Stagflation is a theme that had been building traction towards the end of last year. The narrative considered three common indicators: economic growth, inflation and unemployment. Often, economists expect inflation and unemployment to be growing in opposite directions. This is because in a high inflationary environment, there should be increased consumer activity, suggesting the economy being near full production.
But such is not the case for Botswana, the reason being that the inflation is not being driven by demand but is supply side – taxes, levies and tariffs increased at the start of Q2 2021. Rubbing salt into the wounds of Batswana were the fuel price increases, the last of which was effected on 20 December 2021, coupled with a P1.00 increase in public transport fares for both taxis and minibuses. These took January inflation to 10.6 percent.
The immediate backdrop is that inflation is worryingly high, having risen progressively since the second quarter of 2021, Moses Pelaelo, the Governor of the Bank of Botswana said this week during the launch of the Monetary Policy Statement. At this level, he said “there is a risk of self-fulfilling expectations of sustained high inflation as manifested in inflation-indexed contract price adjustments, agitation for higher transport fares, negotiations for wage and salary increases, a rise in house rentals and general price increases for goods and services”.
Amidst this, Botswana has a real wage growth which contradicts why inflation should be increasing. Government expenditure increased marginally by 0.1 percent in the first 11 months of 2021 compared to a decrease of 0.8 percent in the prior year, according to Pelaelo. “Within this, public sector personal emoluments rose by 4.4 percent,” he noted, adding that demand conditions as indicated by a negative output gap (the difference between actual and potential output for the economy) were modest and non-inflationary.
The elephant in the room is rising unemployment as businesses struggled and used retrenchments as a saving grace. Recent labour force survey results by Statistics Botswana indicated that the unemployment rate in Q4 2021 was 26 percent from 24.5 percent, which Pelaelo says affirms the “below-trend output growth”. Botswana’s fast recovery for the year in 2021, which Econsult economists expect will outpace projections by the finance ministry and the IMF, is attributed to base effects. Growth was coming from a lower base as in the past year GDP growth was negative. Against this background, some economists anticipate that growth will slow down this year. Pelaelo lent credence to this: “The domestic economy is forecast to grow by 4.3 percent in 2022, driven mainly by the continuing recovery of mining activity and improvement in global output,” he said.
Pelaelo’s point of improving mining activity adds to entrenched concerns by observers that without diversification, there is limited economic growth for Botswana, given that the economy is centred on mining. “Concerns over whether or not the improved economic output will translate into job creation and therefore a reduction in unemployment still remain,” Sethunya Kegakgametse and Kitso Mokhurutshe, economists at Econsult, said in a quarterly report recently released. Mining is a significant revenue earner and allows the government the ability to roll out some initiatives, the success of which some argue can lead to a stagflationary environment.
Although economic recovery has been broad-based, Kegakgametse and Mokhurutshe observed that its main driver has been diamond mining and trading sectors which are capital intensive and have a low labour share of income. Statistics Botswana shows that the Wholesale & Retail Trade sector remains the highest employment sector in Botswana, constituting 18.7 percent of the total employed persons. It is followed by Public Administration and Educational sectors with 15.8 and 10.6 percent respectively. Mining and quarrying is listed among the least employers.
Adding to these problems is that although the inflation is pushed by costs, Botswana is in an environment where interest rates are expected to increase, given that the way it is increasing it is a growth inhibitor.
In his speech this week, Pelaelo was quick to point out that the risks to the inflation outcome are skewed to the upside. This, he said, relates to second round effects and expectations: a larger increase in commodity prices (especially energy prices) than currently incorporated in the inflation forecast, particularly emanating from current geopolitical tensions as the talk of a possible war in Europe intensifies, short-term unintended consequences of import restrictions, and persistence of supply and logistical constraints due to lags in production.
“Against these are the downside risks to inflation which include, weaker economic activity than projected, re- emergence of virulent COVID-19 variants (winter months are coming) and resultant restrictions on economic activity, and lower international commodity prices than currently projected,” he said. Without the additional factor of rate hikes, economists who spoke to this publication fear that it would lead to a stagflation environment. Rate hike is even more significant for Botswana because the expectation is that growth will be at a lower rate than last year.
The strange thing is that while the central bank is expected to increase rates to arrest the inflation, a rate hike is usually done against the backdrop of demand side inflation, which is not the case for Botswana. This is because the economy will be overheating and needs to be cooled down. On top of that, observers argue that a rate hike needs to be looked at from an investment point of view. Inflation has skyrocketed to 10.6 percent while the bank rate is at 3.75 percent. This means the real interest rate is widening. The question is, why would anyone invest in Botswana when they can get a better rate of return in other places?
As Pelaelo already mentioned, some central banks, particularly in emerging market economies, increased their policy rates in 2021 responding to the rising inflationary pressures. Moreover, he noted that some central banks in the advanced economies signalled that they would tighten policy rates, going forward, to control inflation and, in some cases, taper the asset purchase programmes introduced in 2020 to support the financial sector. Closer to home, he turned his mind to the South African Reserve Bank which increased the repo rate by 25 basis points to 3.75 percent in 2021 and by another 25 basis points to 4 percent in January this year to counter perceived upside risks to the inflation outlook. The Bank of Namibia also opted to increase interest rates by 25 basis points to 4.0 percent.
Critics argue that it would not make sense why Botswana would stay widening in terms of real interest rate differentials while everyone is trying to narrow. It is all these factors which economists argue might force the Bank of Botswana to start to act soon. But from a central bank’s stand point, they have been hanging back because they think it is transitory. Even though their outlook has increased, economists’ view is that they are waiting to see the dip and gather how much they actually need to respond before they start hiking.