BOTSWANA DEVALUES CURRENCY

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E.O. 12958: N/A
TAGS: ECON BEXP EFIN ETRD BC TRADE
SUBJECT: BOTSWANA DEVALUES CURRENCY



1. Summary: The Ministry of Finance and Development
Planning (MOF) announced a 12 percent devaluation of
the Pula on May 29 as well as a restructured formula
for calculating the exchange rate. The Pula is
currently pegged to a basket of currencies,
including the U.S. Dollar, the Yen, the Euro, the
Rand and the British Pound. While the peg to this
basket of currencies will not be affected by the
restructuring, the new system will allow for
continuous adjustments through what is known as a
crawling peg as well as a widening of the margin
between the buy and sell rates for currencies quoted
by the Bank of Botswana (BOB). The rationale
presented by the MOF for the devaluation and
restructuring was to enhance the competitive
position of domestic producers and exporters,
encourage the development of a local inter-bank
foreign exchange market, and provide reassurance to
foreign direct investors based on a stable
competitive real effective exchange rate. This
devaluation could be the first step towards
converting to a floating exchange rate system and
may enhance its export competitiveness, but the
timing of the move has raised eyebrows among members
of the financial sector in Botswana as the decision
comes two days before the BOB is due to pay out on
several long-term bonds. End Summary.


2. While the devaluation is being sold as a means of
ensuring the future stability of the real exchange
rate, the abrupt devaluation and restructuring will
have several short to medium term consequences on
inflation, the budget, the bond market and investor
confidence, and ultimately the type of exchange rate
system employed by Botswana.

Importing Inflation
--------------


3. Devaluing the currency will put immediate upward
inflationary pressure on the economy as the vast
majority of products sold in Botswana are imported,
primarily from South Africa. Dr. Keith Jefferies,
former deputy governor of the BOB, told EconOff that
inflationary pressure will surely rise, possibly by
as much as 5 or 6 percent to between 10 or 12
percent on a per annum basis for a year or so. Dr.
Jefferies also said, "The BOB may adjust its
inflation band (Note: The BOB sets an annual
inflation target band, which is currently between 3-
6 percent for the 2005/6 fiscal year),but only
temporarily as the inflationary bulge should be
short-lived, just as it was for the last
devaluation." The MOF last devalued the currency by
7.5 percent in February 2004. Finally, the
inflationary pressure created by the devaluation
means there are no more foreseeable cuts in interest
rates, which remain extremely high at a 14 percent
prime rate that stifles local investment.

Budgetary Impact
--------------


4. There is no getting around the obvious impact
this move has on the GOB's fiscal standing, adding
an immediate boon to its revenue generation,
particularly from diamond sales, which are dollar-
denominated and account for nearly 50 percent of
government revenue. Over the course of the past
couple of years, the GOB has been holding its purse
strings tightly following three consecutive budget
deficits. But the devaluation will free up a
substantial amount of money, potentially $300
million, to spend on much needed infrastructure
development projects, many of which have stalled.


5. However, given the potential for driving up
inflation even further if it acts too quickly, the
MOF's press statement wisely indicates that the new
exchange rate system "will be supported by ongoing
fiscal and monetary prudence." This suggests that
the GOB does not intend to spend the additional cash
raised by the devaluation immediately, but rather
spread over a period of time. Either way, this
devaluation will obviously help what was predicted
to be another deficit year.

Investor Confidence and the Bond Market
--------------


6. Despite the stated objective of reassuring
foreign investors, the move is likely to have the
opposite impact of shaking their confidence, at
least in the short term, following the second major
devaluation of the Pula in just 16 months. The
previous devaluation of 7.5 percent was done in
February 2004, and had the benefit of nearly
balancing the 2003/2004 fiscal year books. Former
Governor of the BOB, Mr. Quill Hermans, told
EconOff, that despite the fact that the devaluation
was needed and had been predicted, it constituted a
"body blow to investor confidence." Martin
Makgathle, CEO of Motswedi securities concurred,
saying he believes it has "shaken investor
confidence" and is worried about sustaining the
perception of Botswana as a stable economic country.


