Bifm Economic Review 1st Quarter 2009 Economic Review Dr. Keith Jefferis Chairman of Bifm Investment CommitteeIntroductionThe first quarter of 2009 has turned out to be one of the most The anticipated resumption in growth is in part due to thechallenging periods faced by the Botswana economy in the beneficial impact of the large fiscal stimulus packages beingpast thirty years. The impact of the global financial and implemented in the USA and elsewhere. However, the budgeteconomic crisis has hit the country hard, as the slowdown in deficits resulting from fiscal stimulus will have a long-termworld trade has affected Botswana’s major exports - diamonds, negative impact on growth, as the rapid accumulation ofcopper-nickel and tourism. In view of sharply reduced demand public debt is in the medium term likely to lead to a crowdingfor diamonds, the mines have remained closed since the out of private sector investment and higher real interest rates,Christmas break, with a partial re-opening currently scheduled while monetised deficits could also lead to higher inflation.for mid-April. The closure has resulted in redundancies amongst While the global recession may be technically over by the endminers and a negative impact on suppliers, and there are of 2009, the impact will nevertheless be long-lasting, with theconcerns that the impact is still to be felt more widely in the prospect of several years of below-trend global growth.economy. There has been a sharp reduction in diamond Furthermore, risks remain high; for instance, the Economistexports, resulting in deficits in the balance of international Intelligence Unit (EIU) estimated that there is only a 60%trade, the drawdown of foreign exchange reserves, and a chance of a resumption of reasonably healthy growth in thedecline in government revenues. The 2009 Budget, released next couple of years, and a significant risk of prolongedin early February, projected a small increase in spending in the stagnation.2009/10 financial year as the government tried to minimisethe impact of the crisis on the economy. However, the resultis a massive increase in the projected budget deficit, andconcerns about the sustainability of the fiscal position. On thebright side, inflation has continued to decline, as expected, Fig.1: Economic Growth Forecasts Real GDP growth, qoq, % annualisedwhich has enabled a further reduction in interest rates. 10The Global Economy 5The global economic situation has continued to deteriorate 0through the first quarter of the year, with growth estimatesand projections for the coming months revised steadily -5downwards. It is now clear that the world economy is in deeprecession, with the last quarter of 2008 and first quarter of -102009 showing the most severe contraction in economic outputfor 80 years. Estimates from JP Morgan are that the world -15economy will contract by 3.6% over the 12 months from July 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q102008 to June 2009. While there is an expectation that globaleconomic growth will turn positive in the second half of 2009, World Developed Emerging markets USA Euro Japanand there are already some signs that the recession is bottomingout, it is likely that growth will be weak, and will remain Source: J P Morgansluggish through 2010.
2 Economic ReviewWith several major developed countries still grappling withthe fallout from the 2008 systemic banking crisis, developing Figure 2: Diamond Exportscountries are more concerned with two subsequent (3 month moving avg.)developments: the sharp contraction in international capital 3,000flows and the slowdown in global growth and international Monthly exports (P million) 2,500trade. Private capital flows to developing countries are estimatedto have fallen by half in 2008 compared to 2007, and are 2,000projected to decline by a further 65% in 2009. This will leadto lower investment and problems in financing current account 1,500deficits. As many developing countries are highly dependent 1,000upon exports, they are vulnerable to a growth slowdown intheir major export markets, compounded by lower prices in 500the case of many commodity exporters. 