Linah K Mohohlo: 2010 Monetary Policy Statement
Speech by Mrs Linah K Mohohlo, Governor of the Bank of Botswana, at the launch of the
Monetary Policy Statement for 2010, Gaborone, 25 February 2010.
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Once again, it is my pleasure to welcome you to the launch of the Monetary Policy Statement
for 2010. As you are aware, the Statement is the principal means through which the Bank
informs the nation and other stakeholders about the monetary policy framework and its
implementation. This is done in order to foster policy credibility and anchor public
expectations of a low, predictable and sustainable level of inflation. The Statement also
reviews current economic trends; it evaluates policy implementation in the past year, and
attempts to foresee prospective developments that may influence the inflation outlook. In this
way, the validity of the policy framework can be assessed objectively, and the Bank's
consequent policy intentions for the coming year can be appreciated.
You will recall that two years ago, the Bank adopted a new forward-looking monetary policy
framework which rightly expects policy effectiveness in the medium-term. The framework is
based on a model of inflation forecasting which incorporates a wider set of economic
indicators. Indeed, with the benefit of continuous technical refinements, the actual domestic
inflation has broadly been in line with the model projections.
Before I present the Monetary Policy Statement for 2010, I consider it useful to restate the
other core functions of the Bank which, when taken together, provide synergies for monetary
policy, for the promotion and maintenance of monetary stability, and for the efficiency of the
payments system as well as the soundness of the financial sector.
In addition to the formulation and implementation of monetary policy, the regulation and
supervision of banks, is another critical function of the Bank.
The Bank is also responsible for designing, producing and issuing currency, which is a
means of payment for transactions and a store of value. Towards this end, you will recall
that, in August last year, the Bank launched a new family of banknotes to replace those that
had been in use for many years. The banknotes are more fortified against counterfeiting;
they update the country's special characteristics and celebrate our heritage.
Yet another key function of the Bank is the management and investment of the foreign
exchange reserves, which are a major part of the nation's wealth. Due to the global financial
and economic crisis, this particular area of the Bank's responsibilities has recently come
under close scrutiny. I wish to take this opportunity, therefore, to reassure the nation that,
despite the turmoil in major financial and capital markets, the Bank's prudent investment
policy and strategy have served the country well. The purchasing power of the reserves has
been maintained and, despite very low export receipts and the high import bill, the reserves
remain relatively sizeable at approximately USD9 billion (P59 billion), which is equivalent to
20 months of imports of goods and services.
The Bank is also the banker to the Government and commercial banks, for which it serves as
the lender of last resort. In addition, as economic and financial advisor to the Government,
the Bank worked very closely with the authorities throughout the year in addressing the
challenging external and domestic macroeconomic environment.
Honoured Guests:
I now return to the main agenda of this evening, which is the anticipated direction of the Bank's
monetary policy stance during 2010. As I mentioned earlier, the Bank's monetary policy
objective is to achieve price stability, as defined by a sustainable, low and predictable level of
inflation. This objective is set as a medium-term inflation objective range of 3-6 percent. In
order to attain price stability within this parameter, the Bank uses interest rates and open
market operations to affect demand and supply conditions in the economy and ultimately the
rate of price changes.
You will know that low inflation contributes towards the broader national objective of
sustainable economic growth by making saving attractive and investment return predictable,
while fostering international competitiveness of domestic producers. In addition, maintaining
the purchasing power of money by controlling inflation contributes to the welfare of all
economic agents, particularly households.
Apart from interest rates and credit availability, domestic demand and economic activity are
also influenced by other factors, especially fiscal policy as well as trade and exchange rate
developments. Excessive domestic demand in relation to available goods and services
contributes to inflationary pressures; so too do foreign inflation, changes in administered
prices (such as government levies and utility tariffs) and public expectations about the future
level and direction of inflation.
In its application, however, monetary policy responds to a sustained deviation of the inflation
forecast from the objective range in the medium-term. The Bank's responses are based on
an assessment of the factors that impact on inflation, including public expectations which
could, in turn, be influenced by monetary policy. For example, interest rates would be
increased to pre-empt a potential rise in inflation and the consequent erosion of incomes and
financial savings. Conversely, the Bank would reduce interest rates in the event of sustained
low or rapidly falling inflation. In particular, the Bank's reactions are informed by the
performance of the economy in relation to potential output. A sustained level of economic
performance above a production trend or potential tends to be inflationary and could suggest
the need to raise interest rates to dampen inflationary pressures, while economic
performance below output trend could require a reduction of interest rates to stimulate
economic activity. However, this policy response is not mechanical; it takes account of expert
judgement and supplementary analysis in order to accommodate other factors that may not
be fully incorporated in the forecasting model.
