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Economic Review
Bifm Economic Review 1st Quarter 2008
In common with much of the rest of the
world, Botswana experienced a mixed set
of economic developments during the first
quarter of 2008. While the most recent
growth data and related indicators show
that the economy performed strongly
through 2007, recent months have been
less positive. Inflation has risen sharply,
and shows signs of increasing further over
the next few months before beginning to
fall towards the end of the year. Botswana
also faces uncertainty due to power supply
problems in Southern Africa, and the
impact of economic slowdown in the major
developed economies as a result of the
credit crunch and the associated crisis in the
financial sector, which could affect export
performance.
Economic Growth
The economic growth data released along
with the 20087 Budget, covering the
period July 2006 to June 2007, confirmed
earlier indications that there had been
a strong growth recovery in late 2006
and early 2007. Overall GDP growth rose
from (a revised) 0.6% in the previous year
(2005/6) to 6.2% in 2006/07. The growth
recovery in the non-mining private sector
was particularly impressive; after several
years of a downward growth trend, growth
picked up from (a revised) 5.7% to 9.7%.
The recovery in growth was broad-based,
with transport and communications, trade,
manufacturing and construction the fastest
growing sectors, and all showing much
faster growth than in the previous year.
Although this is only one year of data, these
growth results show that some economic
diversification has taken place, which is
in turn consistent with the picture that
has been emerging recently of successful
export diversification. The revival of the
manufacturing sector, which achieved
growth of 12%, is particularly significant,
as the sector had been struggling for several
years. Export data suggest that the textiles
sector has been growing rapidly, but apart
from this it is unfortunately not possible to
distinguish which particular component of
the manufacturing sector has done well,
as the CSO classes 75% of manufacturing
output simply as “other manufacturing”
(i.e. not meat, beverages or textiles).
Although economic growth has been
impressive, this has not translated into
strong employment growth. Total formal
sector employment rose by only 2.4%
between March 2006 and March 2007,
spread more or less equally across the
private sector and government. This result
is disappointing, as the rapid growth of
the private sector noted above would be
expected to lead to much faster job growth.
But there appears to be inconsistency
between the employment data and the
GDP growth data, which could make one
(or both) of the data series unreliable.
For instance, employment in the fastest
growing economic sector – transport and
communications – supposedly contracted
by 5.1%, even though the sector grew by
20%, and employment in the non-mining
private sector as a whole only grew by
2.2%, even though output grew by 9.7%.
Summary of Economic Developments Dr Keith Jefferis Chairman of Bifm Investment Committee
Introduction
Figure 1: Economic Growth (%)
Source: CSO, Econsult
Figure 2: Economic Growth by Sector (%)
Source: CSO
Economic ReviewHopefully the CSO will be able to improve consistency between various different data sources in future.
The published growth data only cover the period to June 2007, so for the most recent nine months we have to rely on other economic indicators. These suggest that the growth recovery has continued, with data on the real growth of business credit, electricity consumption and government spending all indicating that growth continued to be strong through the second half of 2007.
Nevertheless there are a number of risks to growth going forward. The impact of the problems facing the financial sectors in developed economies is likely, even on the most optimistic forecasts, to lead to a period of slower global economic growth through 2008 and into 2009. The IMF has revised down its global growth forecast for 2008 to 3.7%, with only a slight recovery to 3.8% in 2009. But what is striking is the contrast between projected growth in the major developed economies (only 1.3% in both 2008 and 2009) and that in emerging and developing countries (6.7%). It is encouraging that developing countries appear likely to sustain high growth even with a slowdown in the industrialised countries, an indication of the “decoupling” of growth that has been much talked about. For Africa, forecasts of continued growth of well over 6% are particularly welcome.
Botswana, however, is in a difficult situation. As an export-dependent economy, Botswana
is vulnerable to fluctuations in global
economic growth. Furthermore, Botswana’s
exports are primarily to the major developed
economies that are unlikely to grow rapidly.
The United States is the largest market for
two of Botswana’s three biggest exports
(diamonds and textiles). Taking account of
the ultimate destination of diamonds in the
world market, nearly 70% of Botswana’s
exports go directly or indirectly to the USA,
Europe and Japan, which are all facing a
severe growth slowdown, if not recession.
