linah k mohohlo : 2003 monetary policy statement statement by mrs linah k mohohlo, governor of the bank of botswana, gaborone, 25 february 2003. * * * introduction i am privileged and honoured to welcome you to this important event in the calendar of the bank - the presentation of the monetary policy statement for 2003. let me begin by refreshing memories on the objective and content of the monetary policy statement, which the bank of botswana issues every year. the statement serves several purposes. first, it provides an opportunity for the bank to report on inflation and monetary policy developments in the previous year, and to present its assessment of the outlook for inflation in the current year. second, it enables the bank to outline policy issues and the approach that will be taken in formulating its policy stance in response to inflation - related developments throughout the year. third, the monetary policy statement contains, certainly since last year, the bank ’ s annual objectives for inflation and credit growth, and an explanation of how these are derived. the statement, therefore, plays an important role in conveying to stakeholders and the public at large a range of information relating to one of the bank ’ s core functions - the formulation and implementation of monetary policy. while the transparency entailed in the presentation of the monetary policy statement is important in its own right, it is also important in influencing economic and financial expectations, as well as the behaviour of economic agents. the bank ’ s aim is to engender a public expectation of sustainable low inflation consistent with the broad objective of macroeconomic balance as a basis for sustainable growth. in addition, the statement serves as a vehicle for enhancing the accountability of the bank to its stakeholders. in my remarks this evening, i will present only the main highlights of the full text of the 2003 monetary policy statement. it is important, therefore, that you take the time to read the full text of the statement, so you can obtain a more detailed analysis of monetary policy developments. i will briefly review the behaviour of inflation in 2002 and its underlying causes, before assessing the extent to which monetary policy succeeded in achieving its objectives in 2002. i will then outline the bank ’ s view of prospective economic and financial developments in 2003 and, on the basis of that assessment, the policy outlook for the current year. the bank ’ s monetary policy framework and objectives i believe you are aware that the principal objective of monetary policy in botswana, as it is for most central banks around the world

changes. in a market - based economy such as botswana ’ s, monetary policy influences inflation indirectly through its effect on interest rate changes, which then influence credit as a key means of financing expenditure on both consumption and investment. the effectiveness of interest rates in controlling credit is monitored closely. the bank also recognises that the rate of growth of government spending is an important component of domestic demand, since the government allocates large amounts of funds to finance public consumption and investment. the fact that the government plays a large role in the economy underscores the need for complementarity between fiscal and monetary policies in achieving the inflation objective. this is the policy framework that provides a backdrop to the bank ’ s assessment of the economic and financial environment over the past year, in which inflation or price developments took place. developments in inflation in 2002 as you will no doubt recall, the monetary policy statement for 2002 set an inflation objective range of 4 - 6 percent. in setting this objective, the bank was aware that headline inflation would be influenced by a number of transitory factors, especially the introduction of the 10 percent value added tax ( vat ) in july 2002. before the introduction of vat, annual headline inflation stabilised at around 6 percent during most of the first half of 2002. however, following the introduction of vat, and as you will recall, inflation started rising, and increased from 5. 9 percent in june 2002 to just over 11 percent by the end of the year. the bank had anticipated a temporary increase in headline inflation arising from the introduction of vat, of between 4 percent and 6 percent over and above underlying inflation. this prospect was conveyed in a press release in june 2002. it was pointed out, at the time, that the vat - related price increases would be a one - off temporary adjustment and that, in the absence of any significant second - round price effects, due for instance to compensatory wage increases, the impact of vat would not result in a sustained rise in inflation. in the event, and in line with the bank ’ s expectations, the effect of vat was that the month - on - month rate of change in prices rose from an average of 0. 5 percent over the twelve months to june 2002, to 3. 2 percent a month later in july 2002. thereafter, the monthly rate of price increases progressively slowed down to reach 0. 4 percent in october. the monthly price increase was then higher in november, primarily due to