Dr. Matsheka’s headache …tough times ahead for Botswana

As the National Development Plan 11 (NDP11) comes to an end, the new Minister of Finance and Economic Development Dr Thapelo Matsheka shudders to note that diamond production has stagnated and will no longer bring much revenue for the state. At the same time, economic diversification is but a pipe-dream, foreign direct investment is almost an illusion, the country’s foreign reserves are declining and are much less capable of providing a buffer against external shocks, while the national budget deficit is burgeoning. These headwinds have combined to thrust Dr. Matsheka, a neophyte on Government Enclave, between a rock and a hard place in the drought-stricken dust bowl that is the Republic of Botswana. Staff Writer KEABETSWE NEWEL reports

As the new broom at the country’s most crucial Ministry, Dr Thapelo Matsheka comes at a time when government coffers do not have much to give, putting the minister in a tight corner. A government document titled “Mid-Term Review of National Development Plan 11” authored by Dr. Matsheka’s ministry on 20 November 2018 paints a gloomy picture of Botswana’s economic progress and financial headway.

According to the ministry, diamonds have been central to Botswana’s economy as the largest contributor to GDP, export earnings and government revenues. However, it says Botswana is now a mature diamond producer – having been doing so for almost 50 years – which means that diamonds are no longer a major driver of growth, although they continue to play an essential role in providing the foundation for the economy, government spending and balance of payments.

What the ministry fears is that domestically, the maturing of diamond mining poses challenges in that production is at a plateau rather than growing while costs of production are increasing as mines get older and deeper. In the global context, the ministry must also contend with the fact that due to the global financial crisis (GFC) and recession of 2008/9, diamond prices have been volatile and on a general downward trend in contrast to the historical experience whereby diamond prices were expected to trend upwards. “The relationship between rough and polished diamond prices has also changed, leading to squeezed margins and instability amongst mid-stream participants (diamond traders, cutters and polishers),” reads the document.

Other key changes involve the availability of finance and the nature of the consumer and consumer tastes. Perhaps most significantly, the finance ministry says the entry of low-cost lab-grown diamonds (LGDs), otherwise known as synthetic diamonds, has transformed the supply-side and undermined the rarity of (natural) diamonds. But diamond mining still remains an important driver of economic growth, the largest single contributor to government revenues in most years and the source of 80 percent of goods export earnings. After a very poor year in 2015 and strong recovery in 2016, rough diamond sales through De Beers Global Sightholder Sales (DBGSS) in Gaborone declined slightly in 2017 and 2018 and fell even more in 2019. The market for small, low value diamonds has been particularly weak, due in part to competition from synthetic diamonds. Restricted bank financing in India – the main destination for rough diamonds for cutting and polishing – has also caused some market instability

Since 2010/11, diamond prices have experienced a seven-year downward trend, according to the ministry, increasing volatility, while the margin between rough and polished prices has narrowed, making cutting and polishing less profitable. As in any mature mining sector, Dr Matsheka’s ministry is worried by depletion of mineral reserves and rising production costs as mines get older and deeper. The ministry says open pit diamond mining has come to an end at Letlhakane and that large investments are required to widen and deepen open pits at Orapa and Jwaneng. De Beers said about P100 billion will be invested in Jwaneng and Orapa mine expansions.

“This will prolong the mines’ lifespan and hence lead to mineral revenues being received over a longer period,” says the finance ministry’s document. “However, payments to government will be reduced in the short term as the capital investments required are largely funded out of Debswana’s internally generated funds and these have a bearing on dividends and taxes due to government. In addition, the combination of rising mining costs and decreasing prices in real terms means that profitability and, therefore, payments to government are squeezed further.”

Diamond production in recent years has been in the range of 20 to 25 million carats (mcts) per annum, much lower than the peak production of over 34 mcts in 2006. The finance ministry says this is one reason for the reduced contribution of mining to GDP and also explains why mining has not been a significant contributor to economic growth over the past decade. The ministry further says that diversifying the economy to reduce the high level of dependence on mining has long been a central objective of NDPs but little has been achieved in this regard. Government wanted a shift towards growth led by the non-mining private sector with less reliance on mining (and government). To some extent, the ministry says there has been some success.

