Huge diamond reserves have served the basis for Botswana’s sovereign wealth fund, the Pula Fund. Yet, consistently low diamond prices and eventual depletion of reserves coupled with draw-downs for budgetary support are raising serious questions over the fund’s ability to smooth the African country’s transition to a non-commodity economy.

1. The Future of the Pula Fund
Daniel Brett
Huge diamond reserves have served the basis for Botswana’s sovereign wealth fund, the
Pula Fund. Yet, consistently low diamond prices and eventual depletion of reserves
coupled with draw-downs for budgetary support are raising serious questions over the
fund’s ability to smooth the African country’s transition to a non-commodity economy.
Revenue from diamond mining is the bulwark of the Botswanan economy, putting the landlocked
middle-income African state in a rare position of economic stability and relative affluence in a
continent that is marked by instability and weak economic performance. Since 1994, a portion of
foreign exchange reserves, swelled by diamond exports and accounting for 18-20 months import
cover, have been devoted to the Pula Fund.
Managed by the Bank of Botswana (the central bank), the fund is ostensibly a future generations
savings fund but its objective under the Bank of Botswana Act is unclear. In reality, it is increasingly
used for politically motivated spending. Drawn-downs have undermined asset growth, while a
conservative approach to asset management has undermined value creation.
Conservative asset allocation restrains fund growth
The fund consists of two parts: the government investment account (GIA) and the Bank of Botswana
account, both of which are held by the central bank. The GIA contains funds raised through fiscal
surpluses which are generated chiefly through the budgetary rule that spending must not exceed
40% of GDP and a Sustainable Budget Index, which is a ratio of recurrent spending to non-mineral
revenues. In addition to assets held at the IMF, the liquidity portfolio, which represents the
remainder of foreign reserves allocations, contains excess reserves, defined as more than six months
of import cover. In September 2017, the liquidity portfolio totalled BWP16.3bn, equating to 21% of
total foreign exchange reserves, according to the central bank’s latest accounts, while BWP59.1bn
was held by the Pula Fund.
The Pula Fund is guided by an allocation strategy that has, over recent years, devoted around 60-
65% of assets under management (AUM) to long-term fixed income and 35-40% to equities. In terms
of fixed income assets, reserves can only be invested in investment grade sovereign debt with fixed
income following the allocations the IMF uses for the SDR currency basket.
Liquidity portfolio
21%
Assets at the IMF
2%
GIA
67%
Bank of Botswana
33%
Pula Fund
77%
Foreign Reserves Allocation

2. Equity investments are made in a range of countries according to their weight in the MSCI Index. The
central bank’s financial markets department manages 50% of the fund and nine foreign fund
managers take care of the other 50%. The Pula Fund is prevented from investing in Botswana to
prevent the fund from being subjected to diamond market trends, which influence the performance
of the rest of the country’s economy.
The relatively risk-averse approach of investing overwhelmingly in developed markets, particularly
US equities and US dollar denominated securities, has ensured fund stability, but has ensured tepid
fund growth. As such, the fund has missed strong growth in local currency emerging markets
sovereigns and holds assets with relatively subdued yields. In terms of equities, the Pula Fund’s
orientation towards value retention may well prove wise in view of the arguably unsustainable influx
of liquidity in EM equity markets, yet a long-term approach would seek to find value in segments
with growth potential.
The lack of investment in alternative asset classes, such as real estate and private equity, also
indicates that the Pula Fund has failed to follow other SWFs in diversifying portfolios to ensure
greater long-term value creation. Diversification is desirable given the long-term investment horizon
of a fund that is intended for inter-generational savings.
Slowing diamond revenue inflows
While it faces lower potential in terms of asset growth, the Pula Fund is also suffering the effects of
lower diamond prices as well as declining domestic diamond reserves. The mining operations of the
country’s main diamond miner, Debswana (a 50:50 joint venture between the government and De
Beers), have scaled back in recent years in the face of poor market conditions.
In 2016, the Damtshaa mining operations were suspended and the company plans to scale down
production at its Orapa No.1 Mine to 1mn ct per annum. However, 2017 saw a rebound in output. De
Beers’ total diamond output grew 29% y-o-y to 25.3mn ct, of which Debswana contributed two-thirds
of volumes. Debswana reported that in the first three quarters of 2017, output grew 14% y-o-y to
17.2mn ct as the Orapa No.1 mine restarted operations while the Jwaneng mine, Botswana’s largest
diamond mind, also saw increases.
Despite higher production volumes, De Beers has seen diamond sales revenue as global prices have
fallen. Over nine sales cycles in 2017 (January-November), De Beers’ sales fell by 6.2% y-o-y to
USD4.85bn with the IDEX rough diamond price index falling 25% between January 2016 and November
2017.
US dollar,
41.73%
Euro,
30.93%
Renminbi,
10.92%
Yen,
8.33%
Pound
sterling,
8.09%
SDR weighting
US
51%
Europe ex
UK
15%
Emerging
markets
12%
Japan
8%
UK
6%
Canada
3%
Others
3%
Asia ex
Japan
2%
MSCI World Index weighting

