2008:Q2
- 1. Bifm Economic Review 2nd Quarter 2008 Economic Review Summary stable even as food and fuel prices have rocketed (see Figure 1). helps to contain price increases. For oil, by contrast, the scope for increasing supply as of Economic These inflationary pressures are almost prices rise is limited in the short-term, and Developments price stabilisation is much more dependent entirely driven by international developments. upon reducing demand; although demand Food prices have been rising around the for oil has fallen in the major industrialised Dr Keith Jefferis world, especially for dairy products, cereals countries during 2007 and 2008, demand and oils & fats whose prices have more than from the major developing countries has doubled in international markets over the Chairman of past two years (see Figure 2). The overall continued to grow. Bifm Investment Food Price Index published by the UN Food and Agriculture Organisation has risen by The international origin of these inflationary pressures means that almost all countries Committee two-thirds over this period. This inevitably feeds through to domestic prices in a food- are affected in similar ways. In the major industrialised economies, inflation has also I importing nation. The only positive news risen sharply, albeit from lower levels, and is is that international food prices appear to set to reach the highest levels since 1991. have peaked, with a slight price decline in Inflation in South Africa has more or less ntroduction all commodity groups except meat between doubled over the past year, and inflation in The past quarter has been one of almost March and May 2008. Even if prices do not many developing countries is at the highest uniformly bad economic news. Domestically, fall much, price stabilisation will at least rate for several years. there has been rapidly rising inflation, two mean that the impact on inflation will begin interest rate hikes, and setbacks for two What are the prospects for inflation in to reduce. major development projects. To the extent Botswana over the next year or so? In the that there is any good news, it is that International fuel prices have also risen short-term, inflationary trends will continue Botswana is not alone; internationally, it is steadily, doubling over the year to June. to be dominated by fuel prices. Domestic a similar story, with rising inflation almost In contrast to food prices, there is no sign pump prices have risen by less than everywhere, tighter monetary policy, and of an end to the upward movement in oil international oil prices, and even if oil prices a slowdown in economic growth. In this prices. One difference between the two stabilise, domestic prices will still have to issue, we take a closer look at recent commodities is that higher food prices are rise further (see Figure 3). In all likelihood, economic developments, and the extent to quite effective at generating additional inflation will rise by at least another 2%, international economic developments are supply as farmers plant more crops, and this and will peak between 14% and 15% in impacting on Botswana. Figure 1: Food & Fuel Price Inflation Inflation Inflation has continued to rise rapidly in recent months, and is up from 8.2% at the end of 2007 to 12.1% in May 2008. The increase is almost entirely driven by higher international food and fuel prices. Food price inflation reached 18.5% in May, while inflation for the component of the CPI that comprises mostly fuel prices reached 42%. Indeed, apart from these items, inflation has been quite well behaved; inflation excluding food and fuel was only 5.2% in Source: CSO, Econsult May – a rate that has remained remarkably
- 2. 2 Economic Review the third quarter of the year, on the basis of This duty has been imposed under the infant 15% on items such as printers, cellphones, events that have already occurred. However, industry provisions of SACU to protect a digital cameras, blank CDs etc. The apparent if international oil prices rise further, then new local UHT milk producer. Whether the intention is to establish a fund for musicians Botswana’s inflation could move even new producer really needs 40% protection who may be disadvantaged by the illegal higher. is a moot point, but the downside is that the copying of their music. A noble objective, On the bright side, as mentioned above, price of a key consumption item – especially one might think. However, the levy is wide- inflation continues to be focused on the for the poor – will be artificially increased, ranging and completely disproportionate to specific areas of food and fuel, and apart adding further to inflation and poverty. In the matter at hand. Many of these items, from these commodity groups inflation addition, the 40% tariff is in contravention but especially computers, are essential remains very low; there is no sign yet of of Botswana’s commitments to the World items of business equipment, especially the second-round effects