Recent Economic Developments, Outlook and Prospects

1. Recent Economic Developments, Outlook and Prospects KENEWENDO Bogolo J April 2011

2. Outline • Global economy – recent developments • Botswana economy: • Growth • Inflation • International Trade • Exchange Rates • Financial Sector • Govt Budget • Employment • International Assessments • WEF Global Competitiveness Report • IMF Article IV and World Bank PER • Economic Outlook

3. Global growth slowdown ... and recovery • Recovery from global recession has been robust, driven by emerging markets • Some slowing now projected, after initial “bounce” – but “double dip” recession unlikely • Global growth projected to settle in 3% - 3.5% range in 2010-11 • Uncertainty remains in developed countries: • Timing of withdrawl of fiscal stimulus • Long-term impact of public debt • Bank credit still constrained • High unemployment and weak consumer confidence • Euro-zone problems

4. SADC Growth Forecasts to 2014 Source: IMF Regional Economic Outlook for SSA

5. Botswana: Real Economy

6. GDP growth - recovering • 9.2% GDP growth in year to June 2010 • Positive yoy growth since 2010Q1 • Driven by mining recovery • Continued slowdown in non-mining private sector growth • Uncertainty over data quality

7. qoq GDP growth – volatile • -8.6% qoq GDP growth in Q2 2010 • Widely quoted but of little interest • Qoq figures too volatile to be useful

8. Annual sectoral growth to June 2010 • Most sectors recorded positive growth, agric & mining leading • Manufacturing, government and finanance & business services shrinking • Non-mining growth gradually decling 39%

9. Agriculture – source of growth remains a puzzle

10. Business confidence … improving • Sharp drop in confidence during recession • Noticeable improvement since 2009H2 • Still low by standards of recent years

11. Inflation & Monetary Policy

12. Inflation ... modest increases, driven by cost-push • Inflation has been above upper end of BoB’s 3%-6% target range for several months • VAT & electricity prices main culprit • Recent decline likely to be reversed in coming months • Imported inflation low – end 2010 forecasts: • SA – 4.5% • Developed countries – 1% • Inflation regularly coming in below forecasts – suggesting domestic inflationary pressures are weak

13. Inflation expectations • BoB MPS 2010 forecasts inflation in range 4-5% in 2011 • Low international and domestic inflation pressures • Well below historical inflation rates in Botswana • Market not convinced – expected inflation well above BoB forecasts • Implications for interest rates and bond issuance

14. Monetary policy – interest rate cut likely in 2011Q2 • Interest rates sharply lower in response to declining inflation combined with recession • Bank rate cut by 5.5% since Nov 2008 • Interest rates at lowest levels for 20 years • Real prime rate also relatively low • BoB focusing on inflation excluding VAT impact – now less than 5.5% - hence within range for monetary policy purposes • Next interest rate move more likely to be down rather than up • But not until headline inflation below 6%

15. International Trade

16. Exports & imports ... in shock • Exports fell dramatically, then recovered, but to lower levels than in 2007-8 • Imports fell temporarily during recession, but are also now rising again. • Fall in imports much smaller decline than fall in exports • Structural shift towards trade deficit?

17. DTC Diamond Sales • DTC diamond sales have generally been rising since 2009Q2 • Improved prices and volumes, driven by retail market recovery and re-stocking of inventory • Supply restrictions also suporting prices • Debswana recently increased 2010 production / sales projections • But DTC sales still well below peaks of 2007 and early 2008

18. Exports … most categories showing healthy recovery in 2010 • Total exports up 40% in 2010 H1 over same period in 2009 • Minerals up 51% • Non-minerals down 1% • Of the 3 largest exports: • Diamonds up 61% • Cpr/nickel up 19% • Textiles down 51%

19. Trade balance .. big deficits • Trade surplus has generally been strongly positive over past five years • Export weakness and rising imports has led to unprecedented deficits since 2008Q4 • Large deficits still persisting, even with the recovery

