Economic Review

Bifm Economic Review 4th Quarter 2006

Introduction

Economic conditions were substantially betterby the end of 2006 than they were at thebeginning of the year, with declining inflation,strong exports, improved business confidence,and several major investment projects giventhe go-ahead. These factors are likely topersist during 2007, which should see acontinued improvement in economic activity.

Inflation and Monetary Policy

The Central Statistics Office (CSO) hasintroduced a new Consumer Price Index (CPI)basket, rebased to September 2006 and witha much expanded coverage (see feature). As

a result, inflation is currently being measuredby a combination of the old and new baskets,which could introduce some unpredictabilityinto the measurement of inflation through toSeptember 2007, by which time the newbasket will have been in operation for a fullyear.

Having said that, inflation has continued itssteady decline, falling to 8.8% in November2006, down from 9.2% in October (seeFig.1). There were a number of reasons forthis, including the reduction in fuel prices,which now have a larger weight in the revisedCPI basket. However, the softening of pricepressures was more broadly based than this,with 5 of the 12 CPI basket categoriesexperiencing price reductions betweenOctober and November, and besides lowerfuel prices, there was a noticeable reductionin food costs. While the reduction in inflationwas anticipated, the weakness of internationaloil prices means that the decline in inflationhas been faster than expected. Our currentforecast is for inflation to continue to declineduring the first half of 2007, to around 7%,although if there is a further significantreduction in fuel prices inflation could fallbelow this level. In addition, although it istoo early to assess the impact of the newbasket on inflation, the likelihood is that thenew basket will itself lead to a reduction inmeasured inflation.

While the continued decline in inflation isgood news, it still remains well above the

Bank of Botswana s desired range of 4% -7%, and there is unlikely to be any significantreduction in interest rates while this remainsthe case. The prospects for any reduction ininterest rates will be balanced by theresurgence in credit growth, which reached14.9% over the 12 months to November,above the BoB s range of 11% - 14%. Recentgrowth has largely been driven by credit tothe private business sector, at over 20%,while credit to households grew by 15% inthe year to November. Nevertheless, annualcredit growth may begin to fall soon, asshorter term (quarterly) growth rates havealready peaked (see Fig.2).

The reduction in inflation, while internationaland regional inflation has been rising, hasalso helped to close the gap betweenBotswana s inflation rate and the average ofits trading partners (see Fig.3), thus supportingBotswana s international competitiveness.

Exchange Rates

Exchange rates have stabilised somewhatrecently, with the rand recovering much ofthe ground that it lost against the US dollarduring the third quarter of 2006. The pulaended the year at R1.16, and P6.03 to theUS dollar, with the overall trade-weightedexchange rate depreciating by 4.5% overthe year (see Fig.4). Compared to ourforecasts a year ago, the pula (and rand)have been weaker than expected against the

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Summary ofEconomicDevelopmentsDr Keith Jefferis,Chairman ofBifm InvestmentCommittee

Figure 1: Inflation Figure 2: Credit Growth Rates (quarterly, annualised)

Economic Review

dollar, and as a result the pula has beenstronger against the rand.

Given the volatility that characterises therand, to which the pula is partially pegged,predicting exchange rate movements during2007 is a risky business — probably the mostreliable forecast is that forecasts will bewrong. The consensus of opinion is that therand will on average weaken again during2007; however, South Africa s relativelylarge current account deficit, anddependence upon short term portfoliocapital flows to finance it, may well causethe rand to fluctuate widely again. Ourforecast is that the pula will weaken byaround 10% against the dollar during 2007,to finish the year around 6.70, but willremain fairly stable against the rand (ataround 1.16-1.17), albeit with somefluctuations along the way.

Employment

The Central Statistics Office has releasedpreliminary results from the 2005/06 LabourForce Survey (LFS), providing data onemployment and unemployment inBotswana. The CSO is to be commended forgetting these preliminary results out quicklyafter the completion of the survey in June2006. The headline results of the LFSprovide encouraging information: since theprevious LFS in 1995/96, overall employmenthas been growing rapidly, at an average rateof 4.7% a year, which is substantially fasterthan the growth of the population and thelabour force. As a result, the measuredunemployment rate has declined, from 21.5%of the labour force in 1995/96 to 17.3% in2005/06 (and compares with recordedunemployment rates of 19.5% in the 2001Census and 23.8% in the 2002/03 HIES) (seeFig.5).

Further investigation, however, reveals thatthe underlying situation may not be quite soencouraging. While overall employment hasincreased by 203,000 over the ten yearsbetween the two Labour Force Surveys, morethan half of this increase (116,000) was dueto a rise in employment in own farms, landsand cattle posts . This in turn reflects lastyear s relatively good rains and the resultingtemporary increase in subsistence agriculturalactivities. Whether this really counts asemployment , however, is questionable,as the survey methodology counts asemployed someone who did one hour ormore of work over a seven day referenceperiod. Furthermore, the increase in recordedagricultural employment contrasts with theresults of other surveys, which show a long-term decline.

