expenditure, fiscal balance, debt-to-GDP ratio, debt service profile, etc—will then be assessed against the operational sustainability conditions described above. An increasing debt ratio is generally regarded as a cause for concern, because it is typically accompanied by a deterioration in key macroeconomic indicators (i.e., widening fiscal deficits, rising inflation, falling reserves, etc.) and will require policy adjustments sometime in the future.

Medium-term projection for Botswana poses significant challenges. First, there are considerable uncertainties about the prospects of diamonds (prices, recovery of demand, lifespan of the mine, profitability, etc.) and future of the SACU revenue sharing arrangement. There are also uncertainties regarding the non-mining private sector’s response to reduced government spending. Second, detailed and reliable information is often limited with regard to the fiscal account, especially government expenditures by economic classification, debt and guarantees, all of which influence the quality of the projection.

In order to address these problems, sensitivity analysis will be performed by varying key assumptions, such as diamond sector performance, non-mining GDP growth, exchange rate and cost of borrowing, thereby assessing the robustness of the baseline results. The sensitivity analysis can also be interpreted as introducing uncertainties into the deterministic framework. Alternative scenarios that incorporate different policy strategies will be examined in the following section.

Fiscal sustainability analysis for Botswana considers only central government operations. Where information is available, contingent liabilities, such as debt that is explicitly guaranteed by the central government, are included in the analysis. In the absence of information, we do not incorporate quasifiscal operations other than the revenue impact of the central bank’s sterilization operation. The interest expenses associated with sterilization is captured in the budget as transfers from the BoB, which derive from the investment return on the fiscal savings as well as the BoB’s net income (which includes the cost of sterilization).<sup>17</sup> The projection period adopted in this paper is 20 years, with 2010/11 as a starting year. While mediumterm scenarios generally consider a time horizon of 5-10 years, the prospect of a significant change in Botswana’s economic conditions argues for an extended projection period. This will allow policymakers to identify potential future problems and prepare an appropriate policy strategy well in advance, although projections of more distant years are less precise and subject to greater uncertainties.

# **3.2.1 Medium-term Fiscal Projections:  Baseline Scenario**

# **_Macroeconomic Assumptions_**

For Botswana, the backbone of the macro-fiscal framework is the diamond sector’s performance. The diamond sector is assumed to make a decent recovery in 2010/11, after a sharp contraction in 2009/10. Following NDP10, a full recovery of the sector is then assumed to take place over 2011/12—2013/14.<sup>18</sup> Once diamond output returns to the pre-crisis level in 2013/14, thereafter mining sector growth is assumed to plateau because of the base effect. The production profile and real profit per carat of

> problematic for Botswana given the relatively limited availability of macro- and microeconomic data for the identification and estimation of parameters with reasonable precisions.

> 17 The stock of Bank of Botswana Certificates (BoBCs) is not included in the projection of medium-/long-term government domestic debt, due to difficulties in projecting the magnitude of sterilization.

> 18 While the assumption on the diamond sector recovery is in line with NDP10, the growth rates assumed in this paper are somewhat different, taking into account more recent developments since the finalization of the Plan. Specifically, we assume a smaller bounce-back of diamond sector growth, because the actual decline in diamond output in 2009/10 was much smaller than envisaged in NDP10.

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