Minister of Finance, Peggy Serame
Lower borrowing costs may boost retail spending more than business investment
The effects of borrowing for production may take time to impact the economy
The Monetary Policy Committee (MPC) is leveraging its tools to bolster economic growth by cutting the Monetary Policy Rate (MoPR) to 1.9%, anticipating this will reduce borrowing costs, potentially stimulating investment and increasing disposable income.
The MPC is betting on the non-mining sector to offset the downturn in the diamond industry, to some extent, which is expected to take some time to recover. While yields adjusted immediately in response to the MoPR changes, the bank acknowledges that effects on economic growth may take time to materialise, as some variables need more time to unfold.
25 basis points a time
The MPC meets to discuss the outlook and policy actions, its primary focus is on price stability. The committee considers how to use the MoPR to manage inflation and support economic growth. As Governor Cornelius Dekop puts it,
"We're talking about the price of capital and trying to influence it through the policy rate."
Dekop is aware that the MPC must be cautious not to overwhelm the market with sudden, drastic changes in policy, otherwise known as the big bang easing. Especially now that the MPC recently implemented a 25 basis point change in June and exercised another 25 basis points, he said during last week's rate decision announcement. Dekop believes this is sufficient to influence how downstream interest rates will respond.
Supporting growth
When interest rates decrease, the MPC anticipates that it will become cheaper for the government and corporations to raise funds through issuing bonds or taking out loans. The assumption is that cutting rates increases disposable income and makes borrowing cheaper for investment. MPC is thinking business credit will tick up, possibly hoping increased borrowing from households will support the growth. However, this might lead to retail growth, a segment that borrows for consumption rather than production.
Essentially, MPC has made it cheaper for the government to borrow in the local market to fund its budget. Deputy Governor Dr. Tshokologo Kganetsano expects yields to adjust in response to the rate cut.
However, he acknowledges that economic growth may experience a lag, as "some variables need to move first before you can see the impact."
For instance, he said a company might take out a loan to increase production, but it can take time for the production process to yield results. The tricky thing about saying rate decisions have a lag is that economists expect the economy to rebound next year (base effect). This might not necessarily be broad-based — mainly just mining (diamonds), potentially overshadowing the impact of the rate cut.
Economy to operate below full capacity
The MPC believes that the economic situation will not improve in the second quarter, which led to its decision to lower the MoPR by 25 basis points. The committee projects that the economy will continue to operate below full capacity into the medium term and should not generate demand-driven inflationary pressures.
According to Statistics Botswana, real gross domestic product (GDP) decreased by 5.3% in the first quarter of 2024, compared to a growth of 5.3% in the same quarter of 2023. The International Monetary Fund (IMF) has revised its GDP growth forecast for 2024 down to 1%, from an earlier estimate of 3.6%, partly due to a downturn in the diamond industry, attributed to weak global demand and high inventories.
MPC says it is mindful that despite the commitment by the government to stimulate non-mining sectors through potential growth-enhancing economic transformation reforms, initiatives and supportive macroeconomic policies, the prospects for significant economic growth are still not visible.
Non-mining sector expected to pick up the slack
Dekop views this as an opportunity for the non-mining sector to thrive. One of the purposes of the MPC's decision is to support the performance of the non-mining sector, he explained noting that, in terms of government revenue, the non-mining sector is expected to generate more income. Finance Minister Peggy Serame projected that the non-mining sector is expected to grow at an average rate of 5.7%.
“This has the potential to generate new jobs across both the formal and informal sectors during this period.”
Dekop supports the idea that “those sectors need to perform for the economy to turn around.” However, while the MPC cut rates to boost borrowing of firms particularly, he acknowledged that their performance might not reach the 4.2% growth initially anticipated, which was based on government revenue from diamond exports and dividends, as well as investments in public projects. IMF has urged Botswana to curtail some of its developmental project spending as it falls down the fiscal cliff.
Given that the economy is expected to operate below full capacity, the MPC believes that demand pressures are unlikely to create inflationary pressures. As a result, it has revised its projections downwards which influenced the rate cut.
Inflation forecast to average 3%
MPC forecasts that inflation will remain low and within the objective range into the medium term, averaging 3% in 2024. The MPC revised its projections based on several factors. Innocent Molalapata, Director of the Research and Financial Stability Department, explained that they considered the actual inflation data for May and June, which turned out to be lower than anticipated.
“If you take VAT into consideration, the average inflation for Q2 was lower than what we anticipated,” he said adding that this on its own “says when you look at 2024, the average has been revised downwards”.
Another factor was that, with the previous forecast of 3.6%, it was expected that electricity tariffs and domestic fuel prices would increase. However, these prices did not rise as anticipated. The MPC factored this into its projections, resulting in a lower revised estimate.
Low inflation maintained through subsidies
Earlier this year, Economist Dr. Keith Jefferis highlighted the issue of artificially low inflation maintained by government subsidies. Jefferis noted that administered prices for essentials such as petrol and electricity consistently lag behind production costs, which has placed a growing burden on government finances. He found that the regulated price of electricity is significantly below the cost of production and is exceptionally low compared to international standards. Recently, Finance Minister Peggy Serame disclosed a P1.5 billion tariff subsidy to Botswana Power Corporation (BPC).
Inflation expectations anchored
Another factor the MPC considered was the downward revision of international food prices. “This suggests a lower impact on the inflation trajectory,” Molalapata said, adding that the forecast for South Africa’s inflation has also been revised downwards. Similarly, businesses also expect inflation to be within the medium-term objective range; thus, inflation expectations are aligned with the inflation objective (well anchored). As a result, MPC said the current economic conditions and the outlook for both domestic and external economic activity provide scope to ease monetary policy.
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