The tight rope between Pelaelo and Serame

Early in 2019, the world was debating how to figure out a system to get prices elevated in some Western markets. Demand was muted and the world did not really see inflation as a problem. When the COVID-19 pandemic started, the moving rhetoric was that this was going to be transitory. But can transitory inflation be sustained?

Daniel Kavishe, Africa Economist at Rand Merchant Botswana (RMB) observed that massive demand for commodities from China to the rest of the world was triggering improvements in commodity prices. In a period of one year, he watched as Zambia moved from a deficit into a surplus adjustment on the back of higher copper prices. “It had nothing to do with increasing volumes of production,” Kavishe told the throng at the last session of the FNBB annual budget review on Tuesday night this week. Internationally, polished diamond prices continued to increase as well, up 30 percent over the past two years, according to his calculations.

Consolidated rough diamond prices rose by 28 percent, according to the Zimnisky Global Rough Diamond Price Index.

As with other commodity prices, international oil prices remained elevated as demand rebounded globally amid restricted supply. “Inflation will remain above the Bank of Botswana’s objective range of 3 percent to 6 percent as fuel prices rise higher to bridge a lag between international fuel increases and the local fuel increase with an expectation to stabilise later in the year as the economy adjusts to the new normal,” Malebogo Keleapere, Stockbrokers Botswana Research Analyst, wrote in her market outlook.

December 2021 inflation comes in at 8.7 percent, accelerating 0.1 percent from the 8.6 percent registered in November 2021, according to a Kgori Capital quarterly report. The increase was driven by a pickup in food inflation which increased by 0.5 percent to 7.2 percent year-on-year in December. Inflation averaged 6.7 percent in 2021 due to high transport, housing and food inflation which averaged 12.3 percent, 7.7 percent and 6.0 percent respectively, according to Kgori Capital.

“We expect inflation to accelerate further in January 2022 due to the December 2021 ~15 percent increase in pump prices, which appears not to have been factored into December 2021 transport inflation,” Antwi Kwabena, Portfolio Manager at Kgori Capital wrote. “From there we expect inflation to decelerate but continue to trend above the BoB’s objective range until Q3 2022,” he said, expecting average inflation of 6.6 percent in 2022 largely driven by transport and housing.

The Bank of Botswana (BoB) highlighted that inflation risks remain on the upside. The central bank estimates that inflation will hit 10.4 percent in Q1 2022 and average 7 percent this year. The consensus is that inflation will be above target. The Monetary Policy Committee (MPC) increased its inflation expectations as it now expects inflation to fall within its 3-6 percent objective range in Q3 2022 from Q2 2022 previously.

Factors contributing to the revision of the forecast include the following: Domestically, the expected increase in private school fees in the first quarter of 2022 and a possible increase in domestic fuel prices in response to developments in international oil prices. Externally, trading partner inflation revised upward in the short-term, international commodity prices (food and oil) revised upwards and pula forecast to be relatively stable against the rand in the near-term.

Although the expectation is that inflation will return to the 3-6 percent target range, a key question that Sethunya Kegakgametse and Kitso Mokhurutshe, economists at Econsult, ponder on is whether there is likely to be any monetary policy response to rising inflation. When most central banks naturally waited for economies to stabilise, the new year started with a theme of potential policy tightening.

“We can expect interest rates to go up between 50 and 100 basis points across various markets so that they don’t repeat the mistakes that were made during the previous financial crisis,” Kavishe said, although wary that many economies still cannot stomach higher interest rates. “A big section of what’s been protected as an example in the Botswana case is the SME sector. Consider hiking interest rates by 100 basis points at a time when you have most of your businesses still struggling to get to prepared pandemic levels,” Kavishe lamented. Keleapere has observed that there have been dampened business sentiments that led to the closure of some SMEs and other firms, resulting in increased unemployment.

At Absa Bank, experts also hold the view that policy tightening is still likely in 2022 as the central bank may look to normalise monetary policy. “Despite inflation being above the target range since May 2021, the MPC has been reluctant to hike policy rates due to the need to support the recovery and its belief that current upward pressures are a cost-push, transitory factors that do not require policy tightening,” Absa’s Ridle Markus and Samantha Singh wrote in their Q1 2022 report.

The MPC met twice during the quarter, on 21 October and 2 December 2021. It maintained the Bank Rate at 3.75 percent despite inflation continuing to trend above the upper bound of its objective range. The MPC maintained its view that the current pickup in inflation is transitory (due to factors such as the increase in VAT and fuel pump prices) and hence maintained its accommodative position. This was done in order to provide support to the local economy as the country emerges from the COVID-19 pandemic.

If inflation is expected to be transitory, Kegakgametse and Mokhurutshe argue that the appropriate policy response is to “look through” the short-term increase in inflation and calibrate the monetary policy stance to the expected medium-term inflation. But if higher inflation is prolonged, the two said, this runs the risk of it becoming generalised through second-round effects, for instance, through the impact of higher transport costs on the prices of goods and services. “In this case, there is a risk that monetary policy may need to be tightened to bear down on inflation,” they wrote.

Markus and Singh still believe that with real rates likely to be negative for some time (policy rate: 3.75 percent), the Bank of Botswana may consider hiking the policy rate by at least 50 basis points in 2022. Inflation risks emanating from food and fuel prices remain a major threat. “The Bank Rate will remain at 3.75 percent with a possibility of tightened monetary policy revision during the third quarter of 2022 in attempt to control spiking inflation,” Keleapere wrote in a market outlook whose sentiments are augmented by Kwabena. He wrote: “We expect the BoB to implement at least one 25bps rate hike in 2022 as it walks the tightrope between rising inflation and supporting economic growth”.