that would result Trade Organisation (WTO), under which the in service industries which Botswana is from inflation spreading more widely in maximum permitted tariff is 20%. trying to promote through entities such the economy. This may be just a question In a further strange policy move that will add as the IFSC. For a country that is already of time, however; higher fuel costs will to inflation and undermine competitiveness, challenged with regard to international eventually affect many other prices, and the Ministry of Trade and Industry has competitiveness, and is suffering from an there will undoubtedly be pressure for wage imposed an additional tax on computers inflation problem, this policy measure is increases as a result of higher food and and related items under the Copyright completely counterproductive, and the tax other prices. If second-round effects can and Neighbouring Rights Act. The tax on should either be removed or drastically be contained, then inflation will fall rapidly computers is 10%, and ranges from 5% to reduced. once fuel prices stop rising. However, if second-round effects take hold, then it will Figure 2: International Food Prices take much longer to bring down inflation. Apart from monetary policy (discussed below), what can be done to minimise the impact of inflation? One area that needs to be considered is trade policy. Countries such as Kenya and Mauritius have countered the impact of imported inflation by cutting import duties on food items. Botswana could lobby for similar moves by the Southern African Customs Union (SACU), using the channels that are open to all members under the 2002 SACU * to April Source: UN FAO Agreement. The SACU tariff structure is unnecessarily complex, and in general the tariffs are too high; the need to bring down Figure 3: Fuel & Crude Oil Prices food prices provides a good opportunity for the reduction and rationalisation of tariffs, and as well for Botswana and the smaller SACU members to use the available mechanisms to influence the tariff structure in a way that suits their interests. Instead, Botswana has scored something of an own goal by imposing an additional 40% import duty on UHT milk, which has pushed up the price of imported UHT milk by a similar amount – on top of steep rises in milk Source: DEA prices which have occurred internationally.
- 3. 3 Economic Review Monetary Policy Figure 4: Bank Rate In response to rising inflation, the Bank of Botswana has raised interest rates twice in quick succession, by a total of 1%. This takes the Bank Rate (the BoB’s benchmark lending rate) to 15.5%, and the commercial bank prime rate to 17%. This marks the highest ever level of interest rates in Botswana – even when inflation previously reached high levels of 14.2% in 2006 and 17.6% in 1992, the Bank Rate had never exceeded 15.25% (see Figure 4). Source: IMF, BoB As discussed above, virtually all of the inflation being experienced by Botswana is rates can be effective in reducing demand In order to assess whether higher interest imported from international sources, and as and containing inflation, and this is one rates are likely to be effective at bringing such interest rate policy can have no direct reason why many central banks around the down inflation, empirical evidence is needed effect on inflation. The intention, however, world have been increasing interest rates based on analysis of the sources of inflation is to prevent inflation from moving beyond in response to recent increases in inflation. and what economists call “the transmission food and fuel to become more generalised It is sometimes argued, however, that this mechanism of monetary policy”. The Bank in the economy. As we have noted, inflation is not relevant in Botswana, because only of Botswana’s monetary policy decisions are other than for food and fuel has remained a small portion of inflation is determined based on its own modelling of inflation and relatively low, at just over 5%. Monetary locally – rather than by import prices or the transmission mechanism. However, the policy, through higher interest rates, is exchange rates – and hence monetary results of this work has not been published, intended to prevent this from rising. This policy is unlikely to be effective. Monetary and greater transparency regarding the channel works through reducing the level policy is much more effective when high modelling results, inflation forecasts and of demand in the economy, by increasing inflation is caused by domestic demand empirical analysis of impact of interest the cost of borrowing and hence reducing pressures, which is not the case at present. rates on inflation would help to enhance credit growth. When inflation is imported, interest rates the credibility of monetary policy, and To what extent is this likely to be effective? can only influence inflation by moderating convince the sceptics that there is a sound This is difficult to answer definitively. second round effects, and