence in mining output post-crisis upsurge in export-led, mining sector growth with a(notably diamonds) in first half of 2010. On the surface, this deterioration in non-mining growth as government spendingappears good - this rate of growth makes Botswana one of the levels off as the focus turns to fiscal sustainability. This is reflectedfastest growing economies in the world, at least temporarily. But in sectoral growth rates, with manufacturing, government andthe result should be interpreted with some caution. It is driven finance & business services experiencing negative growth in theby the growth in mining output, which reached 16% in Q2, but year to June 2010, and low growth in the trade (wholesale,this largely reflects a comparison with 2008-9, when diamond retail, hotels & restaurants) sector. Nevertheless, growth forproduction fell to very low levels – so most of this is simply a base 2010 is in line with the IMF’s recent forecast of 8.4% for theeffect, and actual output still remains well below pre-crisis levels. year as a whole.As such, the impact is likely to be temporary.
  2. 2. 2 Economic Review Fig 2: Sectoral Output Growth (VA) Fig 3: DTC Diamond Sales Source: CSO, Econsult Source: Rappaport Diamond Report 800 Agric 39% Mine 700 Transp & comms 600 Constr U$S (million) Total 500Soc & pers serv Water & elec 400 Trade 300 Fin & bus serv Govt 200 Manuf 100 -10% -5% 0% 5% 10% 15% 20% 0 Growth in Year to June to 2010 2007 2008 2009 2010FOREIGN TRADE Some other categories of exports have also recovered well,Mining sector recovery has been driven by the upsurge in exports, with strong performance in the first half of 2010 from gold,notably diamond exports. The global market for rough diamonds machinery & electrical equipment, and meat exports. The onlyhas recovered faster than anticipated a year ago, with both sales really problematic area is textiles and garments, with exportsvolumes and prices ahead of expectations. This is somewhat only half the level of the previous year. While there are manysurprising, as the world’s largest market for diamonds, the USA, reasons for the problems faced by the textiles industry, someremains weak, with slow economic growth, continued high related to changes in the operation of trade agreements, theunemployment, and weak consumer confidence. The recovery fundamental problem is a lack of competitiveness. However,in diamond sales seems to be driven mainly by restocking by even with the problems afflicting textiles, overall exports arewholesalers and the cutting and polishing industry, while retail some 40% higher than in the first half of 2009.demand remains sluggish. This trend has also been reflectedin a sharp increase in rough diamond prices, which has not Fig 4: Change in Exports Jan-Jun 2010been matched by an increase in polished prices, resulting incompressed margins in the distribution, manufacturing and 80% Change from Jan - June 2009retail segments of the industry. All of this suggests that the 60%recovery in the international diamond industry that has been 40%witnessed in the past 12 months may not be sustainable, and aforthcoming correction may lead to lower rough prices. 20% 0%Nevertheless, all of this has been beneficial for Botswana and -20%has boosted export earnings. Overall diamond sales through the -40%Diamond Trading Company (the majority of which is Botswana -60%diamonds) have generally been improving through 2010, andsales in the first eight sights (out of a total of ten for the year)were 71% higher than in 2009. However, sales remain lowerthan in the pre-crisis period of 2007 and the first half of 2008.
  3. 3. 3 Economic Review Nevertheless, the general trend is that exports are well below Fig 6: Foreign Exchange Reserves -&./01$-(23&.)$4567,).3$83932:39$ imports, which have continued to rise steadily. As a result the Source: Bank of Botswana balance of trade has been in deficit since late 2008, although 70 14 a small surplus was finally recorded in June 2010, after 20 successive months of deficits. The overall balance of payments 60 12 Pula billion US$ billion (including trade, capital and other flows) has generally been in deficit since that time, apart from the third quarter of 2009 50 10 when the proceeds of borrowing from the African Development Bank were received. 