0The Impact on Botswana 2003 2004 2005 2006 2007 2008 2009Where does this leave Botswana? As a country that has had Source: Econsult, based on CSOa high savings rate and consistent current account surpluses,and is therefore a capital exporter, Botswana is less vulnerableto reduced international capital flows than many other Figure 3: Balance of Trade (Quarterly)developing countries. The countries most at risk are those such 5,000as South Africa that rely on capital inflows to finance current 4,000account deficits and to meet the gap between savings andinvestment. Nevertheless, Botswana has been attracting foreign 3,000direct investment, especially in the minerals sector, and these 2,000 P millionflows are now much reduced, due to both the credit crunch 1,000and deteriorating prospects, at least in the short term, for 0mining projects. -1,000 -2,000Of more immediate concern to Botswana is the impact of the -3,000global crisis on commodity exports. Botswana’s second largest -4,000export, copper-nickel, was affected by lower prices during -5,0002008, but for most of the year diamond exports held up well. 2003 2004 2005 2006 2007 2008However, in the fourth quarter of the year diamond exports Source: Econsult, based on CSOcollapsed, falling from a monthly average of P2 078 millionin the first nine months of the year to an average of onlyP695mn in last the 3 months - a reduction of 67%, while Prospects for a recovery in diamond exportsdiamond exports in January 2009 were only P506mn. Althoughofficial data are not yet available for the period since January, There is a great deal of uncertainty in the international diamondit is likely to have been a similar story, with minimal diamond market, which has been affected by both a fall in retail demandexports through to March. While some of the mines are for diamond jewellery, and credit constraints restricting theexpected to re-open in April, there is still great uncertainty ability of cutters, polishers and wholesalers to buy and holdover the likely level of diamond exports for the remainder of stocks. The ability of diamond producers such as Botswana to2009. The fall in diamond and other exports has led to a sharp sell and export rough diamonds depends on both the level ofturnaround in the trade balance, with a deficit of P4.5 billion retail demand and the resumption of credit availability. Growthin the last quarter of 2008. in retail demand is likely to be slow given the very low level of consumer confidence in the major industrialised economies, and the likelihood that increased consumption of luxury goods will only come quite late in the recovery cycle, after housing and vehicle sales start to pick up. And while credit conditions are easing slowly, it is likely that even with further improvement, credit availability will not recover to the levels seen prior to the credit crunch and financial crisis.
3 Economic ReviewProspects for Botswana’s diamond earnings are also affected In response to very adverse market conditions, the Governmentby adverse price developments. Prices for rough diamonds has given Debswana permission to keep all of the mines closedhad risen steadily between 2003 and mid-2008, but have since since the Christmas break. The Jwaneng and Letlhakane minesfallen sharply, with price falls of up to 50% for auction and are scheduled to re-open in mid-April, along with part oftender sales. Prices for rough diamonds had risen much faster Orapa, while other operations will remain closed at least untilthan those of polished diamonds during the boom years, and the end of 2009 - although we suspect that the closure willas a result have fallen much further during the crash. With actually continue for longer. The decision to close the minesdemand recovering only slowly, rough prices are not has inevitably been controversial, given the negative impactexpected to return to earlier levels in the foreseeable future. on employees and suppliers. It has been suggested that ways should have been found for the mines to have been keptThe diamond market is much less transparent than those for open, and surplus production stockpiled. Financially, this wouldmost other commodities, and market forecasts are less readily perhaps be feasible. While Debswana is a large company, itavailable than they are for commodities such as copper or has relatively low costs of production, and the revenues thatgold. However, we have obtained forecasts of Botswana’s are received from the few diamonds now being sold shoulddiamond production over the period to 2013. These show be sufficient to meet a substantial proportion of operatingproduction falling by around two-thirds in 2009, with a small costs. Furthermore, it is reported that Government has beenrecovery in 2010. The value of production and exports should requested to contribute around P600 million as a shareholdersapproach more “normal” levels in 2011, but even through to loan to De Beers, in which it has a 15% shareholding - raising2013 is projected to remain below the peak seen in 2007. But the question of whether it would have made more sense toperhaps the most striking point is that the steady growth in provide this money to Debswana to enable the mines to remaindiamond production that occurred between 1998 and 2007 open.looks to have come to an end, which has