Previously, BoB has made it clear it would not be in a rush to increase interest rates as inflation was viewed as temporary and there is still significant economic slack in Botswana’s economy. Botswana has experienced strong GDP growth recovery during the first three quarters of 2021 as the country continues to emerge from the COVID-19 pandemic helped also by favourable base effects as the economy contracted 8.5 percent in 2020. National accounts data for the first three quarters of 2021 show that GDP was 13.5 percent higher than during the same period in 2020, said Econsult.

“This suggests that final real GDP growth for 2021 will surpass the 9.7 percent and 8.7 percent growth forecasts set out by the Ministry of Finance and Economic Development (MFED) and the IMF respectively,” Kegakgametse and Mokhurutshe wrote. They said this indicates stronger than expected economic recovery from COVID-19 for the year 2021 to September.

However, they are wary that emergence of the Omicron variant, which was first reported in November 2021, may have dampened growth during the fourth quarter of the year, the extent of which will only be clear once Statistics Botswana publishes GDP data for the full year towards the end of March 2022.  Despite this threat, Markus and Singh revised Botswana’s growth projection for 2021 to 12.5 percent as they also believe that a solid growth rate was recorded in Q4, once again coming off a low base. The growth momentum is likely to ease in 2022 given the higher base in 2021, Markus Singh wrote.

One expert told this publication it will not be an easy decision for the central bank to raise interest rates, given that the recovery has not really firmed and is based on base effects. In addition, unemployment is rising and debt levels are high. Statistics Botswana shows that unemployment rate (persons aged 15 years and above) went up by 1.5 percentage points, from 24.5 percent in fourth of 2020 to 26.0 percent in fourth quarter of 2021. Youth unemployment rate went up by 2.0 percentage point over the period, from 32.4 to 34.4 percent.

Botswana’s inflation edges past 10% y/y

Bank of Botswana statistics show that household debt stands at about P45 billion. While there has been general concern of over indebtedness, the central bank recently released a report which clearly states that borrowers have the ability to service their debts. Nonetheless, an interest rate hike would mean that repayment instalments would increase. Citizens’ pockets are already hurt by increased administered prices. About 90 percent of most households’ income is spent on food, transport and housing.

In light of these circumstances, The Business Weekly & Review spoke to Kivashe on the sidelines about what approach the central bank could take, bearing in mind that the economy is still recovering. He thinks it is a double pronged approach. A part of the pressure for banks to increase interest rates across the region is that generally there is a high rate environment that is expected across the world as people come off the COVID-19 pandemic. “So, the approach that most central banks are taking is that they are not pre-empting a lot of the hikes. A lot of banks in January opted to not hike interest rates immediately. That is until they started seeing the fed fund rate pick up which is expected later on in the year. So that is the first thing, don’t pre-empt them,” Kavishe explained.

Secondly, he thinks a lot of countries are taking the approach of having staggered increases where they would have, as an example, a 25 basis point increase, allow the market to settle and then have an additional 25 basis point increase. “The unfortunate thing is that we are not seeing an environment where rates could stay flat, given that on the flip side, without increased rates at a commensurate pace as increases internationally, you fall into the problem of having capital outflows because you have a lot of your bond investors, as an example, who target an environment which has higher interest rates,” Kavishe said

In recent times, there has been low to moderate demand for government bonds. According to Kgori Capital, there were three government bond auctions held during quarter four 2021 where P4.9 billion of bonds and T-Bills were offered. There was low to moderate demand with P5.8 billion of bids received. However, in a similar manner to Q3 2021’s auctions, they were under-allotted with an allotment ratio (allotment divided by securities on offer) of 57.4 percent, wrote Kwabena, who explained that the bulk of the allotment was at the short end of the curve where P2.3 billion (81.2 percent of total allotment) of T-Bills were issued.

The reason for the low bond raises was that the government rates had been much lower than what market participants thought they should be for a very long time, but the government kept rejecting any bids higher because they had cash. When the government ran out of liquidity, they needed to raise more but participants wanted the right rate that reflected the true risk of the bonds, thus the rate on the bonds were bid higher. The yield curve has been going up but the Treasury is being measured about how they do it, so they still reject a number of bids. Moral of the story is that interest rates may have come down and remained low but market interest rates have actually ticked up.

Bonds Total Returns at December 2021

Ironically, the proceeds from the auction were to fund the Economic Recovery Transformation Plan (ERTP), which was to boost the economy. Observers say Botswana has not seen that actually feed into the economy in any way yet and the monetary policy alone cannot boost the economy.

The Business Weekly & Review also asked Kavishe what the central bank could do in place of interest rate hikes. “There’s still additional stuff central banks have been doing to try and preserve what is going on in the economy,” he said. While he would not speak on Botswana on its own, he said lose monetary policy can be kept in the form of reserve requirement ratio as interest rates hike. This is to support other aspects of the economy. “We have seen other people debate about how quickly they are going to increase the prime lending rate. You have your repo rate/benchmark going up, but then you don’t have an increase in prime lending rate,” Kavishe said, noting that this allows “your domestic people to not feel as much pressure when they are borrowing credit”. “Especially in times like these when credit is hovering between 5 and 6 percent. You want to have a conversation about how quickly you can do it and whether you can reduce that spread between what happening at prime lending rate and what is happening with repo rate,” Kavishe explained.