Botswana’s exchange rate is guided by the Exchange Rate Policy which can be traced back to 1976 when Botswana introduced its own currency, Pula, shortly after the country formally withdrew its membership from the Rand Monetary Area (RMA). According to the information provided by Bank of Botswana on the exchange rate policy, the country had at independence maintained its membership to the RMA pool which was a monetary union made of South Africa, Lesotho, Swaziland and South West Africa, present day Namibia.
The group adopted the Rand as a common currency among the member states and the currency was pegged to the US dollar. Pegging in exchange rate matters is defined as a method of stabilising the country’s currency by fixing its exchange rate to that of another country’s currency. Following the introduction of the Pula denomination in 1976, the Pula was subsequently pegged to the US dollar at P1=US$1.15, the same rate at which the Rand was pegged to the US dollar.
In April 1977, the Pula was revalued by 5 percent against the Rand in a move which was aimed at reducing imported inflationary pressures and at demonstrating the independence of the Pula currency. According to BoB, the choice of the peg currencies for the fixed Pula exchange rate was guided by trade patterns and the need to include the major currencies used in international trade payments.
“A fixed peg regime was also considered appropriate for the relatively small, undiversified Botswana economy that was unlikely to sustain a floating currency,” says the central bank acknowledging that with large inflow of foreign exchange from mineral exports, it was unlikely that the Pula, if allowed to float freely, would appreciate substantially.
The Botswana’s choice of an exchange rate regime is thought to have been largely consistent with the preference among developing countries for intermediate exchange rate frameworks, which capture the positive aspects of the two extremes of fixed and flexible currency arrangements. A fixed basket peg is said to have allowed Botswana to make occasional adjustments to alternatively support the competitiveness of tradeable goods or the objective of price stability, or to change the currency composition of the basket in line with evolving conditions relating to the direction of trade.
As such, from 1980 the exchange rate was adjusted recurrently, as both an anti-inflation tool and to promote domestic industry competitiveness. The country has in 2005 introduced a major change in exchange rate policy that entailed adoption of the current framework, which is based on a packed band mechanism where the base of crawl is based on the differential between the BoB’s inflation objective, and forecast inflation in trading partner countries.
The last devaluation
The Pula was devalued by 12% against the basket of major currencies on May 30, 2005. The move was coupled with the Government of Botswana’s announced changes for the determination of the Pula exchange rate. The new framework is based on one of Botswana’s exchange rate policy objectives of maintaining a stable and competitive weighted average exchange rate for the local currency vis-à-vis the basket of foreign currencies adjusted for inflation rate differentials between trading partners i.e. Real Effective Exchange Rate.
Stockbrokers Botswana said of the development at the time: “We see the benefits of the new crawling peg / band exchange rate mechanism and applaud the moves towards greater flexibility in the exchange rates. However, we take issue with the brute force of the devaluation. It may have been more appropriate to introduce the new mechanism, explain it, and then take steps to devalue to the desired level in a more measured fashion.
This would allow corporates and investors to plan for the adjustments and reduce the shock premium that the move will command. The danger is that where the market is shocked it will over-react – impose higher prices, which will put pressure on the inflation targets; which can lead to further devaluation; which creates further inflationary expectations and thus fomenting a negative spiral. This can however, be avoided by maintaining a tight monetary and fiscal policy”.