20. Foreign exchange reserves .. fell during the crisis, and still falling • Reserves have fallen in both pula and US$ terms • Driven by balance of payments deficits • Temporarily boosted by inflows from foreign borrowing • Import cover now around 17 months • Under threat if public spending not restrained • Exchange rate policy needs high reserves

21. Financial Sector

22. Banking sector: credit boom and then bust • Steady increase in credit growth until 2009, then sharp drop • Decline most dramatic in credit to private business • Subsequent recovery – but much more for business than household credit

23. Banking sector: quarterly data show recent weakening • Quarterly figures provide a more accurate picture than annual rates in a rapidly changing environment • Private business credit growth picked up in 2009H2, but has recently dropped sharply. • HH credit growth recovery much weaker, and has fallenback sharply in last 3 months • Needs to be watched closely for signs of economic weakening

24. Households’ Deposits and Loans • Household deposits and loans have grown in parallel in recent years • Relatively small and constant gap to late-2008 • Deposits declined sharply in 2009 • Gap between savings and borrowing has widened sharply • Net debt burden and vulnerability of consumers is increasing • Situation appears to have stabilised

25. Banking: rising HH arrears, but may have peaked • Sharp increase in arrears since the beginning of 2009 • Particularly pronounced for HHs – highest ever level • Household incomes under stress: • No pay rises in public sector (40% of LF) for 2 years • VAT increase • Over-committed • Signs of stabilisation in 2010

26. Employment

27. Employment • Data available to Sept 2009 • Formal employment – no decline during recession • Only impact was on mining employment – small proportion of total

28. Unemployment • Unemployment data poor • Irregular timing • Inconsistent definitions • Trend appears to be upwards, but not conclusive

29. Fiscal Policy

30. Fiscal position – rapid deterioration • Turnaround from surplus to substantial deficit • Driven by both increased spending and falling revenues • 2009/10 deficit projected at 15% of GDP is unsustainable • 2010/11 Budget has a continuation of revenue decline and P2bn cut in total spending • Deficit cut, but still huge • Revenues less than 30% of GDP – last seen in 1970s

31. Fiscal sustainability – to be restored through spending cuts • 2010 Budget provided 3 year forecasts for the first time • Some revenue recovery forecast in 2011/12 and 2012/13 • But only to 32% of GDP, not the 40% historical average • Spending has to be cut substantially to balance the budget – esp. development spending • Spending projected to be flat in nominal terms – significant cut in real terms and relative to GDP • Major withdrawal of domestic demand

32. Impact of deficits on Govt finances • Net financial position – govt. deposits & reserves at BoB less public debt (foreign & domestic) • Peaked at P41bn in 2008 • Cumulative deficits in 3 yrs 2008-2011 = P30bn • Continuation of deficits will lead govt to become net debtor • Reason for credit rating downgrade

33. International Assessments

34. IMF Article IV report • Priorities • Substantial fiscal consolidation, to be achieved by lower public spending (relative to GDP) • Improved management of public debt, including medium-term debt strategy • Caution in reducing interest rates further • Policies and reforms to create a leaner and more efficient public sector • Structural reforms to promote private sector led growth

35. World Bank Public Expenditure Reform programme • Public spending: reduce to sustainable levels, improve efficiency, reduce public sector wage bill • Planning and Budgeting: move beyond current NDP framework to programme-based budgeting and MTEF • Debt management: integrated framework for managing public sector assets (inc. FX reserves) and liabilities (debt and guarantees)

36. WEF Global Competitiveness Report • Botswana’s ranking has slipped from 66 in 2009 to 76 in 2010 (out of 139 countries) • 4th placed in SSA – after Mauritius, South Africa, Namibia • Main weaknesses relate to: • quality of infrastructure (84) • health and primary education (114) • higher education and training (94) • technological readiness (99) • market size (102) • business sophistication (104)

37. WEF GCR • Main problems facing business: • Poor work ethic • Inadequately educated workforce • Inefficient govt bureaucracy • Access to financing • Inadequate supply of infrastructure • Restrictive labour regulations

