7TH ANNUAL NATIONAL ASSET LIABILITY MANAGEMENT AFRICA
CONFERENCE
RECENT DEVELOPMENTS IN INTERNATIONAL FINANCIAL
MARKETS
Keynote Address
by
Moses D Pelaelo
Governor, Bank of Botswana
November 2, 2017
Introduction
It is indeed an honour and pleasure to have the opportunity to
speak to this gathering this morning. I wish to start by thanking
the organisers and, in particular, the Chairman, former Deputy
Governor at the Bank of Botswana, Mr Oduetse Motshidisi, for
the invitation to this Conference held in this beautiful city of
Cape Town.
As many of you would be aware, while it is true that the primary
mandate of any central bank is price stability, Governors have a
myriad of responsibilities on a daily basis. Beyond the pre-
occupation with the core mandate of monetary and financial
stability, many central banks, including my own, the Bank of
Botswana, have responsibility for the regulation and supervi-
sion of the banking sector; promotion of an efficient payments
system; currency management; and, also, the management of
foreign exchange reserves, as well as the closely related roles
of economic and financial adviser to Government. Equally im-
portant are considerations such as broader financial sector de-
velopment issues including financial inclusion, consumer pro-
tection and financial literacy. My comments today will reflect
these mixed perspectives.
This Conference is being held in the shadow of the tenth anni-
versary of the onset of the Global Financial Crisis and subse-
quent "Great Recession". Unsurprisingly, the causes and les-
sons of the Crisis have been a major topic of discussion in re-
cent months. This meeting is, therefore, taking place at possibly
the most opportune time in the history of global finance. In the
aftermath of this difficult episode, the world should come out
the wiser.
At its recent meeting in Berlin, Germany, the Financial Stability
Board Plenary observed that the international post-crisis policy
reform agenda was nearly complete and that, going forward,
the priority will be placed on monitoring and publicly reporting
on its 24 member jurisdictions' implementation of the agreed re-
forms. Similarly, the recently-concluded annual Meetings of the
IMF and World Bank Group noted signs of sustained global re-
covery, albeit not yet complete, with below-target inflation and
weak wage growth in several advanced countries, while output
growth remains below potential in many cases.
At the same time, it is important not to lose sight of some
megatrends, in demography and technology, for example, that
also have a profound impact on economic developments and,
more specifically, global and domestic financial markets. In this
regard, I note that 2017 is also the tenth anniversary of the iPh-
one, and we all know the profound impact of that development.
What I wish to emphasise here is not only the importance of
technological progress, but also the inherent unpredictability
associated with such developments. I am informed that when
the iPhone was introduced it was envisaged as little more than
a combination of the mobile phone and the iPod, with a camera
added. As a reflection of the random path of technological de-
velopments, the world of apps on which we increasingly de-
pend was not central to the original concept. Also, among to-
day's generation of "new ideas", it seems to be the potential
impact of blockchain or Distributed Ledger Technology that is
attracting most attention. However, as the example of the iPh-
one demonstrates, the future path of its development is far from
clear.
The coincidence of these two tenth anniversaries is of particular
relevance for global financial markets. The vulnerabilities ex-
posed by the Crisis, and the responses they engendered, must
be viewed in the context of dynamic developments in infor-
mation technology. This is in terms of both emerging opportuni-
ties and accompanying threats. Here, Distributed Ledger Tech-
nology is a prominent example, not least because the technol-
ogy has become intertwined with the controversial issue of
cryptocurrencies. This is unfortunate, given that central banks
and regulators, rightly in my view, are increasingly circumspect
about digital currencies. It would be regrettable, however, if
this stifled development of the underlying technology. Distribut-
ed Ledger Technology has already demonstrated sufficient po-
tential, albeit still lacking in maturity, as the basis for more se-
cure and efficient payments systems to attract the interest of
several central banks.
Another matter of serious concern in today's financial world and
markets is cybercrime. Cybercrime is not the focus for this dis-
cussion; it is, however, a major challenge of the modern age
and should never be far from our thoughts. I would like to take
this opportunity to appeal for concerted cooperative and collec-
tive action in meeting this challenge. In this respect, it is wel-
come that more than 70 percent of members of the Financial
Stability Board intend to introduce new initiatives to boost cyber
security in the coming year. It is to be hoped that others will fol-
low their example.
