What is ring-fencing and why does BoB want it?

Mbongeni Mguni | Tuesday July 30, 2024 15:40

Anglo American, the majority shareholder in De Beers, on Thursday released figures showing that diamond production in Botswana fell 24% in the first six months of the year when compared to the same period last year. The diamond group which, in partnership with government, mines more than 95% of the country’s stones, also announced that average prices per carat in the first half of the year fell by 20%.

The diamond downturn seen from the second half of last year is persisting, with Anglo American now talking about a “protracted recovery” and saying it would have to further cut production this year, after the downward revision made in the first quarter.

Besides the devastation the diamond downturn will wreck on the budget numbers, especially in light of the planned record spending of P102 billion, the country’s foreign currency receipts are expected to decline.

The shortfall can be seen in the merchandise trade figures which have recorded successive monthly deficits since last September when the diamond slowdown first manifested on local shores. In the first three months of this year, the country’s imports of goods exceeded exports by P5.1 billion and for April, preliminary figures suggest a shortfall of P2.3 billion.

The situation points to lower levels of foreign currency available for meeting the country’s import bill, which is expected to grow this year due to the significantly higher budget allocation for projects and maintenance.

The Bank of Botswana is required to keep the country’s import cover at a minimum of six months and has in the past secured approval for withdrawals from the Pula Fund to replenish short term foreign exchange requirements in the market.

The Pula Fund, which houses the country’s savings comprising decades of budget surpluses and diamond revenues, took a beating during the pandemic and has been gradually recovering since, as the economy has regathered momentum.

However, with the diamond downturn persisting, eyes are turning towards the Pula Fund.

The central bank last month briefed Cabinet on its 2023 annual report and within that, again brought up the need for ringfencing of the Pula Fund.

Set up as a sovereign wealth fund managed by the BoB and global asset managers, the Pula Fund is designed to act as a fiscal buffer and nest egg for future generations who will live in an era without strong diamond revenues.

However, government often dips into its portion of the Pula Fund to fund various needs such as the 2016 Economic Stimulus Plan and budget shortfalls, while frequent withdrawals are also made to support the country’s import bill. The Pula Fund is part of the foreign reserves, representing long term assets, while other components cater for short and medium term needs.

The ringfencing, according to Bank of Botswana executives, would mean protecting a portion of the Pula Fund from any withdrawals in order to preserve its value for future generations.

“Given the recent developments in the balance of payments and government spending requirements, there is a risk of depletion of the foreign exchange reserves, thus impacting on maintenance of macroeconomic stability and policy discretion,” BoB executives said in the annual report released last month.

Although executives did not elaborate in the report, “policy discretion” has been an elusive goal for other African countries whose economies have struggled for revenues, both in domestic and foreign currency. The result has been that some of these countries have had to accept “policy loans” from the Bretton Woods institutions, where the funding is based on governments following the policy instructions of these institutions.

The BoB executives said a ring-fenced Pula Fund was essential for capital preservation and to enable organic growth through reinvestment of returns.

“In turn, the withdrawal rules would allow for a portion of the returns to be used to augment budget financing and this would increasingly become significant and impactful with sustained expansion of the Fund,” they stated.

A sense of déjà vu should be prevailing amongst the economists and researchers at the BoB. In 2020 when the central bank began advocating for ringfencing, trade figures were deep in the red due to the pandemic.

At the time, Tshokologo Kganetsano, then the central bank’s head of research and financial stability, painted a dire picture of the reserves, saying besides COVID-19, the depletion of the reserves was underpinned by the lack of diversity in the country’s revenues sources.

“We are receiving about P3.5 billion from the Southern African Customs Union every three months, but our monthly import bill is about P5.5 billion,” said Kganetsano who is now the central bank’s deputy governor.

“There have been very little mineral and other exports in 2020 due to the pandemic and just from these numbers, it’s clear there is a very urgent need for diversified revenue sources.”

The BoB’s director of financial markets, Lesego Moseki told Mmegi at the time that Cabinet had been briefed on the need for policies to ringfence the reserves.

“Given the rate at which our reserves are going down and given that one of the objectives of reserves management is to save them for future generations, at the briefing for Cabinet, we said we should manage them in such a way that our future generations do not curse us for not managing them well.

“We must look at a framework that will allow us to ringfence some of those reserves to protect them from consistent withdrawals.

“We will need to design some framework around that.”

Consistent withdrawals have plagued the Pula Fund. In September 2012, the BoB moved P21 billion out of the Fund in order to lift the country’s import cover to the required six month level. This was due to enduring weaknesses in exports from the 2008 global financial crisis, while the countercyclical spending of those years meant imports were rising, eroding the portion of the foreign reserves set aside for short term requirements.

In December 2018, the BoB moved P11.8 billion from the Pula Fund to support transactional needs in the economy after a period of “sustained net outflows”.

Government, meanwhile, has also dipped frequently into its portion of the Pula Fund, known as the Government Investment Account (GIA), a key fiscal buffer. During 2020, COVID-19 spending saw the GIA drop to a historic low of about P3 billion before recovering to a post-pandemic high of P18.6 billion last April helped by the strong diamond rebound in 2022.

Since then, the GIA has been sliding due to higher budget spending, reaching a post-COVID low of P5.2 billion in April 2024.

BoB annual report data shows that last year, government withdrew a net of about P6 billion from the GIA, leaving the balance by December at P8.3 billion.

The BoB, in the latest annual report, says the Pula Fund has actually not been operating as a sovereign wealth fund and is in need of reconfiguration.

“It is recognised that although commonly referred to as a Fund for future generations, the current

Pula Fund is primarily an ‘overflow’ or ‘residual’ account for surplus reserves, subject to short-term trade and capital account fluctuations,” executives said.

“Therefore, as indicated above, it is considered prudent to, going forward, maintain two distinct components of the foreign exchange reserves.

“Thus, a liquidity portfolio of the foreign exchange reserves to support ongoing needs of the economy for the foreign exchange, to anchor the exchange rate policy and to afford short-term economic stabilisation.

“Second, a ring-fenced Pula Fund for capital preservation and to enable organic growth through reinvestment of returns.”

Thus far in the debate on ring-fencing, officials at the Finance Ministry have not spoken out publicly. With narrowing fiscal space this year and a deepening diamond downturn that appears to have turned structural rather than cyclical, the “IN” pile on the desks of Ministry authorities is rising.