Perhaps reflecting the impact of the slowing
of growth in the USA, Botswana’s diamond
exports in the last three months of 2008
were 27% lower than in the same period
in 2006. While there is no immediate
problem from this – the foreign exchange
reserves are maintained at high levels
specifically to cope with such situations –
a deep or prolonged recession in the US
would require eventual adjustment to lower
export earnings and government revenues.
A second risk to growth is the ongoing
power supply crisis in southern Africa. This
is discussed further in a feature later in
this Review.
Inflation
The first quarter of 2008 provided more
bad news on inflation, which rose sharply
from 8.2% at the end of 2007 to 9.8%
in March 2008. This was largely driven by
higher food and fuel prices; over the past
12 months, food prices rose by 18%, while
those for “operation of personal transport”
(which is mostly petrol and diesel costs) rose
by 22.5%. These price increases, combined
with their high weights in the CPI basket,
led transport and food costs together to
contribute 6.8% to the overall inflation rate
of 9.8% in the year to March. Underlying
2
Figure 4: Global Growth Forecast, 2008 (%)
Source: IMF
Figure 5: Inflation: Botswana vs. Trading Partners
Source: CSO, Econsult
Figure 3: Business Growth Indicators (Quarterly)
Source: BPC, BoB, Econsult
Economic Reviewthese price increases were higher prices in international markets; for instance the prices for the key food grains wheat, rice and maize were up 108%, 103% and 66% respectively in the year to March, and the price of crude oil was up 50% over the same period.
The upsurge in inflation is not unique to Botswana, and inflation is generally rising around the world. South Africa has experienced a similar increase in inflation, which of course feeds through to Botswana through import price rises. The only good news on inflation is that because it is being experienced worldwide, there has been little change in Botswana’s relative position with regard to inflation, and hence there is little impact on international competitiveness.
Inflation prospects for the remainder of the year are not particularly good, however. International oil prices keep on rising, and
these will eventually feed through to retail
prices. Despite the substantial increases
in petrol and diesel prices on April 15th,
Botswana fuel prices still lag international
prices by a considerable margin, and further
large price increases are likely.
While there is little that can be done about
the rising cost of fuel imports, one policy
response that could help would be to
liberalise domestic fuel prices. At present,
fuel prices are rigidly controlled by the
government, in an outdated system that
prevents competition from playing a role
in making the industry more efficient and
bringing prices down. As an initial reform, it
would be a straightforward move to change
the regulated fixed price into a maximum
price, thereby allowing fuel retailers to
charge lower prices if they wished to do so
to attract more customers. This would enable
price competition to operate, and in areas
with many filing stations – such as the urban
areas where the majority of the population
lives - this is likely to result in lower prices for
consumers, and make a small contribution
to keeping inflation in check.
The likelihood of further increases in
fuel and food prices means that inflation
will probably keep rising for a few more
months. Our current forecast is for inflation
to rise from current levels to peak around
12%, before declining from October
onwards; however inflation is likely to
remain in double digits for the foreseeable
future. Of course this forecast is subject
to much uncertainty given the difficulties
in predicting what is likely to happen to
fuel prices and the extent of second-round
effects; much will depend on what happens
to other regulated prices such as public
transport fares and electricity tariffs.
3
The Bank of Botswana (BoB) presented its 2008 Monetary Policy Statement (MPS) on February 25th. The MPS introduced some potentially far-reaching changes to the monetary policy framework, although it will
take some time so see how much difference
the changes make in practice.