cannot affect the basis for higher interest rates in the current Certainly, it is widely accepted that interest direct causes of inflation. inflationary environment. Economic Growth 3.6% in South Africa – all 1-2% lower than in 2007. The main causes of slower To what extent has this growth slowdown had an impact on Botswana? So far, the growth are the fallout from the US sub- impact seems to be limited. The latest GDP prime and financial sector crisis, resulting in growth data only go as far as September The international economy is suffering from 2007, but show that, at least up until then, a slowdown in growth as well as sharply risk aversion and reduced credit availability, growth was powering ahead. In the year to higher inflation. While the world economy compounded by the impact of higher food September, total GDP grew by 5.9%, and is not (yet?) in recession, growth is falling and oil prices. The latter has resulted in a the non-mining private sector by a striking almost everywhere. The USA is amongst the massive shift of wealth and purchasing 11.1%, with particularly rapid growth in worst affected countries, with close to zero power from oil importing nations to oil the manufacturing, trade, hotels & tourism, growth, and other developed economies exporters, with an associated loss of real and transport & communications sectors also experiencing growth down to around income amongst the oil importers that has (see Figure 5). 1%. In major developing economies, growth inevitably caused growth to slow, especially However, export data – which are more is also falling, but remains more robust, as the additional earnings received by oil up to date - tell a less encouraging story. with 2008 GDP growth projections of 9.5% importers have largely been saved rather Total exports in the last quarter of 2007 and in China, 7.4% in India, 4.8% in Brazil and than spent. the first quarter of 2008 were down 12%
- 4. 4 Economic Review compared to a year earlier, with particularly 17%). The reduction in these exports, which growth slowdown may be biting, and does sharp falls in exports of beef (down 44%), almost entirely go to developed country not augur well for export led growth over and textiles and diamonds (both down markets, suggest that the effects of the the next couple of years (see Figure 6). Figure 5: Real GDP growth (annual) Figure 6: Change in Exports 6 months to March 2008 Source: CSO, Econsult Source: CSO, Bob Financial Markets overall credit growth, demand for mortgage finance reportedly remains robust. However, the decline in the BSE index largely reflects local developments. A year ago, there was widespread agreement that the While the Botswana Stock Exchange (BSE) stocks of commercial banks, which account A major characteristic of the economic has experienced a period of decline since the third quarter of last year, there are only for the majority of BSE capitalisation, were crisis affecting developed countries is the overvalued, with price-earnings (P/E) ratios superficial similarities with the declines in credit crunch – the reduced availability of up around 30, and a P/E ratio for the stock markets around the world. The BSE credit from banks and financial markets, market as a whole of 19. Since that time, domestic index (DCI) fell from a peak of and rising spreads which mean that riskier 9866 in August 2007 to 6908 in May 2008, the decline in the value of bank stocks – of projects and borrowers have to pay higher a drop of around 30%. The MSCI World up to 50% - has been the main driver of interest rates – if they can get credit at all. index (representing movements across all the falling stock market index. Bank stocks major developed and developing country now have P/E ratios of less than 20, and the There appears to be no equivalent credit stock markets) fell by 18% from its peak market a P/E ratio of 12.9. This has been crunch in Botswana, where the financial over a similar period, and almost all stock associated with declining bank profitability, markets are relatively insulated from global which has largely domestic rather than markets around the world have experienced financial developments. Domestic financial sharp falls. international causes. markets remain very liquid, and credit growth has been robust; total bank credit Figure 7: Growth of Bank Credit grew by 28% in the year to March, the fastest growth since 1999 (see Figure 7). Growth has been particularly rapid in credit to the private business sector, which was up by 35%. Looking specifically at mortgage markets, which have been at the forefront of financial sector problems in the major developed economies, in Botswana it appears to be “business as usual”. Total mortgage lending by the commercial banks and the Botswana Building Society rose by 12.3% in the year Source: BPC, BoB to March 2008, and although lower than