The rise in non-agricultural employment hasbeen less impressive, although at 2.7%annual average growth, it has at least keptpace with (or slightly exceeded) the growthof the population and the labour force.Nevertheless, if it had not been for thefortunate rains during the LFS survey period,recorded unemployment would most likelyhave remained between 20% and 30% ofthe labour force.

Government Budget

Recent data on government revenue andspending are patchy, but the data that areavailable suggest that revenues have beenrising at a steady pace, up 15.1% in the firsthalf of the 2006/07 fiscal year (April-September) compared to the same period in2005/06 (see Fig.6). Expenditure rose by only7.3% over the same period, leading to ahalf-year budget surplus of P2.1billion(compared to a P1.3bn surplus in H12005/06). The main drivers of increased

revenues have been rapid growth in revenuesfrom the Southern African Customs Union(which was expected) and from non-mineralincome tax receipts. On the spending side,the poor performance of developmentspending is clear — down 13% compared tothe previous year — especially when comparedwith a budgeted 38% increase in 2006/07as a whole.

The 2007 Budget, due to be delivered inearly February, will contain final revenue andexpenditure figures for the full 2005/06 fiscalyear, as well as revised figures for 2006/07and projections for 2007/08. Data for2005/06 are likely to show a budget surpluslarger than the P1.5 billion (3% of GDP) thatwas indicated last year, and likewise a surplusfor 2006/07 larger than the P0.9 bn thatwas initially estimated, with revenue abovebudget and expenditure below. Given thepoor expenditure performance, the BudgetSpeech will no doubt devote considerableattention to why government has beenunable to spend the additional resourcesprovided for in 2006/07, especially fordevelopment projects, thus inhibiting theanticipated recovery in economic growth. Itis likely that most of these projects will becarried forward to 2007/08, hopefullyaccompanied by concrete measures toimprove the efficiency of projectimplementation and public procurementprocesses. No major policy initiatives areexpected in the Budget, although there maybe some indication of the likely response tothe report of the Business and EconomicAdvisory Council (BEAC), which governmentis now considering.

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Figure 3: Botswana and Trading Partner Inflation Figure 4: Pula Exchange Rates

Economic Review3

Prospects for 2007

The likelihood of continued above-trendglobal economic growth, combined withstrong economic performance in SouthAfrica, should provide a supportiveenvironment for a continued improvementin Botswana s economic growthperformance. Recent movements incommodity prices have also been favourable,with falling oil prices helping to bring downinflation, and although other commodityprices (notably copper and nickel) have alsofallen, they remain above long-term levelswhich will support continued mineralexploration an development in Botswana.Three major mining-related projects (TatiNickel mine expansion and Activox nickelrefinery near Francistown, the Dukwe coppermine, and the Martin s Drift diamond mine),as well as one or more diamond-cuttingoperations, will be implemented during2007, while final decisions will be taken onat least two others (African Diamonds AK7project near Orapa, and the CICEnergy/International Power Mmamabulacoal mine and power station project). Thesewill all provide a boost for various relatedactivities, including construction, utilities(water, electricity and telecoms),transportation as well as other suppliers ofgoods and services. Other exports shouldcontinue the growth seen in 2006,supported by the improved competitivenessthat resulted from the devaluations of 2004and 2005, and textiles should benefit fromthe five-year extension to the developingcounty concessions under the US AfricaGrowth & Opportunity Act (AGOA)announced in late 2006. The economyshould also benefit from the liberalisationmeasures in the telecommunications sectorannounced in 2006. All of these

developments will contribute positivelytowards economic diversification.

On the macroeconomic front, inflation shouldcontinue to decline slowly and this will inturn provide some room for lower interestrates, which will in turn support investmentand growth. However, it would not berealistic to expect dramatic reductions ineither inflation or interest rates during 2007.Government finances are likely to remainhealthy, and the increase in spending ondevelopment projects that was expected in

2006 should materialise in 2007.

As a result it should be possible to sustaineconomic growth in the 4%-5% range, notparticularly high by Botswana s historicalstandards but reasonably good by thestandards of middle income developingcountries. With population growth estimatedat barely over 1%, economic growth at thisrate will support a meaningful increase inreal per capita incomes, as well as a reductionin unemployment and poverty.

Table 1: Key variables and forecasts

2006 2007

actual /est. forecast

Inflation

CPI average 11.6% 7.2%

CPI end of year 8.8% 7.0%

Interest Rates

Prime lending end of year 16.5% 16%

Exchange rates

Rand per Pula end of year 1.16 1.17

Pula per US$ end of year 6.03 6.67

Economic Growth 4% 5%

Source: Econsult

Feature:The New Consumer Price Index(CPI) Basketsee following pages

Figure 5: Employment & Unemployment Figure 4: Government Revenue & Spending (quarterly)

BoB

Economic Review4

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A new CPI basket was introduced inthe October 2006 CPI report from the CentralStatistics Office. The index has a base ofSeptember 2006=100, and replaces the oldindex which had a November 1996 base.The new basket is derived from expenditurepatterns recorded in the 2002/03 HouseholdIncome and Expenditure Survey (HIES), andtherefore updated the previous basket whichwas based on the 1993/94 HIES.