The key features of the old monetary policy
framework included:
• ashort-term(annual)inflationobjective,
and a medium-term inflation objective,
based on expected inflation rates of
major trading partners; the attainment
of the inflation objective would therefore
result in the maintenance of inter-
national competitiveness (by matching
international inflation); this was changed
slightly in recent years following the
introduction of the crawling exchange
rate peg, which allows the Botswana
inflation target to be slightly higher than
international inflation;
• the main monetary policy instrument
was short-term interest rates (Bank Rate/
BOBC rate);
• the intermediate targetwas the rateof
growth of bank credit;
• monetarypolicychangesweredetermined
on the basis of the actual rate of inflation
vis a vis the objective, and the rate of
Feature: The New Monetary Policy Framework
Figure 6: Fuel and Crude Oil Prices
Source: DEA, US EIA, Econsult
Figure 7: Inflation
Source: CSO
Economic Review4way as in the past - will be a crucial
determinant of policy; hence the quality
of the inflation forecast becomes crucial,
and this in term depends on the quality
of the Bank’s medium-term inflation
forecasting model;
• while short-term inflation modelling
and forecasting is quite easy, being
primarily momentum driven, medium-
term forecasting is much more difficult;
it depends upon both high quality
modelling (i.e. a model which can be
shown to perform well in forecasting on
the basis of historical data) and the ability
to accurately forecast a range of real
activity variables (e.g. the rate of future
economic growth, the level of capacity
utilisation in the economy, productivity
growth, government spending, and real
and nominal economic shocks); it also
depends on the quality of the statistical
data on which model is estimated;
• the model should also be capable of
producing a range of forecasts under
different scenarios, with different
probabilities attached;
• thecredibilityofmonetarypolicyactions
would be enhanced if BoB publishes its
inflation forecasts, and in due course
details of the model itself.
The changes represent a partial move
towards the adoption of inflation targeting.
In particular, the adoption of a medium
term inflation target/objective, and the use
of a model and medium-term forecasts to
determine policy changes, are a common
feature of inflation targeting regimes.
However, there are key differences which
mean that the new monetary policy
framework is some way from being a fully-
fledged inflation targeting (FFIT) regime.
One of the most crucial aspects of FFIT is
that the inflation target must dominate
all other macroeconomic policy objectives,
including exchange rate or fiscal policy
objectives. Botswana of course maintains
a pegged exchange rate, determined by
government, and BoB does not have control
over this important component of monetary
policy and determinant of inflation. FFIT
countries all have floating exchange rates.
In addition, fiscal policy is not managed
so as to minimise its inflationary impact.
Furthermore, there is no clear mandate for
BoB to pursue price stability above all other
objectives (whether a statutory objective or
a statement of government policy), and BoB
cannot at present be held fully accountable
for achieving the target.
Inflation targeting has generally been
quite successful in achieving low inflation
across a wide range of countries, although
the current environment of cost-driven
increases in global inflation will provide
inflation targeting regimes with a severe
test. However, it has generally been adopted
by medium or large economies, and there
is limited experience of its use in small
open economies such as Botswana where
inflation is primarily imported and hence
determined by external factors.
As noted above, the 2008 monetary policy
changes in Botswana can be seen as a
“halfway house” towards the adoption of
full inflation targeting. Whether it works
depends crucially on the performance of the
inflation forecasting model and its modelling
of the monetary transmission mechanism,
which will become apparent over the next
2-3 years. However, the adoption of FFIT
would depend on much more than this,
as it would require reform of the Bank of
Botswana Act, and an explicit commitment
to the framework from government. It
would also require a move towards much
greater exchange rate flexibility, with either
a market-determined floating exchange
rate, or at the very least an acceptance that
in the event of conflict between exchange
rate and inflation objectives, the latter
would take precedence. A more flexible
exchange rate policy would in turn require
a new mechanism for building up foreign
exchange reserves and saving mineral
revenues, and would also run the risk
that the exchange rate would appreciate,
leading to competitiveness problems of the
kind that emerged prior to the devaluations
of 2004 and 2005.
credit growth vis a vis the intermediate
target, as well as the growth rate of
government spending and an assessment
of real economic activity.
The changes introduced in the 2008 MPS
include:
• dropping theannual inflationobjective,
and henceforth focusing only on the
medium term objective;
• droppingtheintermediatecreditgrowth
target;
• monetary policy changes will be
determined on the basis of the deviation
between forecast medium-term inflation
and the medium-term objective, i.e. policy
will be adjusted in order to bring the
medium-term inflation forecast in line
with the inflation objective;
• therewillbelessfocusonmeetingshort-
term objectives for inflation and credit
growth.
What are the implications of these changes?