7. The biggest losers in the devaluation are
bondholders. Given the immediate maturity of its
850 million Pula BW001 bond on June 1, its first
ever bond issuance, the additional revenue raised by
the devaluation comes at a very convenient moment
for the GOB, which must repay these debts. Ms.
Kathy O'Connell, CEO of Legae Investors Mutual Fund,
told EconOff, "It could have been worse. The
Government could have defaulted or extended
repayment of the BW001 maturity, and imagine the
rating agencies would have had a field day with that
one." However, it remains to be seen how the rating
agencies will see this exchange rate restructuring,
considering the impact it has on the Government's
debt obligations, and whether Botswana will retain
its investment-grade sovereign credit ratings.


8. For foreign bondholders, in particular, the
devaluation will have an immediate negative impact
if their returns are converted into foreign
exchange. Given the lack of any rollover or new
bond issuances to coincide with the BW001 maturity,
there will be a lot of excess liquidity flooding the
Botswana capital market this week. With nothing to
put their money into, Botswana Treasury bond yields
should drop as money is shifted into Bank of
Botswana Certificates, and a significant proportion
is likely to be repatriated overseas.


9. Portfolio investors will also be negatively
impacted as the value of their investments falls
correspondingly to the devaluation. Dr. Tebogo
Matome, CEO of the Botswana Stock Exchange, told
EconOff that the devaluation will clearly cost
portfolio investors money, and it will take time to
bring them back to this market. In addition, Dr.
Matome noted that portfolio investment typically
leads the way for foreign direct investments (FDI),
so the negative impact on portfolio investments
could stem the flow of FDI, with a correspondingly
negative impact on the GOB's efforts at diversifying
the economy.


10. Mr. Brian Alexander, Managing Director of Andisa
Capital, a financial services company incorporated
under the Botswana International Financial Services
Center (IFSC),told EconOff that the restructuring
of the exchange rate system is "definitely positive"
for investment in that we won't see large scale
revaluations in the future, which should add
stability to the market. He also said, as an IFSC
company that earns money only in foreign exchange,
the move would boost profits. Mr. Wayne Osterberg,
CEO of Stockbrokers Botswana, told EconOff that he
agreed the restructuring is a good idea, but
lamented that the decision to devalue the currency
was done immediately in a single move, rather than
incrementally under the newly established system.

Moving Towards a Free Float?
--------------


11. Dr. Jefferies, who departed the BOB only
recently, told EconOff that the restructuring of the
exchange rate mechanism signals a first step towards
establishing a floating exchange rate in Botswana.
In addition to the continuous adjustments described
in the new policy, the Bank of Botswana has also
increased the margin between the buy and sell rates
for currencies quoted by the Bank to plus or minus
0.5 percent from the preexisting 0.125 percent.
This move should, as the MOF suggests, catalyze the
development of a market-based inter-bank foreign
exchange market in Botswana, which could in turn set
the benchmark for converting to a floating system.
The MOF's press release explicitly states, "As the
foreign exchange market among the primary dealers
develops, further increases in the width of the band
around the central rate will be announced." This is
a clear indication of the BOB's attempt at letting
the market determine the real exchange rate and
bring a greater level of stability to the system.


12. EconOff asked Mr. Osterberg about a potential
shift to a floating system, and he noted that a
crawling peg system served as a "useful
steppingstone for converting to floating systems in
Chile, Israel and Colombia," and could likely do the
same for Botswana.

Conclusion
--------------


13. Assuming the immediate negative inflationary and
investor confidence impacts are short-lived, the
GOB's decision to shift to a crawling peg system
should bring greater stability to both Botswana's
fiscal circumstances and its burgeoning capital
markets.

HUGGINS