At the regular meetings of the Monetary Policy Committee, economic developments and key
indicators of the inflation outlook are monitored and reviewed, so that a timely policy
response can be taken, if necessary. After each Committee meeting, the decisions, the
reasons for those decisions and the inflation outlook are disseminated to the public through
press releases. This approach helps to influence inflation expectations and contributes
towards fostering policy credibility, which is critical in achieving long-term price stability.
Distinguished Ladies & Gentlemen:
It will come as no surprise to you that this year's Monetary Policy Statement is launched in a
substantially different global and domestic macroeconomic environment than was the case
last year. Twelve months ago, I had little good news to report. We had foreseen a difficult
2009 due to the unfolding global economic downturn. Botswana's diamond mines had
temporarily halted production as the full force of the global recession descended on the
country. A substantial portion of my remarks at the time was devoted to assessing the impact
of the crisis on the domestic economy. We saw no end to the economic recession, as
forecasts for global growth were repeatedly revised downwards. As the year progressed,
diamond exports had slowed to a trickle, and impacted negatively on government revenue,
the Balance of Payments and the foreign exchange reserves. In the circumstances, work on
the tenth National Development Plan had to be postponed so that the budget could be
re-worked to ensure the maintenance of long-term fiscal sustainability.
That was then. As we meet today, the picture is considerably more positive, despite
uncertainties and challenges posed by the fragile economic recovery in many parts of the
world, particularly in Portugal, Ireland, Italy, Greece and Spain (the so called PIIGS). The
International Monetary Fund has forecast global output to expand by 3.9 percent this year.
This performance reflects the resilience of key emerging economies, and the impact of the
stimulus packages that were implemented in most advanced economies.
In fact, the challenge for monetary policy makers in major industrial countries is to design
and implement a proper winding down of the stimulus packages that have supported
economic recovery, while avoiding generating inflationary pressures. This process will need
to be gradual and internationally coordinated within a transparent framework.
Be that as it may, it is recognised that low interest rates and large budget deficits are likely to
be maintained during the course of 2010 and beyond. This policy posture is intended to
sustain economic recovery that remains sluggish and fragile; it will also help to reduce the
risk of the so-called "double dip" recession.
Besides the improved world economic growth, global inflation decreased from 6.3 percent in
2008 to 2.7 percent in 2009. In the four SDR countries - United States of America, Euro
zone, Japan and United Kingdom - average inflation was zero. Low inflation was due to a fall
in international commodity prices and subdued demand. The resulting low capacity utilisation
and high unemployment exerted downward pressure on wages and other prices. In other
instances, some developed economies, such as Japan, a fall in prices or deflation is once
more a matter of major policy concern.
The overall trade-weighted average inflation of Botswana's trading partner countries slowed
down from 6.1 percent in 2008 to 4.4 percent in December 2009. In South Africa, inflation
decreased from 9.5 percent in 2008, and ended 2009 at 6.3 percent, just outside the
country's medium term target range of 3-6 percent.
Here at home, inflation progressively fell in 2009 and was within the 3-6 percent objective
range by the middle of the year. In fact, largely due to base effects of earlier price shocks,
inflation reached 5 percent in November 2009, the lowest in decades. Thereafter, inflation
rose largely due to the winding down of the favourable base effects arising from previous fuel
price reductions. By the end of the year, inflation had risen to 5.8 percent, down from
13.7 percent in December 2008, before increasing further to 6.1 percent last month. Both
measures of core inflation (the 16 percent trimmed mean measure and the one derived when
administered prices are excluded) showed similar sharp declines during 2009; this was
additional evidence of the generalised easing of inflationary pressures.
Due to the impact of the global slowdown on demand for diamonds and other minerals, the
lower mining production in the first three quarters of 2009 resulted in overall output
decreasing by 6.7 percent. In contrast, non-mining output rose by 12.4 percent, reflecting the
support extended by the Government's spending programme, which also contributed to
some recovery in business confidence last year.
However, as indicated by significantly low growth rates of commercial bank credit, demand
remained subdued for both businesses and households. Households were also affected by
generally low wage increases, and a salary freeze for civil servants.
Although the annual growth rate of government expenditure slowed significantly in 2009, it
was still higher than initially budgeted. As highlighted in the recent Budget Speech,
government expenditure for fiscal year 2009/10 is projected to grow by 15.5 percent
compared to the original budget growth rate of 5.3 percent, which to a large extent, reflected
the impact of the sizeable supplementary budget that was approved in December 2009.