As we had previously commented, the oldindex and basket had become increasinglyproblematic as it became more and moreout of date, and hence less accurate whenused to measure inflation. A particularproblem had the omission of items whichhad recently become important inexpenditure patterns (e.g. cellphones andairtime), but more generally the CPI baskethad become less representative ofexpenditure patterns in the economy. Analysisfrom other countries suggests that this typeof problem leads to an upward bias inmeasured inflation, and hence it is likely thatthe old index was exaggerating Botswana sinflation. A second problem had beenexperienced when items in the basket hadbecome unavailable, requiring thesubstitution of new items, and there hadbeen a number of errors (and subsequentrevisions) in the inflation calculation resultingfrom such item substitution.

In updating the basket, its coverage has beenconsiderably expanded in terms of numbersof items included, the number of price quotesobtained each month, and its geographicalcoverage (see table 2). This should help theCPI to provide a more representative (andhence more accurate) record of price changesin the economy. The methodology of CPIcalculation has been improved in variousways; specifically, it uses internationallyagreed criteria for classifying items (which

will help to make measured price changesmore internationally comparable), andchanges the way in which item substitutiontakes place.

Table 2: CPI Basket Coverage

New Old

Items in basket 384 256

Areas surveyed 46 21

Outlets surveyed 1235 550

Price quotes obtained 30˚000 8 100

Coverage of prices in rural areas has beenenhanced, with 26 rural areas now surveyed,compared to 5 in the old basket (see table 3).However, expenditure patterns are dominatedby urban areas (with a 47% weight in totalspending) and urban villages (34%), whilerural areas account for only 19%. Given this,and the expense involved in surveying pricesin rural areas, it is questionable whether sucha large increase in the geographical surveycoverage of rural prices is justified.

Table 3: Geographical Coverage (No. ofareas surveyed)

˚New Old

Urban 5 5

Urban village 16 11

Rural 26 5

There has been extensive change in the itemsmaking up the basket, and their weights (seetable 4). While the new basket contains 12groups, like the old basket, the groups havebeen re-arranged and because of thechanged item composition they are not fullycomparable between the two baskets. Manynew items have been introduced, reflectingchanged lifestyles and economic activities:

additions include new health items (X-rays,consultations with traditional doctors, hospitalstays), transport (combi fares, car rental),recreational items (TV decoders, DVDs,computers), education (college & universityfees) and telecommunications (cellphonepurchase and call charges, internet caf andhome connections) and funeral costs. Someitems have disappeared (e.g. telegrams andsafari suits). The main changes for item andgroup weights include much increased weightsfor fuel (petrol & diesel), restaurant meals,medical aid premiums, telecommunications,leisure goods & services, and clothing. Themain reductions in weights have been forfood and alcohol & tobacco. Notwithstandingthe latter, beer (consumed in various formsand locations) remains the largest singleconsumption item. Within food consumption,we are spending proportionately more onfruit and vegetables, and have shifted meatconsumption from beef to chicken.

The treatment of rent in the CPI basket hasalso been much improved. Previously, BHCrentals were used as proxy for almost allrentals, including private rentals, such thatany change in BHC rents — an administeredprice determined by government — had adisproportionate effect on inflation. In therevised basket, the weight of BHC rentalshas been reduced and that of private rentalssignificantly increased, to reflect moreappropriately the pattern of actual expenditure.

Overall, the new index marks a considerableimprovement over the old one, being moreup to date, comprehensive and withimproved methodology. It should provide amore accurate measurement of inflation.Nevertheless, it would be particularly helpfulif the CSO continued recording andcalculating inflation using both the old and

Feature:The NewConsumer Price Index (CPI) Basket

Economic Review

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5Feature:The New Consumer Price Index (CPI) Basketcontinued

the new baskets over a period of, say, 12 months, so that a more accurate assessment of the divergence between the two could beobtained.

Table 4: CPI Basket Weights (total 100)

Old Basket New Basket

(1996) (2006) Change

Increased Weights

Clothing 5.84 7.52 29%

Recreation 1.55 2.22 43%

Telecommunications 1.60 2.97 86%

Fuel (petrol, diesel, paraffin) 3.10 7.74 150%

Medical aid premiums 1.16 5.18 347%

Restaurant & take-away meals 0.35 3.08 780%

Funeral expenses - 1.74 n/a

Reduced Weights

Food (excl. purch. meals) 25.18 21.84 -13%

o/w fruit & vegetables 2.42 2.61 7.9%

o/w beef 4.18 1.79 -57.2%

o/w chicken 0.69 1.33 92.8%

Alcohol & tobacco 13.49 9.29 -31%

o/w beer (incl. chibuku) 9.57 8.21 -14%

Rent 6.88 5.68 -17%

o/w BHC 5.50 1.64 -70%

o/w private 1.38 4.04 193%