Where did the P1.6bn ‘liberated’ by BoB go?
The Bank of Botswana reduced the Primary Reserve Requirement for commercial banks by half last year, the aim of which was to free up P1.6 billion for use by the banks to finance economic activity. In the event, even with Covid-19 considered, lending has tightened and the economy is shrinking.
In the 1970s, central banks in East Asia practised directed lending where they regulated where credit should go in the economy. They determined the desired GDP growth and then calculated the necessary amount of credit creation to achieve this.
The central banks then allocated this creation proportions across banks and industrial sectors and directed money away from other sectors which they viewed would do no good to the economy. As such, credit ‘unproductive’ to the economy was suppressed and many were denied credit for speculative transactions and markets.
By 1997, the World Bank recognised that this credit creation and allocation had supported the famous East Asian economic miracle where eight countries in Japan, South Korea, Taiwan, Hong Kong, Singapore, Thailand, Malaysia, and Indonesia exhibited dramatic economic growth. Households were encouraged to save rather than take up credit while development banks were set up to work with commercial banks on which sectors to fund.
In the modern day, central banks confine themselves mainly to oversee monetary transmission to ensure price and financial stability through several open market operations and other interventions such as prudential and regulatory requirements. In line with financial liberalisation, Moatlhodi Sebabole, Chief Economist at the First National Bank of Botswana, says these interventions do not include dictating where credit should be channelled.
As such, the Bank of Botswana says it does not engage in the practice of directed lending. “Consistent with the guidelines on sound credit risk management by banks and, in general, appropriate risk management, each licensed bank is expected to have comprehensive and sound credit underwriting policy and standards,” Dr. Seamogano Mosanako, Head, Communications and Information Services at the Bank of Botswana (BoB), says, adding that these should include purpose and structure of credit facility, types of loans, sectors and limits per individual borrower or group of related borrowers.
Sebabole says there are risk matrices that reward good credit (typically secured) in the form of risk discounts (via reduced rates and capital requirements), as well as put risk premia on undesirable credit. “These matrices are meant to ensure the integrity of the financial system and deter undesirable debt levels – with the ultimate goal of sustainable economic growth,” he says. “These ensure the soundness of the financial system as dictated by Basel and other supervisory guidelines.”
In line with openness of markets and to maintain prudency in financial management, the central bank employs several interventions in line with globally accepted principles and ratified governance protocols.
BoB’s monetary policy halved the Primary Reserve Requirement (PRR) for commercial banks to 2.5 percent and the Prudential Capital Adequacy (PCA) ratio to 12.5 percent from 15 percent last year. The aim was to provide supportive monetary conditions for economic activity. The reduction of the PRR was aimed at freeing up P1.6 billion which was to be used by banks to finance economic activity.
But where will the credit go to spur economic growth? According to Dr. Mosanako, BoB neither prescribes the amount of credit that a bank can advance to a borrower nor make prescriptions on industry or sectoral lending as long as the bank complies with the safety and soundness requirements stipulated under Section 17 of the Banking Act (Cap 46:04).
Banks that are in it for the money have discretion on where to extend credit based on their credit appetite.
Generally, increasing money supply means more money is made available that can be invested in ‘productive’ avenues. But sometimes when there is more money, those who can afford can use it on speculative markets which can drive up asset prices. For example, as interest rates go down, some can afford mortgages, which is seen as wealth creation.
The residential property loans over the past five years in Botswana has been modest and has trended downwards from 6 percent in 2016 and to low of just 1.2 percent in 2020. In 2020, mortgages as a share of overall credit have trended between 15.2 and 15.7 percent, the former being the latest margin as at November last year.
Although the residential market is speculative, Dr. Mosanako told this publication that the bank promotes growth in mortgage loans as a part of financial development necessary to sustain long-term growth of the economy, creation of wealth and increased economic welfare. “Botswana has one of the lowest ratios of housing finance to GDP even regionally, and this needs to improve,” she wrote, adding that it is recognised that there can be occasional sharp increases in prices and overvaluation of residential properties due to supply and structural constraints. “The cost of housing is included in the calculation of inflation. Therefore, sharp increases could generate high inflation,” she says.
A fortnight ago, Standard Chartered bankers told this publication that wealth redistribution that follows property price increases, particularly if the period of boom is longer, does adversely affect the living standards of the segment of the population that does not own homes, meaning tenants, who make up a large portion of the population.
For Botswana, Dr. Mosanako argues that it is more critical to address the structural constraints of mortgage financing so as to increase supply across income levels and, therefore, help moderate price increases and improve accessibility by diverse income groups, as well as geographically.
Another example of speculative market is buying stocks. The Permanent Secretary (PS) of the Ministry of Finance and Economic Development, Dr. Alfred Mandlebe, said last week that BoB’s decision to reduce interest rates was geared at supporting economic activity and making purchasing shares on the Botswana Stock Exchange (BSE) more attractive, given the lower interest rates on bank deposits and money market instruments. An increase in share prices on the stock exchange is referred to as a rally and like housing it is believed to be a form of wealth creation because of capital gains. But in essence the rise is technically inflation.
There are some experts who view that inflation can be avoided if the amount of money in the economy is regulated and if it does not exceed actual activity that is happening in the economy. In other words, money is issued only for ‘productive investments’ or ‘productive goods and services,’ an example of productive being lending to a business start-up, which then creates jobs and thus additional purchasing power of the economy.
Although Dr. Mosanako believes the notion of “unproductive credit” is misleading, she points out that households may require credit for acquisition of movable or immovable assets, investment in property, consumption and other economic activities. “Generally, credit facilitates large investments, acquisition of property and consumption/investment smoothing over a period of time,” she says.
Sebabole adds that there is causality between credit growth and GDP growth. However, other factors determine economic growth, primary of which is employment growth and productivity. While credit growth, especially credit towards productive economic activities, can increase business activity, Sebabole says it is not the only deterministic factor of GDP growth.
Kwabena Antwi, the Investment Analyst at Kgori Capital, argues that it is government that is charged with the mandate of encouraging growth in certain sectors of the economy by utilising the tools at its disposal such as directing money towards preferred sectors via direct funding or through State Owned Enterprises. While that is the case, how it has worked out for the economy is an open question. But government’s financial pressures have motivated debate around desirability of a private sector-led economy with the government’s role basically limited to levelling out the playing field. Observers say government cannot afford to be funding investments.