major implicationsfor government revenues into the medium term. In particular, Ultimately, however, it appears that Debswana and themineral revenues are likely to grow more slowly than the Government has had little choice in the matter. Under aneconomy, and therefore account for a declining share of GDP. agreement between De Beers and the European Union competition authorities, De Beers (and we presume Debswana) is prohibited from stockpiling diamonds, in order to prevent price manipulation; as a result, De Beers has to sell everything that it produces. In present market conditions, that would Figure 4: Diamond Exports - Actual & mean selling diamonds at very low prices, which is not Forecast something that De Beers is willing to accept. Indeed, it is 5,000 reported that the price reductions on De Beers sales through the Diamond Trading Company (DTC) are much less than the 4,000 price reductions that have occurred on open market sales, a strategy that reduces demand for Botswanas diamonds even $ million 3,000 further. 2,000 The turmoil in the diamond market inevitably raises questions 1,000 regarding Botswana’s relationship with De Beers and whether 0 it needs to be changed. Both De Beers and Debswana are in a weak financial position, and if Government is being requested 2007 2009 2012 2000 2001 2002 2003 2004 2005 2006 2008 2010 2011 2013 1999 1998 to provide financing, then it should be considering what it requires in return; for instance, should government be thinking Actual F’cast of increasing its stake in either company? Furthermore, the Trend 97-08 marketing agreement for Botswana diamonds comes up for Source: Bank of Botswana (actual); WWW Diamond Forecasts Ltd renewal later in 2009. This agreement at present requires all Botswana diamonds to be sold through the DTC. But it may be time for an independent marketing channel to be opened, for instance by selling a portion of Botswana’s diamonds by auction. This would give Botswana an independent “window” on the market, enable a better assessment of market conditions, and perhaps provide an opportunity for Botswana to develop as a centre for the trading of diamonds from other countries.
4 Economic ReviewEconomic Growth Inflation and Monetary PolicyData on GDP show that overall economic growth was a One of the few positive economic developments recently hasrelatively sluggish 3.0% during 2008. Negative growth of - been the reduction in inflation, which has fallen from 15.1%3.7% in the mining sector was offset by reasonably healthy in November 2008 to 11.7% in February 2009. While this isgrowth of 8.3% in the non-mining private sector, with being driven mainly by the rapid decline in fuel prices, it isparticularly rapid growth in transport & communications and being supported by falling inflation for most other commodityfinance & business services. groups, including food prices, as well as lower international inflation. It is likely that inflation will continue to fall steadily through the first half of 2009, and will probably fall below Figure 5: Economic Growth by Sector, 6% - the upper end of the BoB’s inflation objective range - 2009 by August, and remain around the 5%-6% level for the Fin & bus serv remainder of the year. Transp & comms Government Soc & pers serv Figure 6: Inflation and Forecast Trade etc. 16% Water & elec Total 14% Construction 12% Manufacturing 10% Agriculture 8% Mining 6% -5% 0% 5% 10% 15% 4% 2% Source: CSO 0% 2003 2004 2005 2006 2007 2008 2009 2010Our forecasts for 2009 are much gloomier, however. The Source: CSO; Econsultdecision to close all of the diamond mines for several months,and to keep two of the mines closed until the end of 2009,will have a major negative impact on GDP growth. We estimatethat GDP will contract by around 16% in 2009. Although The Bank of Botswana’s 2009 Monetary Policy Statement wasthere should be positive growth in 2010 as the mines re-open, released in late February. The MPS made it clear that concernswe estimate overall real growth will only average around 1- about the global recession and weak domestic demand were2% a year over the period from 2009 to 2011, well below likely to dominate the prospects for inflation for the rest ofrecent average growth rates. This illustrates that the global 2009. This in turn was likely to provide room for a looseningcrisis will have a negative impact on Botswana well into the of monetary policy, and that lower interest rates would helpmedium term. to support the domestic economy. Subsequently, the Bank Rate was cut by a further 100 basis points (bps) to 14.0%, the lowest rate for nearly 10 years. It is likely that interest rates will be cut further during 2009; we estimate that rates will come down by a further 100-200 bps.