- 5. 5 Economic Review Threats on the Figure 8: Business Confidence Index Horizon? (% of firms rating current business conditions satisfactory) Although Botswana’s growth does not seem to have been badly affected by the international economic slowdown, and credit is still readily available, the situation may not last. There have been a couple of high-profile corporate failures in the transport sector (Lobtrans and African Express), which may make the banks more reluctant to provide corporate credit, or impose tighter terms and conditions which would restrict credit availability. More generally, growth prospects for 2008 Source: BoB are uncertain, despite strong economic growth in the second half of 2007. Growth is likely to be negatively affected by the costs for the project – up from an initial promoted by CIC Energy and International global economic slowdown (through $350m to an estimated $1500m - meant Power. Following similar concerns about reduced demand for exports) and the that the project was no longer viable. These rising construction and equipment costs, regional electricity shortage (discussed in rising costs reflected higher construction, it was announced in late June that it had detail in the previous issue of this Economic equipment and project management costs. not proved possible to reach agreement on Review), although strong government The regional power shortage was also an the sharing of risks between the various spending domestically should help to important contributory factor to the decision project stakeholders. Reading between the support growth rates. Views in the private to postpone; the Activox refinery would have lines, it appears that the preferred supplier sector are mixed: the Bank of Botswana’s been Botswana’s largest single consumer of power station equipment (Siemens of Business Expectations Survey conducted of power, and given the shortfall in power Germany) and the main off-taker (Eskom in March 2008 reported that businesses supplies projected for Botswana over the of South Africa) were unwilling to shoulder expected an average growth rate of 5.9% next four years or so, Tati Nickel could not sufficient financial risks (besides contracting in 2007/08 (compared to 6.1% in 2006/07, be assured of receiving the required power as supplier and purchaser, respectively), the most recent actual data), rising to 6.4% to commission the project on time, with the resulting in risk levels that the project in 2008/09. At the same time, business resulting delays reducing project viability promoters (CIC and International Power) confidence levels have fallen slightly, with even further. Falling nickel prices, - down to the overall percentage of firms rating current and other funders were unwilling or unable $22 000 a tonne at the end of May 2008, to take on themselves. Besides rising business conditions satisfactory falling to from a peak of $54 000 a year earlier – also costs, the project has also fallen victim to 70%, from 71% in September 2007 (see contributed to the demise of the project. tightening credit conditions in international Figure 8). Perhaps more telling is that the Contrary to some reports, however, the Tati markets. While there may still be a power proportion of firms who are optimistic Nickel mine itself is not threatened; it will station built at Mmamabula, it is likely to be about business conditions in 12 months time fell from 85% to 73%. keep on producing concentrates which are much smaller than the 2x2400MW project then smelted into copper/nickel matte at that has been discussed up to now. There The impact of deteriorating economic BCL in Selebi-Phikwe. There remain good may also still be potential for development conditions has already had a negative on prospects of an expansion of the Phoenix of the coal mine for coal exports and/or a two of the major development projects open pit, and also for a re-opening of coal-to-liquids project, but coming on top that were expected to boost growth in the nearby Selkirk underground mine. coming years. In May it was announced of May’s cancellation of the Activox refinery, However, the postponement of the project the problems at Mmamabula are indeed that the Activox Nickel Refinery Project may prompt a review of the tax concessions being built near Francistown by Tati Nickel, unwelcome news. Both projects had been that were granted to Tati Nickel to support a subsidiary of Russia’s Norilsk Nickel, had seen as major contributors to Botswana’s the Activox project, which would appear to been indefinitely postponed. The refinery efforts to diversify the economy through be no longer justified. was intended to process nickel and copper value addition to minerals produced concentrates from Tati Nickel’s nearby The second major mining-related project in the country, a task that will become Phoenix Mine into finished metal. However, to experience severe problems has been more difficult as international economic Norilsk decided that rapidly rising capital the Mmamabula Energy Project being conditions deteriorate. 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 thegate100092