38. Economic Outlook

39. Base Case: International Economic Prospects • Global growth declines slightly but remain positive – no double dip recession • Emerging markets continue to outgrow developed markets – hence shifting global economic balance • Commodity markets stable (steady real growth in prices) • Orderly unwinding of economic problems: • Reducing government debt • Withdrawal of fiscal stimulus • Private sector de-leveraging • Interest rates and inflation “low for long” in major developed economies • Euro-zone stability

40. Base Case: Domestic Economy • Mining: • Steady recovery in diamond exports; prices not too volatile • Similarly with other mineral exports (copper, nickel) • New mine development proceeds (AK6, Boseto, uranium) • Non-mining: • Gradual withdrawal of government spending • Household sector stresses manageable • Fiscal • Outturn better than budget projections • Depletion of govt reserves is stemmed • No govt pay rise in 2011, given effective (but unintended) rise in 2010 • Serious budget/planning reform undertaken • No SACU crisis – just gradual decline in revenues • Inflation stays low from 2011 • Interest cuts in 2011 Q2

41. IMF Growth Forecasts • Growth forecasts released in Article IV report • Projections for reasonably robust recovery after initial slowdown in non-mining growth • Based on assumption of appropriate policy measures • Jump in non-mining growth based on investment in new electricity generating capacity, plus beneficial impact of reforms

42. IMF inflation forecasts • Projected steady decline in inflation over next five years • Suggests BoB may be somewhat optimistic, but not excessively so • Private sector expectations unduly backward looking • If IMF forecasts are correct, we are approaching a period of structural change in inflation

43. Fiscal sustainability – IMF budget projections • Revised budget forecasts provided by IMF • Some revenue recovery forecast in 2011/12 and 2012/13 • But only to 35% of GDP, not the 40% historical average • Recovery of diamond production will help revenues in 2010/11 – reducing budget deficit • But medium-term budget prospects still require spending cuts for sustainability • e.g. ongoing revisions to SACU revenue formula

44. Exchange Rate Forecasts • Pula weakness vs rand driven by rand strength, compounded by crawling peg • ZAR strength now seen as continuing into medium term • If so, BWP will remain around 1.05 in medium term

45. Exchange Rate Forecasts

46. Other variable forecasts • Disposable income: follow non-mining GDP growth (avg. 5-6% a year real growth to 2015) • Private sector credit growth: average 12% a year growth to 2015 • Interest rates: 50bps cut in 2011, 2012 and 2013 (taking bank rate to 8.5%);

47. Downside scenarios - international • Currency wars • Pursuit of “cheap” currencies to boost exports • Possibly leading to protectionism • Debt markets • Lose confidence in government debt – pushing up borrowing costs • Financial/asset markets • Falling financial asset prices • Housing prices remain weak • Consumer confidence • Fails to recover • Spending remains weak • Deflation • Double dip recession: • Growth turns negative in developed econs • Emerging mkts dragged down • International trade • Contraction (as in 2008-9) • Commodity prices weak • Export-dependent nations hard hit

48. Downside scenarios – regional/domestic • Regional • Zimbabwe impasse continues (diamond wealth boosts ZANU PF confidence, no agreement on referendum/constitution/election, MDC leaves GNU) • SA fails to boost growth, spectre of mines nationalisation, industrial unrest, ANC politics • Domestic • Policy-making driven by populist politics not rational analysis • Reluctance to undertake public finance/public sector reform • Failure to implement policies to promote private sector growth and diversification • Labour unrest

49. Potential Outcomes - Botswana Positive Negative International recession undermines mineral-led growth Government fails to implement policies supportive of diversification Pressures to maintain public sector employment & expensive spending programmes undermine fiscal discipline SACU collapses, protectionist policies introduced Growth stagnates, rising budget deficits, government finances collapse, reserves depleted, pula peg unsustainable • Mining sector diversifies (coal, copper, nickel, gas, uranium) as diamonds decline • Non-mining private sector reduces dependence upon govt and becomes more export focused • Government adjusts its size and spending to reflect lower medium/long-term revenue forecasts • Growth continues around 5-7% - supported by job creation, sufficient to reduce poverty

50. Thank You