5 Economic ReviewFeature: The Implications of the Global Financialand Economic Crisis for the Government BudgetOne of the most serious dimensions of the global financial The deficit is not in itself a major problem; Government hasand economic crisis for Botswana will be the impact on the sufficient savings at the Bank of Botswana (P31 billion as atgovernment budget. The 2009 Budget, delivered on February the end of 2008) to finance this deficit. Our concerns relate2nd, includes Botswana’s own version of a fiscal stimulus to the medium term. Here the official picture is opaque. Unlikepackage, with overall spending set to increase by 5% during most countries, Botswana does not publish medium termthe 2009/10 fiscal year, following a 45% increase in budgeted economic or budget forecasts (except infrequently along withspending in 2008/09. The Budget recognises that overall National Development Plans). Although it has been suggestedrevenues will fall sharply, due to lower mineral revenues, and that publishing forecasts at a time of such economic uncertaintyas a result projects a large budget deficit, of P13.4 billion or would be unwise, as the situation is changing so fast, this14% of GDP, following a projected deficit of 7% of GDP in argument is weak; there is always a best available forecast,2008/09. even if subject to uncertainty and in need of frequent revision, and if anything when the situation is so fluid a forecast becomesThere are several reasons for this outcome. Most of the budget even more important as a guide for decision-making.spending plans were drawn up before the full impact of the Notwithstanding the absence of a medium-term forecast, theglobal financial and economic crisis, and it appears that they Budget appears to assume that the fiscal situation will recoverwere not significantly adjusted even when it became apparent quickly, as the only commitment beyond one year is that thehow much revenues would be affected. In addition, government fiscal deficit will average 10% of GDP over the 2009/10 andis concerned that immediately cutting spending in response 2010/11 financial years.to lower revenues would exacerbate the impact of the crisis,and as well might be premature while there is so much In the absence of official forecasts we have prepared our ownuncertainty over the depth and duration of the crisis. Essentially, medium-term fiscal forecasts. The baseline scenario is basedthe Government’s position is that given the great uncertainty on updated projections of mineral and SACU revenues, butover the global economic situation, Botswana should use its takes projected expenditure and assumes that all budgetedreserves to ride through the crisis, which it hopes will only last funds will be spent. We predict that this would lead to spendingfor a short while. of over 50% of GDP and a budget deficit of 23% of GDP in 2009/10, not the 14% projected by MFDP.We understand the reasons for the government’s position buttake issue with several aspects of it. First, we believe that theBudget underestimates the likely magnitude of the deficit in Figure 7: Budget Balance Projections - Baseline2009/10, for several reasons. The prospects for diamond Scenarioexports and mineral revenues have worsened since the Budget 15% 15000was presented, and this is compounded by anticipated shortfalls 10% 10000on SACU revenues, so that if all of the budgeted funds for 5% 5000 % of GDP P million 0% 02009/10 are spent, the deficit is likely to be larger than the -5% -5000projected P13.4 billion. Furthermore, in calculating spending -10% -10000and the deficit as a percentage of GDP, the Ministry of Finance -15% -15000 -20% -20000and Development Planning (MFDP) seems to be assuming that -25% -25000GDP will continue to grow in 2009/10 (although formal GDP 1998/99 1999/00 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14forecasts are not published).This is extremely unlikely; with diamond production and prices P mn % of GDPfalling, it is likely that both nominal and real GDP will fall in2009/10, thereby raising the budget deficit relative to GDP. Our Source: MFDP; Econsultestimate is that the deficit, if all funds were spent, would in factbe over 20% of GDP. Although the budget suggests thatspending will be kept within 40% of GDP as per the Fiscal Rule,in fact this figure is likely to be breached by a large margin.
