Macroeconomic policies are being appropriately redirected away from short-term demand management toward medium-term considerations. Substantial fiscal consolidation will be needed as recovery proceeds, to put the public finances back on a sustainable footing and to safeguard external stability. Much of the adjustment will need to come from lower public spending, as mineral revenues are on a declining trend; and the scope for raising nonmineral taxes is limited by the size of the private sector. The budget for 2010/11 makes a good start on this process of adjustment. Plans to balance the budget by 2012/13 and register modest surpluses thereafter are ambitious but warranted. Recent increases in public debt, and the more challenging fiscal environment going forward, will require a clearer framework for management of the government's assets and liabilities. Anchoring inflation expectations will also be important, because inflation has not yet been brought down sustainably within the authorities' objective range of 3-6 percent. It will be important therefore to err on the side of caution before proceeding with further reductions in interest rates and to proceed with fiscal consolidation as envisaged.

The medium-term outlook is favorable provided the authorities proceed with planned fiscal consolidation. Staff projects that real GDP growth will average about 6 percent over the medium term, as diamond production gradually recovers towards pre-crisis levels and investment in the power sector boosts growth in the nonmining sector.

Sustaining high growth rates will require an ambitious set of policies and reforms to create a leaner and more effective public sector and promote private sector-led growth. The principle objectives of this economic reform agenda should be: Doing more with less. With the prospects of lower revenues looming over the medium-term fiscal environment, the authorities will have to find ways to increase the value for money of public spending programs. Doing so will require strengthening public financial management, including through a transition to program-based budgeting and implementation of a medium-term expenditure framework. Letting the private sector lead the way. Private sector-led growth will require structural reforms to encourage entrepreneurship and investment. The focus should be mainly on cross-cutting structural reforms that can benefit the whole economy. Current investments in power generation will address a key bottleneck to growth. With appropriate safeguards, plans to privatize selected parastatals, greater use of public-private partnerships, and rationalization of commercial services currently provided by the government could also mobilize greater private sector participation in the economy.

Background

Botswana is recovering from its worst recession in at least 40 years. The economy contracted by 3.7 percent last year as demand for diamonds collapsed in the wake of the global financial crisis. The prompt easing of fiscal and monetary policies cushioned the impact of difficulties in the mining sector on the rest of the economy such that the nonmining sector grew by a healthy 6.2 percent in 2009. The domestic banking system has remained profitable, liquid and well capitalized, although there have been some recent increases in nonperforming loans to households.

The economy will likely see some rebalancing this year and next as mining continues its gradual recovery while the nonmining sector decelerates as fiscal stimulus is withdrawn. Overall GDP growth is projected to reach 8.4 percent in 2010, led by a rebound in diamond production. Nonmineral GDP growth, however, is expected to slow somewhat to 4.8 percent. Inflation increased to 7.8 percent in May 2010 because of increases in the rate of value added tax (VAT) and adjustments in administered prices. It may increase a little further in the coming months, in response to additional administered price increases, before falling back within the Bank of Botswana's inflation objective of 3-6 percent in mid-to-late 2011. The current account balance is set to improve gradually as recovery in the diamond market boosts export receipts.

Risks to the outlook are broadly balanced. A double-dip recession in advanced economies could trigger renewed difficulties in the diamond market. In contrast, new demand from China and India could drive a stronger recovery in the diamonds sector. Developments in South Africa will also be important as the strength of South Africa's recovery will largely determine the revenues that Botswana receives through the Southern African Customs Union (SACU) revenue-sharing arrangement. The prospects for additional investment in the power sector are also tied to developments in South Africa.