The Bank of Botswana (BoB) was non-committal during an economic briefing this past week when the Business Weekly & Review asked how high they expect to raise the policy rate given that inflation is expected to remain above the 3-6 percent range prescribed by the central bank for an extended period.
Dr Lesedi Senatla, the Director of the Department of Research & Financial Stability, said the central bank depends on what data says should be done at any particular point in time. “Our policy formulation at the Bank of Botswana is data-driven,” he asserted. “We do scenario analysis. What you need to deal with is persistence.” If people begin to embrace the idea of inflation, as the central bank believes is the case, people also start to increase everything because of that very shock that was supposedly transitional but threatens to be prolonged.
The bank now has a problem on its hands and Dr Senatla is adamant that they have to send a clear message that they are not going to tolerate this inflation. This is why BoB seems to be responding to supply shocks (because of entrenched expectations) through an interest rate hike. However, he did not state a defined target expectation in his response. “We don’t have our minds already made up that we would have the rate this high. If you are just dealing with supply shocks, those wash out of the CPI with time.” In other words, Bank of Botswana is responding to supply driven inflation, as it ought to with demand driven inflation. And it seems it had to.
Fitch Solutions forecast that the Bank of Botswana will hike the monetary policy rate by 150 basis points (bps) to 3.65 percent in the second half of 2022. Fitch expects the BoB’s tightening cycle to spill over into 2023, anticipating the bank to raise the monetary policy rate by another 50bps to 4.15 percent. Headline inflation increased from an average of 1.9 percent in 2020 to 6.7 percent in 2021, according to Dr Senatla’s slides. He explained that the increase in inflation was due to increased levies/taxes, administered prices and associated second-round effects. Headline inflation averaged 10.9 percent in the first six months of 2022 and hit 12.7 percent in June 2022.
RMB, a unit of the FNBB, explained that the acceleration was driven by increases in major components such as transport, food and non-alcoholic beverages, housing, water, electricity, and gas and other fuels. A weaker pula and elevated global energy prices also contributed to higher inflation, RMB added. At its last meeting, the Monetary Policy Committee (MPC) iterated that the current high level of inflation is mainly driven by supply-side factors, which had contributed approximately 6.1 percentage points to the prevailing inflation of May (11.9 percent). At its 16 June 2022 meeting, the MPC raised the rate by 50 bps to 2.15 percent.
This was the second successive rate hike. The MPC held the interest rate at its February meeting but hiked it by 51bps at its April meeting. The increase was motivated by runaway inflation as the central bank sought to show that it is not just watching but doing something about the situation. This had generated heated debate on whether interest rates are the right tool to squash or to arrest inflation driven by fuel and food prices. This publication sought to understand from the central bank whether rate hikes aren’t a rather blunt tool. Are interest rates the right tool?
In addressing the question, Deputy governor Dr Kealeboga Masalila acknowledged that given the sources of inflation, which is supply driven, “MPC cannot deal with those directly”. But he agreed that inflation in general needs to be dealt with decisively. “It is an enemy and adverse to economic growth and welfare,” he admitted. “It perpetuates poverty and inequality.” The Business Weekly & Review had previously asked if the central bank doesn’t think the government should subsidise fuel, transport and food as opposed to resorting to interest rates, which are a rather blunt tool. However, BoB cleverly steered clear of the hot potato. Atleast until government intervened.
Finance minister Peggy Serame on Wednesday announced a reduction in value-added tax (VAT) from 14 percent to 12 percent to combat soaring inflation and help households cope with price increases. The reduction in the VAT will be for six months, starting in August. Cooking oil and gas prices will be zero-rated for VAT over the same period, while allowances for university students at public institutions will be increased by 18.5 percent from September. The government will also give P120 million to the state-owned Botswana Meat Commission (BMC) to assist farmers. The interventions will be reviewed after six months and are expected to cost the government P1.8 billion.
But the reliefs are not expected to have too much of an impact on inflation. Economists see them as just measures that will make it less uncomfortable by limiting significant declines in consumption spending, especially on necessities affected by VAT. Because the inflation pressures are supply-driven, there is very little that consumers can do to protect themselves from price rises. Given that spending on necessities accounts for approximately 70 percent of average household spend, reductions in household consumption could indicate that consumers are likely not able to meet their essential requirements.
Masalila echoed Senatla’s remarks that this current inflation is manifesting in terms of second-round effects due expectations. When fuel prices go up, Masalila said, they are a cost to producers and service providers who are therefore inevitably forced to increase their prices to cover the costs. These include rentals, contracts for construction, wage negotiators, restaurants, to name a few. Masalila said they are looking at the current inflation and therefore also need to increase rentals and wages at least by 12 percent (i.e. expectations). This culminates in actual inflation. In his responses, Masalila iterated that they need to deal with that by policy response and by communication. “Policy response demonstrates that we are focused on price stability and returning inflation to the objective range,” he explained
But he emphasised that any policy response has to be measured and calibrated to what is happening: what you can impact and also considering other unintended consequences. The key phrase he repeatedly emphasised was “well measured and calibrated”, adding that it also has to be well coordinated with other stakeholders. The bank is cautious not to damage growth or, as alluded to by economists, scare demand and production prospects. “We don’t want to do that,” Masalila said.
Analysts have pointed to fears of rising food, fuel and energy prices and rising interest rates leading to significant demand destruction. This in turn adding to worries by economists about slow growth given the confluence of these factors. The debate has been whether financial conditions should not be ameliorated somewhat. Masalila said “even in saying we deal decisively with inflation by using tools at our disposal, we do not at this juncture believe that we are negative on growth by so doing”.
Although rates had been increased by 101 basis points, the bank believes they still remain modest and, in its view, accommodating. “They accommodate productive borrowing as well as investments while at the same time moderating demand that can be inflationary,” Masalila said. In reference to coordination, fiscal policy which is what he said government is doing, “is largely stimulating”. “By definition a budget fiscal deficit says government spending is expansionary and supportive of economic growth,” Masalila pointed out.
In that regard, he also noted that wages, as signaled by the government, have increased by at least 5 percent and “what government does is replicated across the economy”. Therefore, Masalila believes there is that stimulative impact. “The structural transformation policies and agenda are also positive for economic activity. We see this in continuation of infrastructure development, improvement of reticulation of activities, electricity and water. These are growth supporting.” The other one is continuation in improving health responses and support for education and skills development.