6 Economic Review Figure 8: Revenue and Expenditure Projections - Figure 9: Budget Balance Projections - Baseline Scenario Alternative Scenario 55% 15% 15000 50% 10% 10000 % of GDP 5% 5000 P million 45% % of GDP 40% 0% 0 35% -5% -5000 -10% -10000 30% -15% -15000 25% -20% -20000 1998/99 1999/00 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 20% 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 /9 /0 /0 /0 /0 /0 /0 /0 /0 /0 /0 /1 /1 /1 /1 /1 98 999 000 001 002 003 004 005 006 007 008 009 010 011 012 0 1 3 19 1 2 2 2 2 2 2 2 2 2 2 2 2 2 2 P mn % of GDP Revenues Spending Source: MFDP; Econsult Source: MFDP; EconsultBeyond this, our baseline forecasts assume that spending will First, NDP 10 will have to focus on fiscal and macroeconomicgradually be brought down to conform with the Fiscal Rule, sustainability as well as achieving Vision 2016 objectives. Thewhich requires spending to average 40% of GDP. However, fiscal environment is likely to remain unfavourable, at leasteven while complying with the Fiscal Rule, it is unlikely that throughout the first half of the NDP 10 period and possiblythis would be a sustainable fiscal position. The deficit would beyond, and as a result, the level of real resources availablestay high, because medium term revenues are projected to be to finance government programmes and projects will bearound 30% of GDP, due to lower diamond prices and SACU declining, and the Plan’s objectives must be framed withinrevenues, not the 40% assumed by the Fiscal Rule. this context.As a result, all of government’s accumulated savings wouldbe exhausted within a couple of years, borrowing would be Second, with projections indicating that government revenuesnecessary, public debt would rise rapidly and unsustainably, will average only around 30% of GDP even when diamondand the foreign reserves would be severely depleted. In short, earnings recover, the existing Fiscal Rule based on revenuesthis scenario would turn the government from being a net averaging 40% of GDP needs to be revised.saver to a net borrower, result in an unsustainable fiscalposition, and demolish the reputation for fiscal prudence that As part of this revision, the whole notion of medium-termhas been built up over many years. fiscal sustainability needs to be re-thought, and consideration should be given to defining fiscal sustainability in terms of theAn alternative scenario involves adjusting spending so as to non-mineral fiscal balance, which is comparable to the “bestbring it in line with medium term revenue forecasts at a speed practice” recommendations for oil producing and other mineralwhich does not exhaust all of government’s accumulated economies. A budget sustainability analysis carried out for thesavings. This will require some major cuts in government IMF Article IV report in 2007 suggests that the sustainablespending; various different combinations are possible, but one non-mineral budget deficit for Botswana is between 10% andway or another spending needs to be brought down from 19% of non-mining GDP, and that the overall budget shouldaround 50% of GDP in 2009/10 to under 30% of GDP in a generally be in surplus. Adopting this benchmark would mostshort period of time, which in turn involves cuts of around likely to lead to a downward revision of sustainable levels of25% in real terms from the projected spending level for government spending.2009/10 in the 2009 Budget. This in turn requires severalchanges in both policy and practice for government spending. Third, the quality of the economic forecasts on which projectedMFDP has appealed for suggestions as to how to achieve a adherence to fiscal rules is based needs to be improved, andsustainable budget position, and we make the following government should commit to producing medium term fiscalproposals in response to this call. projections (such as rolling 3-year forecasts). The almost complete lack of official economic forecasts in the public domain reflects badly on Botswana, and undermines the extent of independent scrutiny of - and confidence in - Government’s own figures and commitments, such as the commitments to achieve an average budget deficit of 10% of GDP over the next two years and to adhere to the current fiscal rules, which are unlikely to be met.
