Why it matters:
Botswana's currency system is important for keeping the economy stable and attracting foreign investment. However, recent changes in the country's foreign reserves and trade balance are raising concerns about the future value of the Pula (the local currency) and the economy as a whole.
Context:
Foreign reserves are mainly built up through exporting more than importing (mainly through diamonds). However, Botswana has been spending more on imports than it’s earning from exports in recent years because of the poor performance of the diamond market.
This means Botswana is spending more than it's earning (reserves); more money is leaving the wallet than is coming in.
The Ministry of Finance reported that by September 2024, the country's reserves had fallen by 17.4%, from P63.9 billion in September 2023 to P52.8 billion.
What’s at play?
Trade Deficits and Their Impact:
Statistics Botswana shows that exports fell by 17.9% in October 2024.
Imports rose by 1.3%
The country reports a trade deficit of P4.9 billion.
Foreign currency dynamics:
The government uses foreign reserves to pay for imports and settle debts.
Banks ask the Bank of Botswana for foreign currency to serve their customers.
This demand for foreign currency puts pressure on the reserves.
Zoom in:
Increased Trading Margin:
The Minister of Finance approved raising the Pula's trading margin from ±0.125% to ±0.5%.
Bank of Botswana expects that commercial banks won’t need to rely as much on them for foreign currency.
They will trade with each other.
This eases pressure on foreign reserves as the bank won’t need to dip into the reserves for this purpose.
Changes in Currency Basket:
BoB has adjusted the weighting of the South African Rand (ZAR) in the Pula currency basket from 45% to 50% while reducing the Special Drawing Rights (SDR) weight from 55% to 50%.
The government wants to trade more with South Africa.
Now, when the Pula goes up or down compared to the Rand, it will change more slowly than it did before the adjustments.
This is expected to keep exporting and importing industries competitive.
BoB expects local firms and industries to export products and services to earn foreign currency for the economy.
Downward Rate of Crawl:
The government has kept the Pula’s downward rate of crawl at 1.51% to help Pula’s value adjust to inflation differences in both Botswana and its trading partners. If Botswana's inflation is higher than its trading partners, the Pula depreciates to keep exports competitive.
If inflation in Botswana is expected to be 4% and in its trading partner countries it’s expected to be 3%, the Bank of Botswana would set a downward rate of crawl at 1% by subtracting 3% from 4%. So, if nothing else changes, the Pula's value would drop by 1%. This is how the Bank of Botswana came to the 1.51% downward rate of crawl.
If inflation in Botswana is expected to be 3% and in its trading partner countries it's expected to be 4%, the Bank of Botswana would set an upward rate of crawl at 1%.
This helps exporting industries to be competitive.
Zoom Out:
The big picture of the problem:
While these changes to the exchange rate system are important, they won’t fix all of Botswana's economic problems. To really boost the economy, Botswana needs to improve productivity, efficiency, and put in place big changes through new policies.
Action from All Sectors:
Policymakers, consumers, investors, and producers must work together to ensure that all economic resources are used efficiently to improve the country’s competitiveness and long-term economic health.
The Backstory:
Introduction of the Pula:
Pula was introduced in 1976 when Botswana left the Rand Monetary Area to have control over its own interest and exchange rates.
It was set at P1 = $1.15 and was valued the same as the South African rand, which was also pegged to the US dollar.
By pegging the Pula to the US dollar and the South African rand, Botswana faced imported inflation from South Africa. As the rand’s value rose due to higher gold prices, the cost of imports from South Africa increased, bringing inflation into Botswana.
Basket Of Currencies:
To reduce the impact of rand fluctuations and make things more stable, Botswana changed its exchange rate system in 1980.
Instead of pegging the Pula only to the rand, Botswana linked it to a basket of currencies, including the South African rand and Special Drawing Rights (SDRs), for more flexibility. SDRs are made up of major
currencies like the US dollar, British pound, Euro, Japanese yen, and Chinese renminbi.
The choice of these currencies was mainly based on Botswana's trade patterns and the main currencies used for international trade payments.
Devaluations:
Between 1981 and 1991, the Pula was revalued and devalued multiple times to address issues like inflation, competitiveness, and economic stability (This is where it deliberately increases and decreases the value of the currency).
Between 2004 and 2005, the Pula was devalued by 7.5% and then 12% to reduce its overvalue and make Botswana’s products more competitive locally and internationally.
When the Pula is overvalued, local products become too expensive and lose competitiveness. People from outside can’t afford to buy them, and locals prefer cheaper imports, like from South Africa. To fix this, the Pula was devalued to make local products more competitive.
Adjustments Of Weight in Currency Basket:
The weights of the currencies in the basket were changed several times to match shifting trade patterns.
For example, the Zimbabwean dollar was added to the currency basket in 1991, making up 10% of it, but was removed in 1994.
Crawling Peg System:
The crawling peg was introduced in 2005 to keep the Pula's exchange rate stable, adjusted for inflation of Botswana and trading partners.
The goal was to keep local producers competitive in both local and international markets while avoiding the need for frequent devaluations and revaluations like in the past.
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