3. The decline in diamond sales values will put downward pressure on foreign exchange reserves and
government revenues and could, in turn, lead to reduced inflows into the Pula Fund as well as further
withdrawals to fund recurrent expenditure.
Efforts are ongoing to expand diamond production with Lucara Diamond Corporation announcing in
November 2017 plans for a USD195mn underground expansion at the Karowe mine, set to produce
2.7mnct by 2026. However, this will not resolve the problem of the overall structural decline in mining
reserves, nor will it offset the impact of volatile diamond prices.
While Botswana could support output growth over the short-term, government forecasts show that
diamond reserves will be all but exhausted by 2040. By that time, Botswana will need to have in place
a SWF with sufficient assets to ensure the country can continue its economic transformation while
catering to the needs of a growing population.
Resorting to drawdowns contributing to stagnation
The Pula Fund’s purpose has slipped over the years, straying from the intention to generate inter-
generational savings to becoming a slush fund that supports budgetary policy. In 2017, the fund’s
value was estimated at around BWP58bn (USD5.6bn) and has seen sluggish growth over recent
years. A fund of this size will not be able to sustain the economy as diamond revenues – accounting
for 75% of forex earnings and 35% of public revenues – diminish.
Since 2000, there have been six years of significant drawdowns from the GIA for various purposes.
Drawdowns from the GIA led to declines in the Pula Fund’s AUM of BWP8.1bn, BWP12.1bn and
BWP7.0bn in 2008, 2012 and 2015, respectively. Some withdrawals have included financing public
pensions and the budget deficit, but also the government has tapped funds to avoid politically
sensitive decisions such as raising taxes, introducing school fees or capping the rise in civil servants’
wages. As a result of the combination of low yield investment and GIA withdrawals, the SWF’s AUM
had a CAGR of just 1.35% in 2008-2017, which after allowing for Botswana’s inflation rate of
consistently over 3% and at times as high as 15% amounts to a real terms decline.
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
2005 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
1,000carats
Botswana Diamond Mine Output
Source: USGS, Debswana, 2017 = estimate

4. Withdrawals call into question the fund’s governance. While Botswana has been a signatory to the
Santiago Principles since 2008, the Pula Fund has low levels of transparency and gaps in regulation
with a lack of clear oversight rules. It lacks a constitutive charter or legislative framework that guides
withdrawals and spending, enabling the government to use the fund to finance the budget, although
it is unable to use funds to finance off-budget expenditure or withdraw more than the GIA’s share of
the fund.
Outlook: fund recovery, but growth disincentivises needed reform
Complacency is the enemy of success and rising diamond revenues over the short-term will
encourage political complacency that will damage the Pula Fund’s role in terms of amassing inter-
generational savings. A steady recovery in the country's crucial diamonds industry will pave the way
for stronger economic growth, thereby narrowing the fiscal deficit and reducing the need for GIA
withdrawals. The revival should ensure Botswana avoids a sovereigns rating downgrade, which was
mooted throughout 2017. This will, in turn, disincentivise the government from undertaking the
necessary fiscal restructuring that will be essential as diamond reserves deplete.
With the country approaching a general election in 2019 and the 40% GDP spending limit more
achievable with higher growth, there is even less impetus for reducing expenditure. The Botswana
Democratic Party (BDP) is in danger of being voted out of office for the first time since independence
in 1965 due to growing frustrations and an anti-incumbency factor that is being felt throughout
southern Africa. While a political crisis and social unrest are unlikely, higher levels of government
expenditure are likely as the BDP seeks to see off a strong opposition challenge. Should it lose
power, a populist successor could resort to tapping more funds from the GIA to support its agenda.
At the same time, the country is making little headway towards economic diversification with the
collapse of Pula Steel - the first company in the country to process scrap metal into intermediate
products called billets – in 2017 a testament to the difficulties facing the country’s industrial base.
This will ensure the government’s revenue and foreign exchange will remain narrowly based on
diamond exports. In the long-run, this will lead to a current account deficit that will quickly erode
foreign exchange reserves and the Pula Fund will diminish to nothing.
-30%
-20%
-10%
0%
10%
20%
30%
40%
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Growth,y-o-y
BWPmn Pula Fund AUM
Fund size Growth