In order to ease expenditure constraints and finance the larger budget deficit for the fiscal
year 2009/10 that is projected at P13.5 billion or 15.1 percent of GDP, the Government
borrowed from the African Development Bank and World Bank. A further deficit of a similar
magnitude - P12.1 billion or 12.2 percent of GDP - is forecast for the fiscal year 2010/11,
and the Government's objective of restoring fiscal balance, through a combination of robust
revenue growth and rigorous expenditure control, is expected in 2012/13.
Honoured Guests:
I wish to emphasise that, while the large deficits in the current economic environment has
been appropriate unavoidable and, to a certain extent, affordable, it is essential that the fiscal
consolidation required for long-term budget sustainability is achieved going forward. It is
urgent that there is increased vigilance in all aspects of macroeconomic management
including policy reforms, in order to energise the country's performance in a competitive
global environment. This has been underscored by the sovereign credit rating agencies when
they recently announced Botswana's relatively intact sovereign credit ratings for 2009 of
"A minus" for Standard and Poor's and "A" for Moody's Investors Service. More importantly,
despite the marginal downward revision by Standard and Poor's, Botswana's ratings remain
firmly in the Investment Grade, and are still the highest in Africa.
It was, however, against the background of lacklustre economic fundamentals that monetary
policy was conducted in 2009. In light of the positive inflation outlook and low inflation, the
Bank loosened monetary policy throughout the year. The Bank Rate was reduced on five
occasions by a cumulative 5 percentage points to 10 percent, and commercial bank lending
rates were correspondingly reduced. This policy stance complemented the economic
stimulus provided by the Government's expansionary fiscal policy.
Looking ahead, the global economic outlook is projected to improve significantly as more
economies continue to emerge from recession. However, as mentioned earlier, economic
recovery in developed economies is slow and, in most cases, fragile, while concerns about
the build-up of government debt are growing. Furthermore, high unemployment and low
growth in household incomes will contribute to weak demand.
In the circumstances, global inflationary pressures are expected to remain low. However,
there are risks to the inflation outlook due to uncertainty about international oil and commodity
prices that tend to accompany an economic recovery. For this reason, global inflation is
forecast to increase from 2.7 percent in 2009 to 3.8 percent in 2010, while inflation in
SDR countries is expected to increase from zero in 2009 to 1.5 percent this year. In contrast,
South Africa's headline inflation is forecast to fall from 6.3 percent in 2009 to 5.8 percent this
year, in which case it will move towards the inflation target range of 3-6 percent.
In Botswana, expectations are that the exchange rate influence on import prices will be
minimal. The Bank's inflation objective range of 3-6 percent is very close to the forecast
trading partner countries' inflation range of 3-5 percent. This means that the downward crawl
of the nominal effective exchange rate that is required for maintaining a competitive real
effective exchange rate should be small in 2010. Overall, the effect of imported inflation on
domestic inflation transmitted through foreign price increases is also expected to be minimal.
Although the domestic economy is expected to grow in 2010, total output is projected to
remain below trend in the medium-term, due to the lingering effects of the global recession
and the planned cuts in government expenditure. In addition, growth in household disposable
income and, consequently, demand for domestic goods and services, is likely to be sluggish
due to the continuing wage freeze for civil servants, the planned increase in value added tax,
other government levies and utility tariffs. Moreover, the improvement in business confidence
that may have taken place so far due to the increase in government spending, could be
dampened by the planned expenditure cuts.
So far, on the basis of available information, inflation will rise modestly in the short-term,
largely as a result of the increase in value added tax, but it will subsequently stabilise around
the Bank's medium-term objective range of 3-6 percent next year.
Therefore, Honourable Ministers, Distinguished Ladies & Gentlemen, the outlook for inflation
and output suggests a largely neutral monetary policy stance in the medium term. With
prospects for low and stable inflation, and in an environment in which the Government's
contribution to economic activity is constrained by limited revenue, it is of paramount
importance that coordinated and complementary monetary and fiscal policies remain the
order of the day, in the best interest of sustainable economic growth. It should be pointed out
that the projected short-term increase in inflation implies a need to keep inflationary
expectations in check. Needless to add, uncertainties cannot be ruled out. Accordingly,
therefore, as events unfold during the course of the year, the Bank will respond appropriately
and timely to attain price stability and to ensure that inflation remains within the medium-term
objective range of 3-6 percent, without undermining sustainable economic growth.
Distinguished Guests, Ladies & Gentlemen:
This concludes my Statement, and I thank you for your attention. Please enjoy the rest of the
evening.