7 Economic ReviewFourth, a fundamental review is needed of government • Ongoing recurrent expenditure programmes need to bespending on both capital projects and ongoing programmes, reviewed, especially those that have been in place for aand of how decisions on spending are reached; such a review long time, to ensure that they are justified in terms ofshould focus on effectiveness of spending in achieving objectives benefits achieved relative to needs and costs;and securing value for money. There is a need to restore theability to make rational choices between competing priorities • Infrastructure spending should be reviewed with theand demands. In particular: objective of providing more resources for maintenance, with less focus on building new infrastructure;• Effective project appraisal techniques should be restored, • Where development projects run the risk of overloading focusing on cost-benefit analysis and ensuring that public the construction sector and causing cost escalation (e.g. spending is justified in terms of the economic or social building many senior secondary schools at the same time), returns that it is likely to generate (there is much evidence expenditure should be cut back or spread over a longer that money is being spent with little or no quantification period; of anticipated benefits in relation to costs); • All government ministries need to prioritise their spending,• Public money should only be spent on projects or so that when spending has to be cut back, they can do so programmes that can justify themselves in terms of long- in a rational manner and ensure that available resources term economic benefits (and not short-term economic are devoted to the highest priorities; impact such as construction activity) or social benefits that can be achieved in a cost-effective manner, relative to the • There should be a renewed focus on cost recovery where number of people benefitting; public services are provided above “basic needs” levels;• Particular attention should be paid to avoiding “white • Public spending decisions should be opened up for greater elephant” projects, such as where buildings or infrastructure public scrutiny - not just through the NDP process, but by is provided far in excess of demand or the ability to use it making the documentary basis for spending choices and effectively; decisions available.• Parastatals and government agencies should be rationalised, A renewed focus on eliminating waste, improving efficiency, especially where there are overlapping or unproductive getting rid of unproductive programmes and projects may functions; appear to be politically unpopular. However, because such unproductive spending has limited social or economic benefits• Care should be taken when justifying “economic” (by definition), it should be possible to terminate such spending programmes in terms of anticipated social benefits; if the without incurring any significant adverse economic or social objectives are essentially related to enhancing social welfare, effects. In the long-term, the country is better served by it is in principle better to do this through designing effective improving the efficiency and effectiveness of public spending, social welfare programmes (this point applies particularly, in an environment of a sustainable fiscal policy. Many of the but not only, to agricultural support programmes); reforms proposed above are long-overdue, but have been avoided in recent years because of the ample availability of• Given the high cost of providing infrastructure in some financial resources (the soft budget constraint). They are rural areas, the Rural Development Policy and National necessary regardless of the crisis, but are now even more Settlement Policy need to be reviewed and revised to make pressing. them more sustainable and economically rational; there needs to be a more effective recognition that it is not feasible to provide the same level of public services and infrastructure to all locations, and that Batswana should not expect that services and infrastructure will be provided to all, regardless of cost; more attention should be paid to alternative methods of providing rural infrastructure and services;
8 Economic ReviewFinally, the impact of the crisis illustrates the need to boosteconomic growth through regulatory and other reforms, andshould certainly not be used as a reason to delay such reforms.Public spending will not be as big a driver of growth in thecoming years as it has been in the past, reinforcing the needto address other constraints to growth. Many of these havelong been identified, and include factors such as an overly-dominant public sector, unduly restrictive business licensingand immigration regulations, and limited availability of land.Unfortunately, commitment to the reform agenda sometimesseems patchy, and some recent developments have beenbackward steps. In recent months, for instance, businesslicensing regulations have become even more restrictive, byextending the range of businesses that need a licence tooperate, whereas government has earlier made commitmentsto relax the licensing regulations. Getting work permits approvedfor skilled foreigners has become more difficult, after a periodwhen restrictions were relaxed, illustrating another policyinconsistency. Additional restrictions have been announcedon the transfer of land ownership and change of use. This isalso counter-productive. Botswana already has artificially-created land shortages caused by outdated laws, regulationsand custom. However, efficient use of land requires its transferfrom low productivity uses such as traditional agriculture tohigh productivity uses such as commercial, industrial andresidential uses, preferably in a speedy and flexible manner.By preventing or further restricting such changes, anotherbarrier is placed in the way of private sector-led growth andemployment creation.The crisis provides an opportunity to improve the efficiency ofpublic spending and speed up regulatory reform. Indeed, thecrisis may make help to bring about decisions and introducechanges that in more buoyant times could be postponed; asIndia’s former Prime Minister, P V Narasimha Rao once said,“decisions are easy when there are no options left”. But aswith Rao’s abolition of India’s “licence raj”, such changes arenecessary to improve Botswanas long-term economic growthprospects. 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