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AfricaNovember 6 2006

Blemishes on Africa’s gem

Bank of Botswana governor Linah Mohohlo does not duck tough questions about the economy. James Eedes reports.
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Double-digit inflation normally spells trouble but Bank of Botswana governor Linah Mohohlo shows little sign of panic. Such steeliness may be a job requirement of central bankers, but for Botswana, one of Africa’s most enduring economic success stories, the stakes are high: lack of economic diversification, one of the world’s highest HIV infection rates and sluggish growth cast a shadow over four decades of development.

In Singapore, at the annual meetings of the IMF and World Bank in September, Ms Mohohlo was gamely fielding questions about the country’s inflation rate, most recently reported to be 10.7% for August on a 12-month basis. Although it is customary to scrutinise the central bank for its response to such rapid price acceleration, Ms Mohohlo was at once diplomatic and deliberate, pointing out that it was the government that was mostly responsible for sparking inflation.

The rate of price increases peaked at 14.2% in April this year, a record level triggered by the devaluation of the local currency in May last year and rises in administered prices, including the reintroduction of school fees. The country has also suffered the effects of high oil prices.

Inflationary fuel

So a mix of factors has fuelled inflation. On closer examination, though, there are structural concerns. In an attempt to boost the competitiveness of the country’s non-mining private sector, the government devalued the pula first in February 2004 by 7.5%, then by a further 12% in May last year. Mining and the public sector account for almost 60% of gross domestic product and there is a pressing need to diversify the economy. Strong inflows of foreign currency from the proceeds of diamond sales, accounting for 70% of the country’s foreign exchange earnings, exert upward pressure on the pula, making it harder for non-mining exporters to compete.

In addition to the two devaluations, the government also imposed a crawling band on the exchange rate, although it does not reveal the rate of movement. Other measures to stimulate the economy include increased public investment and an across-the-board 8% public sector wage increase. Not surprisingly, inflationary pressures have swelled.

Interest rate hikes

In response, the Bank of Botswana has hiked interest rates to 15%, designed to curb credit expansion, and moved to anchor inflation expectations with a string of public statements committing itself to an informal inflation target of 4%-7% by year-end and reiterating its intention to adopt a formal inflation target of 3%-6%.

With inflation on a downward trend, the bank’s interventions might do the job, especially if oil prices remain softer. But it will come at a cost, with economic growth slowing to a forecast 4.2% in 2006, the slowest pace of expansion in 12 years. Ironically, the devaluation of the pula was designed to boost Botswana’s export competitiveness, a key element of plans to increase the economic contribution of the non-mining private sector. In reality, the country has made little progress in this regard.

Ms Mohohlo is circumspect about manipulating the currency to boost competitiveness. “Obviously, you do not use just one tool to address competitiveness. There are also issues relating to productivity improvements, which are major concerns,” she says.

She is even more doubtful about the government’s decision not to announce the rate of crawl. “We don’t necessarily agree with that because we believe in transparency. Like any other developing country, we are trying to attract foreign direct investment. No investor is going to come into the country if they don’t know if their money is going to be eroded by inflation.

“We are talking to [the government] and we hope it will see the light,” she adds. “One should not have to guess the rate of crawl. Once you introduce this mechanism, you have to be transparent with all aspects of it.”

Policy frustration

There are other signs that Ms Mohohlo is frustrated at the government’s seeming unwillingness to co-ordinate its policies towards the objective of price stability.

“When we design our monetary policy, it is important to look at what we believe is going to drive demand. To some extent demand is driven by credit; the instruments to control credit rest with the [Bank of Botswana]. But government expenditure is also a major driver of demand and therefore can be inflationary. We pay close attention and we advise the government what we think its fiscal policy needs to do in a given period for it to be complementary and supportive of monetary policy. This year, the government has forecasted the 2006/07 budget will grow by about 15%, which is higher than what we would want.”

Is she frustrated? “I wouldn’t call it frustration; it’s a relationship you cannot terminate. In fact, it’s like a successful marriage: you really can’t say you are frustrated with it because then you would need to be getting out. If you are committed, you make things work.”

Ms Mohohlo knows the importance of keeping Botswana’s track record of sound economic management intact. Botswana benefits enormously from being the highest rated African sovereign, even higher rated than South Africa. But it is a reputation and credibility that is easily lost, too.

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