“In 2018, for example, the share of the non-mining private sector in value added (GDP at basic prices ) rose to 66 percent, compared to 63 percent in 2015 and around 50 percent in the late 1990s. One striking outcome of diversification is that mining is no longer the largest sector of the economy. Since 2017, the Trade, Hotels & Restaurants sector has been larger,” says the ministry document.

However, the ministry is aware of the fact that diversification of GDP is not in itself sufficient for sustainable growth and for the achievement of NDP and Vision 2036 objectives; the level of growth is also important. It says successful diversification requires an economic growth rate that is high enough to generate sufficient jobs to help address unemployment, raise household incomes and reduce poverty. “This has not yet been achieved, and achieving a higher rate of job creation remains a major challenge. A further issue is that the sectoral structure of diversified growth matters: as NDP 11 makes clear, an important economic objective is export-led growth. If growth is led by sectors serving the domestic economy, it will not be sustainable in the long term, as the economy and population of Botswana is too small to provide an adequate market and enable firms to benefit from economies of scale,” the ministry states.

But this is not to negate the fact that the economy will always need imports and must be able to pay for them with foreign exchange earnings. Further, the finance ministry says increasing the level of exports and diversifying the composition of exports is of crucial importance in sustainable future growth. It notes that diamond exports are unlikely to show significant growth and are becoming more volatile, making it essential that other exports are developed, including other minerals, manufactured goods and services. “While there have been efforts to promote exports, the success of this strategy has been limited. In 2018, diamonds accounted for 72 percent of total exports of goods and services, including both rough and polished diamonds but excluding re-exports. Most other categories of exports (other minerals and manufacture goods) remain small, although there have been some success stories,” says the document.

According to Dr. Matsheka’s ministry, export growth and has not kept up with the growth of the economy more generally. It further states that non-diamond exports have been growing more slowly than GDP (or non-mining GDP) as a whole, and therefore the objective of export-led growth remains critical. This in turn indicates that Botswana has a competitiveness challenge that needs to be addressed as a matter of urgency.
The ministry says this trend of slow export growth shows up in the balance of payments. It says while the trade balance (exports minus imports) has been positive in recent years after several years of balance of trade deficits during and after the global financial crisis, the size of recent surpluses has been much smaller than they were during the early 2000s. The overall balance of payments has been in deficit for most of the past decade. Partly as a result of this, the nation’s foreign exchange reserves relative to GDP have been declining steadily.

For the past four fiscal periods, budget deficits have piled up to over P17 billion and were partly financed by a drawdown on foreign reserves. As at September 2019, the Pula Fund, Botswana’s sovereign wealth Fund, was at P55 billion, a major decline from the P61 billion seen in September 2018. If budget deficits persist, Dr. Matsheka will continue with drawdowns on foreign reserves, just like his predecessor Kenneth Matambo. Besides the trade surplus, another contributor to the balance of payments is foreign direct investment (FDI) which the Ministry of Finance worries remains an illusion. “Inflows of FDI have slowed to a trickle in recent years; they have declined to less than 1 percent of GDP in 2016-18, compared to inflows of consistently over 4 percent of GDP during the 2000s. This illustrates the need to address competitiveness issues and to make further improvements in the attractiveness of the business and economic environment,” the ministry says.

The foreign exchange reserves represent one of the nation’s two key financial buffers that enable Botswana to withstand macro-economic shocks (the other being the Government Investment Account at the Bank of Botswana). Total foreign exchange reserves have been declining in monetary terms and were P71.4 billion at the end of 2018, down from a peak of P84.9 billion at the end of 2015.

However, the Ministry of Finance says it is more meaningful to measure the size of the reserves in relation to the size of the economy or the level of imports. At the end of 2018, the reserves amounted to 38 percent of GDP, compared to a peak of 128 percent of GDP at the end of 2001. They have experienced a general downward trend since the global financial and economic crisis. Hence the reserves are now less capable of providing a buffer against external shocks (to the balance of payments) than they were in the past, according to the Ministry of Finance.