Distinguished Ladies and Gentleman, I now wish to focus my
remarks on three broad areas. First, a brief look at the domes-
tic economy of Botswana, including the capacity to generate
external foreign exchange reserves. This will highlight the
growth of the domestic financial sector and the impact of the
global financial crisis on the economy.
Second, from the global perspective, I will consider recent de-
velopments in financial markets and the associated policy chal-
lenges; in particular, the extended period of low yields together
with heightened risks, including geopolitical risks. Again, this
has major implications for effective asset/liability management.
Before concluding, I will give some consideration to the emerg-
ing challenges, where the increasingly optimistic outlook for the
global economy has encouraged talk of policy "normalisation".
The Botswana Economy
In the five decades since Independence, in 1966, Botswana's
economy has grown rapidly, from one of the poorest in the
world to an upper-middle-income country with a per capita in-
come of approximately seven thousand US dollars. Central to
this growth has been relatively strong institutions and govern-
ance, healthy fiscal position and external balance sheet, low
public debt burden and the prudent management of mineral
revenues. From the mid-eighties, persistent twin fiscal and
balance of payments surpluses led to rapid growth of foreign
exchange reserves that, at their peak, were equivalent to al-
most three years of import cover. In turn, this allowed the au-
thorities to move relatively quickly to open the economy, includ-
ing the abolition of foreign exchange controls by 1999. Since
2001, both S&P Global Ratings and Moody's Investors Service
have consistently assigned Botswana the highest, investment
grade, sovereign ratings in Africa. On October 27, 2017, S&P
Global Ratings affirmed the country's ratings of A-/A-2 for
short- and long-term foreign and domestic-currency denomi-
nated debt, while revising the outlook from negative to stable.
The revision of the outlook is significant as it reflects expected
stable economic growth at a time when many Sub-Saharan Af-
rican countries face relatively weak growth and shrinking fiscal
space.
This has been a remarkably resilient development model, in
combination with the Government's consistently prudent ap-
proach to fiscal management and sustainable budgeting. How-
ever, beginning in the 2000s and, in particular, since the global
financial crisis, the twin surpluses have not been so reliable,
with recurring fiscal and external deficits. This has implications
for the management of the Government's net asset position, in-
cluding balancing options for taking on more public debt vis-à-
vis drawing on the accumulated national savings.
The structural transformation of the economy is also an im-
portant consideration. In the past, the model whereby foreign
exchange reserves were held pending opportunities for their
productive deployment in funding public infrastructure was
clearly appropriate. But now, with relatively low returns on such
investments, the holding of financial reserves as a sustainable
source of income for both current and future generations is in-
creasingly important.
The financial sector, too, has expanded rapidly, both in size
and the range of services. In 2016, the financial and business
services sector accounted for 13.6 percent of GDP, dwarfing
most other non-mining private sector activity; for example,
manufacturing accounted for only 5.2 percent. Over the past
ten years, cumulative growth of the financial sector, in real
terms, has been almost exactly 100 percent, compared to 52
percent for the economy as a whole. A major driving force in
this development has been the rapid growth of the domestic
pension fund industry. In the early 2000s, the Government took
a decision to effectively privatise a large portion of the foreign
exchange reserves through the establishment of a defined con-
tribution pension fund scheme for the public service.
Despite its openness, the impact of the global financial crisis on
the Botswana economy was relatively mild. The main negative
shock was to the mining sector, but the transmission to the rest
of the economy was muted, helped by government drawing on
its financial savings to maintain public spending. For the finan-
cial sector, the predominantly "plain vanilla" characteristics and
limited international linkages provided a shield against the
worst effects, buttressed further by effective regulation and
prudential supervision.