40 8 Fig 5: Balance of Payments 30 6 Source: Bank of Botswana 2006 2007 2008 2009 2010 6.0 Pula US$ 5.0 4.0 Inflation and Monetary PolicyPula billion (quartely) 3.0 Inflation has hovered in the range of 6%-8% in recent months 2.0 without any clear direction. A gradual decline from 7.8% in 1.0 May to 6.7% in August was reversed with an increase to 7.0% 0.0 in September, and it is anticipated that inflation will continue to -1.0 fluctuate in the same 6%-8% range through to March 2011. -2.0 Beyond that time, however, there are good prospects of a -3.0 further decline in inflation that will take the rate back within the -4.0 Bank of Botswana’s 3%-6% inflation objective range, sometime -5.0 in the second quarter of 2011. Our view is that, barring any 2004 2005 2006 2007 2008 2009 2010 unforeseen oil price shocks from the international market, or further changes in domestic taxes such as VAT or the alcohol The result of ongoing balance of payments deficits is that levy, inflation should then remain within the BoB’s range for the inevitably, the foreign exchange reserves have declined. Between foreseeable future. This reflects both low international inflation January and July 2010 the reserves fell by around 9% in pula and weak domestic demand pressures. and US dollar terms, and by July were around 20% lower than their peak in mid-2008. The decline in reserves is not of any Fig 7: Inflation & Forecast immediate concern, as they still remain high with around 17 Source: CSO, Econsult months of import cover. 16% 14% The main concern is that, going forward, the country continues 12% to run balance of payments deficits and the reserves fall further. 10% This would eventually have implications for the exchange rate, as the current exchange rate policy is dependent upon a high 8% level of reserves to support the crawling peg. Preventing this 6% outcome requires restoring a balanced government budget, as 4% the fiscal deficit is one of the main drivers of the balance of 2% payments. 0% 2003 2004 2005 2006 2007 2008 2009 2010 2010
  4. 4. 4 Economic ReviewHowever it appears that there is not much consensus regarding This has implications for interest rates. After cutting rates by ainflation expectations, with wide divergence between private total of 5.5% in 2008 and 2009, the BoB has kept rates on holdsector and official views. According to the BoB’s Business even with the pick-up in inflation in recent months, reflectingExpectations survey, private sector businesses anticipate the expectation that inflation will be contained in the mediuminflation to average 8.8% in 2010 and 9.5% in 2011. The Bank term. Indeed, from a monetary policy perspective the relevantof Botswana’s forecasts in its 2010 Monetary Policy Statement, measure of inflation excludes tax increases, and so if the increasehowever, show that the Bank expects inflation to fall to 5% in VAT in April 2010 is excluded, inflation remains within thein 2011. More recent projections from the IMF (in the 2010 Bank’s objective range. Our expectation is that the next moveArticle IV report), provide forecasts that are closer to the BoB’s in interest rates will be downwards, although probably not untilprojections. the headline rate falls below 6% sometime in 2011. If inflation behaves in line with the IMF projections, then further interest rate cuts can be expected in 2012. Fig 8: Inflation Expectations Source: BoB, IMF, Econsult10% FINANCIAl SECTOR 8% In the second half of 2009 and the early months of 2010, a recovery in credit growth appeared to be under way, following 6% the sharp contraction in early 2009 as the international crisis 4% took hold. In recent months, however, this recovery seems to have faded. Quarter-on-quarter credit growth, which provides 2% a more accurate picture of recent changes than annual growth 0% rates, had fallen to zero by July 2010. 2010 2011 Fig 9: Credit Growth Business BoB IMF Source: Bank of Botswana, Econsult 70%This most likely reflects the backward-looking nature of inflation 60% Growth (qoq, annualisedexpectations in the market – the anticipated level of inflation in 50%the future is similar to what it has been in the past. This may work 40%some of the time, but will not work if there is structural change 30%taking place in the determinants of inflation. It is possible that 20%we are currently at such a juncture. International inflationary 10% 0%pressures are low, with persistent excess productive capacity -10%likely to keep inflation low for some time. Domestically, the -20%likelihood that government spending will be growing slowly, 2005 2006 2007 2008 2009 2010if at all, due to the need to balance the budget, means thatdemand pressures will also be weak. Hence there are good Total HH Priv. bus.prospects that inflation will remain relatively low by historicalstandards in coming years. IMF forecasts, for instance, projectaverage annual inflation remaining between 5% and 6% from2012 through to 2015.