The overall impact should be positive. The
previous focus on short-term objectives
was problematic, in that monetary policy
changes work with a fairly long lag (typically
12-24 months) and hence any changes
made in response to current inflation (in
relation to the annual target) would not
have had an effect within the desired time
frame. So moving towards a medium term
target makes sense in terms of the time
lags involved in the impact of monetary
policy. There have also been concerns
over the usefulness of credit growth as
an intermediate target, its responsiveness
to changes in monetary policy and its
links to inflation - i.e. whether it actually
functioned as an intermediate target as
intended. The new framework should also
enable a more measured monetary policy
response to short-term changes in inflation.
It is also more in keeping with international
practice.
For the changes in monetary policy to be
effective, however, there are several key
requirements:
• the divergence between the medium-
term inflation forecast and the medium-
term inflation objective – set in the same
Economic Review5Feature: Power Supply Issues
required, and is usually reached in winter) reached around 500MW in 2007.
As Figure 9 shows, electricity demand and consumption are very closely related to the level of economic activity. In the non-mining sector of the economy, growth of 1% translates to approximately a 1.6% increase in electricity consumption. If this relationship is maintained, a shortfall in electricity supplies could have a major negative impact on growth: a 10% cut in power supplies would lead to a fall of 6-7% in non-mining GDP.
Over the next few years it is likely that the electricity supply situation will become much tighter, due to a combination of supply shortfalls and rising demand. There are a number of large mining projects, notably the Tati Nickel Activox refinery near Francistown, which will lead to sharply increased electricity demand over the period to 2012. Unless significant demand-management measures - including higher prices - are put in place, it is also likely demand from the non-mining sector, including households, will continue to grow steadily; as noted above, this has been increasing at around 9% a year.
On the supply side, the most important pending development is the reduction in “firm supply” from Eskom under the new Eskom/BPC contract; this was 410MW in 2007, and has been reduced to 350MW in 2008 and 2009, and will fall further to 250MW in 2010 and 150MW in 2011.
Figure 10 shows recent and forecast peak demand. Peak demand determines the level of installed capacity (or firm import supply commitments) needed. The chart assumes that non-mining demand will continue to
One of the major economic developments in the first quarter of 2008 has been the emergence of serious electricity supply problems in South Africa and their spill-over into Botswana, leading to serious supply interruptions in late January and early February. This reflects the reduced level of firm supplies from South Africa under the new Eskom/Botswana Power Corporation (BPC) contract from January 1, 2008 as well as the shared impact of load shedding in South Africa. The impact on Botswana has been considerable, with lost production, reduced productivity and additional costs facing many businesses. Unlike South Africa, however, there are no reports of mining production being adversely affected in Botswana.
Figure 8 shows Botswana’s sources of electricity used in recent years. Around 80% of electricity is imported, with 70% from Eskom. Domestic supply (from BPC’s Morupule power station) accounts for around 20%. Morupule supply has been declining slowly, presumably reflecting the aging of the power station and the resulting maintenance needs. On the demand side, mining accounts for around one-third of total consumption. Over the past decade, mining demand has been increasing at around 5% a year, and non-mining demand at 9% a year. Peak demand (which is the key determinant of the generation capacity
grow at almost 10% a year, while mining demand includes the impact of anticipated new projects, giving total demand growth of around 11% a year and a capacity requirement of 750MW by 2011. The power supply shortfall (the difference between projected demand and anticipated supplies from Morupule and Eskom) therefore rises from around 100MW in 2008 to some 500MW in 2011.
Various strategies are in place to meet this shortfall. Imports of up to 60MW from Cabora Bassa in Mozambique, via Zimbabwe, are supplementing supplies (although they were not available during the crisis period in January and February due to problems with transmission links in Zimbabwe). There is also a tentative scheme to re-open the mothballed Bulawayo power station in Zimbabwe, using coal from Botswana, which could provide Botswana with a further 45MW of power. However, this is progressing slowly, with no firm indication of when this power will be available. Clearly, power supplies originating from or transiting through Zimbabwe are unreliable.
