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

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

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 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

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

Botswana: Real Economy

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

qoq GDP growth – volatile -8.6% qoq GDP growth in Q Widely quoted but of little interest Qoq figures too volatile to be useful

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%

Agriculture – source of growth remains a puzzle

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

Inflation & Monetary Policy

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

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

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%

International Trade

Exports & imports... in shock Exports fell dramatically, then recovered, but to lower levels than in 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?

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

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%

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

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

Financial Sector

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

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

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

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

Employment

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

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

Fiscal Policy

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

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

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 = P30bn Continuation of deficits will lead govt to become net debtor Reason for credit rating downgrade

International Assessments

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

World Bank Public Expenditure Reform programme Public spending: reduce to sustainable levels, improve efficiency, reduce public sector wage bill 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 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) Debt management: integrated framework for managing public sector assets (inc. FX reserves) and liabilities (debt and guarantees)

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

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

Economic Outlook

Base Case: International Economic Prospects Global growth declines slightly but remain positive – no double dip recession Global growth declines slightly but remain positive – no double dip recession Emerging markets continue to outgrow developed markets – hence shifting global economic balance Emerging markets continue to outgrow developed markets – hence shifting global economic balance Commodity markets stable (steady real growth in prices) 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

Base Case: Domestic Economy Mining: Mining: Steady recovery in diamond exports; prices not too volatile Steady recovery in diamond exports; prices not too volatile Similarly with other mineral exports (copper, nickel) Similarly with other mineral exports (copper, nickel) New mine development proceeds (AK6, Boseto, uranium) New mine development proceeds (AK6, Boseto, uranium) Non-mining: Non-mining: Gradual withdrawal of government spending Gradual withdrawal of government spending Household sector stresses manageable 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

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

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

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

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

Exchange Rate Forecasts

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

Downside scenarios - international Currency wars Currency wars Pursuit of “cheap” currencies to boost exports Pursuit of “cheap” currencies to boost exports Possibly leading to protectionism Possibly leading to protectionism Debt markets Debt markets Lose confidence in government debt – pushing up borrowing costs Lose confidence in government debt – pushing up borrowing costs Financial/asset markets Financial/asset markets Falling financial asset prices Falling financial asset prices Housing prices remain weak 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 ) Commodity prices weak Export-dependent nations hard hit

Downside scenarios – regional/domestic Regional Regional Zimbabwe impasse continues (diamond wealth boosts ZANU PF confidence, no agreement on referendum/constitution/electi on, MDC leaves GNU) Zimbabwe impasse continues (diamond wealth boosts ZANU PF confidence, no agreement on referendum/constitution/electi on, MDC leaves GNU) SA fails to boost growth, spectre of mines nationalisation, industrial unrest, ANC politics 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

Potential Outcomes - Botswana Positive 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 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

Thank You