  5. 5. 5 Economic ReviewThe reasons for this sharp drop in credit growth are not at all diamond earnings. This also means that the 2010/11 budgetclear. There are concerns about household debt sustainability, deficit is likely to be smaller than anticipated.and arrears remain high on lending to households, but theposition appears to have stabilised since the beginning of the The opening up of fiscal space is very welcome, given theyear. For credit to the private business sector, this may simply unanticipated outcome of the introduction of the new Publicreflect the slowdown in growth that is showing up in the GDP Service Act in May 2010. This appears to have resulted in andata. effective salary increase of around 10% throughout the public sector. Given concerns about the size of the public sector salary bill raised by the IMF and the World Bank (see below), this isGOvERNMENT BUDGET potentially problematic, and makes it less likely that there willNo data on the government budget have been published since be a pubic sector salary adjustment at the time of the 2011February, and we still do not have the final budget figure for Budget. It is likely, however, that the effective public sectorthe 2009/10 financial year that finished in March. This lack pay rise, combined with back-pay, will lead to an increase inof fiscal transparency is itself a concern. However, indications consumption spending and credit growth that could provide aare that budget was underspent last year, and that the deficit short-term boost to the economy. Nevertheless, the size of thefigure, when eventually published, will be significantly smaller increase, the fact that Government seems to have been unawarethan the figure projected at the time of the 2010 Budget in that the new Act would have this outcome, and the negativeFebruary. In the current financial year (2010/11), indications are impact that it has had on labour relations in the public sector,that mineral revenues are ahead of budget due to improved do not augur well for achieving public finance sustainability. Box: IMF Article IV Report, 2010 and World Bank Public Expenditure ReviewThe 2010 IMF Article IV report was released on September 9, Substantial fiscal consolidation to put the public financesfollowing the visit of an IMF team in June. The relatively quick back on a sustainable footing, to be achieved by lower publicrelease of the report represents a step forward, as previous spending (relative to GDP, not necessarily in absolute terms);Article IV reports have been subject to lengthy delays (the 2009Report was only released in June 2010). The Article IV reports Improved management of public debt; within anprovide a general economic overview, highlighting issues (mainly integrated framework for managing public sector assetsmacroeconomic issues) that the IMF considers to be important. (including the foreign exchange reserves) and liabilities (debt and guarantees) and a medium-term debt strategy, which isThe 2010 report focused on four areas: fiscal policies; monetary currently lacking;and exchange rate policies; financial sector policies; andreforming public finances. The general tone of the report is quite Caution in reducing interest rates further, until there arepositive, and notes that the Botswana showed considerable signs that inflation expectations have been revised downwards;resilience during the global financial and economic crisis. Keypriorities highlighted by the IMF include the following: Policies and reforms to create a leaner and more effective public sector, providing greater value for money; key reforms include strengthening of public financial
  6. 6. 6 Economic Review management, moving beyond the current NDP framework to Many of the IMF’s recommendations with regard to public programme-based budgeting and the implementation of a finance endorse more detailed recommendations made by the medium-term expenditure framework. World Bank in its Public Expenditure Review (PER), released in August. The PER undertakes a long term analysis of public Promoting private sector led growth through structural finance, budgeting and planning, and concludes that, with reforms to encourage entrepreneurship and investment, with government revenues projected to decline significantly in the a focus on cross-cutting reforms that can benefit the whole medium-term, present systems are not well suited to making economy, including privatisation, greater use of PPPs, and the necessary adjustments. The PER makes a number of key rationalisation of commercial services provided by government. recommendations, including: The overall economic outlook is quite positive, on the assumption • Re-examining policies and institutions and undertaking that the necessary reforms will be undertaken. Economic fiscal reforms to ensure medium-term fiscal sustainability; projections are provided through to 2015. The IMF’s baseline • Limiting the growth of the government workforce and forecasts entail real GDP growth averaging 6% a year over wage bill; this period, inflation falling to below 6% on a sustained basis, and a gradual return to budget surpluses. The IMF cautions • Raising domestic revenues and bringing down public that failure to undertake the necessary reforms to the public spending levels; finances and investment climate would lead to severe adverse outcomes, including slower growth, debt accumulation, and • Introducing new measures of fiscal sustainability; the running down of foreign exchange reserves which would in turn undermine exchange rate policy. • Replacing the project-focused National Development Planning (NDP) framework with programme-based Fig 10: IMF GDP Growth Forecasts budgeting and a Medium-Term Fiscal Framework; Source: IMF • Improving the capacity for project screening and appraisal, 20 15 and making public investment more efficient; 10 5 • Modernising the system of social safety nets and making Percent 0 them more cost-effective and better targeted towards -5 assisting low-income households. -10 -15 • Increasing transparency and improving data and information -20 on public finances and debt. -25 2007 2008 2009 2010 2011 2012 2013 2014 2015 The PER recommendations are currently being reviewed by the Ministry of Finance and Development Planning. Total Mineral Non-mineral
  7. 7. 7 Economic ReviewOUTlOOKSo far in 2010 the Botswana economy has demonstrated of the medium-term economic outlook and, in the words ofstrong overall GDP growth, driven by a good recovery in the World Economic Forum’s Global Competitiveness Report, tothe diamond sector. This is likely to continue in the coming move from a “factor driven economy” to an “efficiency drivenmonths, which should continue to have a beneficial impact economy” as diamonds gradually run out. Discussions at theon the trade balance, the foreign exchange reserves and the National Business Conference in Francistown on the theme ofgovernment budget. This provides breathing space, but should “Deepening diversification through private sector leadership”not be interpreted as meaning that the pressure to reform highlighted the wide range of reforms that need to take place tois off. The IMF and the World Bank have highlighted major provide an environment supportive of private sector led growth.challenges remaining in dealing with public finance reform, But as the IMF points out, if these reforms are undertaken, theplanning and budgeting reform, and improvements to the prospects for the achievement of respectable economic growthbusiness climate to support diversification. That these changes rates in the medium term are good.are necessary is not because of the global crisis, but because 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, www.bifm.co.bwDynamic Wealth Management Disclaimer: The views expressed in this publication are those of the author and do not necessarily reflect those of Bifm