BPC is also about to commence a major expansion of the Morupule coal-fired power station. Morupule B will have a capacity of 600MW (compared to 120MW for the existing plant), so when commissioned will meet almost all domestic requirements. Although it is the stated intention to generate first power from Morupule B by 2010, this appears optimistic, and a more likely scenario is that Morupule B will only be online in 2011 at the earliest. The much larger Mmamabula project, which will provide 2400MW, mostly for export, will only come online in 2013.
Figure 8: Sources of Electricity Figure 9: Growth of Non-mining Electricity Consumption and GDP
Source: CSO, BPC, Econsult
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
Economic Review6To meet the shortfall that is likely to result in 2009 and 2010, BPC has tendered for up to 240MW of short-term generating capacity. This is a common response to supply deficits, and was used extensively in East Africa (Kenya, Uganda and Tanzania) in 2006 in response to shortfalls in hydro power generation due to drought; such “emergency capacity” can be put in place fairly quickly, and is typically diesel powered. The solution adopted in Botswana is likely to be either diesel-powered generation, or possibly gas-fired generation using coal-bed methane.
One way or another it is likely that the required power will be made available and that Botswana will escape severe shortages in 2009 and 2010. The problem, however, will be the cost. Indicative costs of new generation capacity from different power sources are shown in Table 1.
As the table shows, the cost of emergency capacity from small-scale gas or diesel plants is many times higher than that of hydro or coal-fired power, which have been the main sources of power in the region up to now. Current tariff levels in Botswana vary between 40 – 46 thebe/kwh (approx. 6 – 7 US c) for domestic and small business consumers, with lower tariffs for large scale business and mining users. Clearly, current tariff levels are nowhere near enough to cover the cost of emergency power generation, and are unlikely to cover the costs of new coal-fired power generation. Although Botswana electricity tariffs have not been as low as in South Africa, they are still relatively low by world – or even African – standards. Substantial tariff increases – in the region of 50% or more, over and above inflation – are probably necessary to finance the true costs of Botswana’s new generating capacity. BPC has just been granted a 10% - 14% tariff increase by government, but further tariff increases will be necessary over the next 2-3 years to enable BPC to pay for new capacity, to provide an incentive for independent power producers (IPPs), and to provide appropriate signals to consumers to use power more efficiently. Even with such increases, subsidies will be necessary to cover the cost of emergency power
generation. These subsidies could be very expensive: depending on the exact amount of emergency power required, and the price of gas or diesel, the subsidies could amount to P3 billion a year – equivalent to some 10% of government spending and 3% or more of GDP.
While steep price increases will no doubt be unpopular, the experiences of other countries indicates that when faced with a choice, consumers prefer tariff increases to interruptions in supply.
In the discussion of potential sources of power to meet rising needs, in both Botswana and elsewhere in the southern African region, little has been said about the potential of solar power. Clearly Botswana has one of the main inputs – ample supplies of sunshine – and there have been some small scale attempts to use solar as a means of providing electricity and water heating in off-grid areas. For rural electrification, where grid infrastructure costs are high and power usage low, domestic solar installations using photovoltaic technology are already more cost-effective than the provision of grid power to smaller and more isolated
settlements. At a larger scale, however, there is little experience internationally of power stations based on solar energy to provide electricity to the grid, although there are a few experimental plants in Europe, the USA and Australia producing up to 20MW. With current technology, capital costs are high and solar is still relatively expensive when compared to coal or hydro power.
However, the economics of power generation are changing in a direction that is likely to favour solar energy: coal input costs are rising (following higher oil and gas prices); environmental factors weigh against coal with its high carbon dioxide emissions, and changes taking place in solar energy technology are bringing down costs. The development of carbon-offset trading mechanisms under the Kyoto Protocol, where carbon credits can be sold, would provide additional revenue to solar power producers. In the medium-to-long term, large-scale solar power may well prove an attractive alternative (or complement) to coal-fired power generation in Botswana.
Table 1: Approximate Cost of Electricity from Different Sources (New Capacity)
Source Cost (US cents per kWh) Cost (thebe per kWh)
Large-scale hydro 2 - 4 12 – 25
Large-scale coal 6 – 8 40 - 50
Small-scale diesel 25 – 35 160 - 230
Figure 10: Electricity Demand and Supply Projections
Source: Econsult