There is no room for complacency, however, as the intercon-
nectedness of Africa with global financial markets continues to
develop, encouraged by the search for yield and ample market
liquidity resulting from an extended period of ultra-loose mone-
tary policy. More generally, for the "Africa Rising" narrative to
regain the much-needed momentum requires sustained recov-
ery in global commodities markets. At the same time, increas-
ingly stringent global regulatory requirements, especially on
market conduct and financial crimes, notably the anti-money
laundering and combatting of the financing of terrorism re-
gimes, have created challenges. In this regard, a number of
countries in the region have been subjected to enhanced due
diligence by correspondent banks and, in general, negative
perceptions among counterparties towards doing business with
African banks. In response to the latter, it is clearly necessary
for countries to do everything in their power to ensure that the
Know Your Customer, and the Anti-Money Laundering and
Combatting of the Financing of Terrorism regulations in their ju-
risdictions are of the highest possible standards. Adoption and
effective implementation of such standards is also supportive of
development of the regional markets.
Developments in Global Markets and Economic Policy Un-
certainty
The extended low interest rate environment, resulting in mea-
gre returns on international investments, was in large part the
consequence of central banks' use of "unconventional" policies,
such as quantitative easing and negative interest rates. But a
long-term trend decline in the "neutral" rate of interest that bal-
ances economic activity also appears to have contributed.
The resulting "search for yield" has driven important develop-
ments in the asset management industry. Traditionally con-
servative funds (including those under the custody of central
banks) have had to face up to the need to balance a cautious
approach to taking on more risk with moving away from comfort
zones based on high-quality fixed income debt instruments and
listed equities in liquid major markets. In such circumstances,
the traditional guiding mantra of "safety, liquidity, return" needs
recalibration in order to retain its operational relevance.
It appears that the greatest challenge has been to balance the
increasingly positive signs of global economic recovery, with
uncertainty driven by geopolitical event risks. It is perhaps
tempting to suggest that this has receded somewhat after a se-
ries of elections across Europe where the rise of populist par-
ties appeared to have been halted, if not fully rebuffed. This
may be too optimistic, however, as indicated by the recent Aus-
trian elections or, perhaps, the unfolding consequences of
events in Spain; the direction of Brexit or the Trump administra-
tion are also still very much unknown. The cumulative chances
of a highly-unpleasant surprise from further "Black Swan"
events are surely not negligible. The question would be how do
investors position themselves against these risks?
Looking more closely at equities markets, in particular in the
United States, there could be a legitimate concern that the cur-
rent optimism is bordering on irrational exuberance shutting out
evident political risk. It is of course not difficult to cite plausible
reasons why equities markets should be buoyant: earnings
growth, good exposure to emerging markets, low bond market
yields and the prospects of tax reform, among others. However,
on their own, these factors do not seem to justify market valua-
tions where cyclically adjusted price-to-earnings ratios are at
levels that fall short only of the peaks before the dotcom bubble
burst in 2000 and the Great Crash in 1929.
Interest in the next market crash has been heightened by an-
other recent anniversary: Black Monday, on October 19, 1987.
Technological developments over the intervening years are,
once again, a key factor and a cause for both concern and
comfort. For example, there is uncertainty about how markets
increasingly driven by passive funds would respond in times of
stress. When investors are increasingly hard-wired into follow-
ing the herd, the risk of herd-mentality sweeping the markets is
likely to be amplified. On the other hand, it can be reasonably
argued that improved information flows, increased diversity of
investors and interconnectedness of global markets will help
prevent market drift and misalignment leading to a crash.
Overall, we simply do not know the likely balance of risks.
In terms of major developments in recent years that impact on
financial markets, I cannot fail to note the relentless rise of Chi-
na, now surely a major global player, and with the power of the
current leadership amply demonstrated at the just-ended con-
gress of the ruling Communist Party. Beyond the raw strength
of the world's second largest economy, with its growth still
close to 7 percent per annum, China is the technological leader
in key emerging fields such as cashless payments. On the
other hand, risks remain pronounced, reflecting issues of trans-
parency, the challenging transition to a consumption-led econ-
omy based on inclusive growth and its financial system.
Its emerging status as both a source of and destination for in-
vestment is also well known. But China remains something of
an enigma to investors, who must aim to chart a prudent path
between the opportunities and challenges. Moreover, with its
currency now included in the Special Drawing Rights of the
IMF, and as Renminbi assets increasingly gain acceptance as
part of mainstream benchmark indices, this is a challenge that
is increasingly difficult to avoid.
