As the world evolves and the pace at which life moves continues to accelerate, it is our responsibility as a banking partner to help our clients navigate this ever-changing complex environment that we live in.
Over the course of the last century, the world has become more integrated and inter-dependent, as reflected by increasing levels of international trade and the migration of people seeking better opportunities and living standards shaping destinies and nations alike.
Further, technology and innovation are constantly reshaping the world we live in and how we live in this global marketplace. Socio-economic dynamics are calling for a new world order, a cleaner, safer, freer world that is more tolerant and accepting of a diverse spectrum of people and cultures. This is the world we live in. In a highly adaptable ever-changing world, you need a banking partner to help you steer the course and traverse unchartered territories. Bank of #TheChangeables.
Over the last two decades, global markets have been characterised by uncertainty and increasing volatility, from the financial crisis (2008-2009), Brexit (2016), COVID-19 (2019-2022) to the invasion of Ukraine by Russia (2022). The ability to predict the future, let alone the outcome of tomorrow, has never been more elusive and happenstance. As global leaders and central banks the world over tackle the issue of rising global inflation, coupled with corporates seeking to address supply chain interruptions and logistical challenges, it has become increasingly more difficult to charter a course and navigate global markets.
Given this backdrop, where do we as Batswana find ourselves in the broader spectrum of global economics? As a renowned diamond exporting nation – the largest diamond exporter in the world by value – Botswana is strongly impacted by global events far beyond our reach and influence. Augment this with the reality that we import 70 percent of all goods and services, despite our best efforts to become more self-sufficient, we find ourselves managing a currency very closely linked to one of the world’s most volatile emerging market currencies, the South African Rand.
Botswana’s exchange rate regime is managed crawling peg linked 45 percent to the South African Rand, a reduction of 5 percent from 50 percent in 2017 when the Bank of Botswana adjusted the peg, and 55 percent to the International Monetary Fund (IMF) Special Drawings Rights (SDR). The SDR is a basket of currencies that are considered to be the official unit of account of the IMF. The currencies in the basket are weighted as follows: 42 percent US Dollar, 31 percent Euro, 11 percent Chinese Renminbi, 8 percent Japanese Yen and 8 percent Pound Sterling.
The adoption of this exchange rate policy allows Botswana to introduce discrete step-like adjustments to the exchange rate based on a predetermined formula. The structure of the peg reflects the relationships with our key trading partners, both from an import and export perspective and notwithstanding the 45:55 spilt between the Rand and the IMF SDR, the single most influential driver of the Pula exchange rate is the free-floating South African Rand.
According to the RMB Botswana Research Desk, approximately 80 percent of the fluctuations in USD/BWP, along with movements of the Pula against other major currencies, can be attributed to movements in USD/ZAR. How then do we respond to an ever-changing environment, with new risks unfolding almost on a daily ? The future cannot be predicated but one can work towards creating stability and predictability in cash flows. The first step in this endeavour is setting a budget foreign exchange (FX) rate – a conservative approach taking into consideration historic exchange rates but also a measured view of future forecasted rates based on currency fair values.
Once a budget foreign exchange rate has been established, the question at hand becomes what risk management strategy does one adopt? Your options include:
- Do nothing. Enter into the spot market and execute foreign exchange trades at the prevailing market levels. The risk presented by this approach is that one is at the mercy of the markets, opening up opportunities for both FX gains and losses. However, there is no certainty and no predictability under this scenario.
- The alternative is to enter into a risk management strategy. This may include entering into forward exchange contracts, synthetic forwards or derivative instruments. The purpose of these instruments is not to second-guess the market or derive FX gains but, rather, to create certainty and predictability in one’s cashflows. Once the market arrives at an exchange rate that aligns with one’s budget rate, it presents the opportune moment to enter into forward exchange contracts. The duration of the contract is dependent on factors such as risk appetite, liquidity and the actual business requirements.
- When entering risk management strategies, it is always prudent to revisit the strategy on a regular basis to determine the effectiveness thereof and to make adjustments where necessary.
- A balanced approach that facilitates exposure to market volatility and potential upside is also worth considering, if the view held is that the market will move in one’s favour. In these instances, it may be appropriate to acquire forward cover for a portion of the requirement, say 50 percent of the total requirement. This approach exposes the balance of the requirement to fluctuations in the currency pair.
- Fundamentally, the journey to navigating global markets starts with one’s own assessment of the budget rate. Thereafter the question remains whether or not to enter into an FX risk management strategy that aligns with the business’s risk appetite and requirements.
At RMB Botswana we pride ourselves in understanding our client’s businesses with a view to help them craft risk management strategies that align with their needs. Our world-class research desk provides in-depth research across assets classes, sub-Saharan markets and our leading economists are readily available to unpack market events in one-on-one engagements. Ours is to partner with you and your business as we navigate unchartered territories and the ever-changing global markets, to provide innovative solutions that speak to your values as well as ours, in the true spirit of traditional values and innovative ideas.