The Emerging Challenges of "Policy" Normalisation
As I mentioned earlier, the recent IMF and World Bank Annual
Meetings noted improved global growth, spread broadly over
both developed and emerging economies, as well as reduced
market turbulence. Importantly, growth in world trade has also
resumed after a period of stagnation. Moreover, it was pleas-
ing that this optimism was tempered by realism, including warn-
ings of continuing underlying risk from several quarters. Equal-
ly important was the call to use this window of opportunity, of
the relatively benign prevailing conditions, to "fix the roof", in-
cluding undertaking the much-needed structural reforms. In
particular, in many countries debt remains at worrying high lev-
els, with potentially negative consequences for continued finan-
cial stability. Nonetheless, this "recovery" phase poses a new
range of challenges to policymakers, with significant implica-
tions for developments in the global financial markets. Here I
shall briefly mention a few.
First, what will constitute the new normal for monetary policy is
far from obvious. Recent pronouncements by leading central
bankers have hardly provided much light in this respect, reflect-
ing, in part, the fear that clarity will result in further market "tan-
trums". More fundamentally, although I would stop short at la-
belling this, like the Financial Times, a "crisis of confidence" for
central banks, there is a need for a frank discussion on the ro-
bustness of the models used to guide monetary policy deci-
sions. In particular, whether the long-standing reliance on the
Philips Curve paradigm is still justified; but also the need to ef-
fectively integrate financial indicators into the modeling pro-
cess.
Second, the role of fiscal policy requires careful consideration.
At least with hindsight, it does seem that there is a strong case
that the retreat to unswerving fiscal austerity added to the
negative impact of the 2007-08 global crisis. However, the un-
derlying reasons for fiscal caution still resonate. This dilemma
was well summarised in the recent communique from the IMF,
which noted that "Fiscal policy should be used flexibly and be
growth-friendly, while enhancing resilience, avoiding pro-
cyclicality, and ensuring that public debt as a share of Gross
Domestic Product is on a sustainable path". This is a tricky
combination of requirements to meet simultaneously.
In terms of major policy issues, the need for financial sector re-
forms and smart regulation is also significant. At the epicentre
of the global financial crisis were deregulation, weaknesses in
banking system governance structures and erosion of fiduciary
responsibility and trust. The lesson to be learned, in this re-
gard, is that strong micro-foundations of a financial system, es-
pecially banks, are of crucial importance at both national and
international levels. That is why, for example, the Financial
Stability Board was established; banking supervisory and regu-
latory regimes strengthened in many jurisdictions; and capital
adequacy and liquidity requirements extensively reviewed. But,
as I indicated earlier, the Financial Stability Board recognises
that, while the policy design is nearly complete and the new
rule books are in place, this is not sufficient. Hence, it is nec-
essary to now turn towards effective implementation. In the
context of an integrated and globalised financial system, this
requires effective coordination, collaboration and communica-
tion, not only among the 24 member jurisdictions of the Finan-
cial Stability Board, but also by including more effectively coun-
tries such as ours in Sub-Saharan Africa. For example, the un-
intended consequences of the global reform agenda, such as
the global de-risking and withdrawal of correspondent banking
relationships, requires urgent attention. I should mention that, in
my capacity as Co-Chairperson of the Financial Stability Board
Regional Consultative Group for Sub-Saharan Africa, I hope to
have greater focus on these issues.
Conclusion
Distinguished Ladies and Gentlemen, in concluding, I remind
you that the saying "may you live in interesting times" is reput-
edly an old Chinese curse. To the extent that the past decade
has certainly been "interesting", the continued challenge to pol-
icymakers is to make life at least a little bit boring, while not re-
peating the mistakes of the past.
On a more positive note, despite the recent pushback by the
supporters of economic nationalism, the fundamental driving
forces of globalisation are not reversible. Nor is it desirable that
they should be, given the extent to which they have contributed
to global poverty reduction. However, the globalised economy
is a source of not just tremendous opportunities, even for con-
servative investors, but additional risks and associated costs of
mitigation. These include the potential for various levels of con-
tagion, as indicated by both the experience of the global finan-
cial crisis and the rise of cybercrime which, as I indicated my
remarks, is an increasingly global phenomenon. No central
bank Governor, wealth or fund manager can afford to act as if
they are immune from such risks.
Distinguished Ladies and Gentlemen, I thank you for your kind
attention.