Researchers at the International Monetary Fund (IMF) recently published a 20-page report detailing the urgency and benefits of transforming the Pula Fund into a Sovereign Wealth Fund (SWF) and weighing the various ways government could do this.
Through various scenarios and comparison with best-case SWFs in Norway and Chile, the researchers estimated that maintaining an overall budget surplus of about one percent of Gross Domestic Product over the medium term and channelling this to an SWF, would be sufficient to create a credible insurance buffer against shocks.
The recent report is the latest analysis to emerge as more focus turns to the country’s savings, amidst a prolonged diamond downturn that has dented budget revenues and cast doubts on the economy’s ability to survive any near-term shocks.
Set up to be an SWF in 1993 and 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, known as the Government Investment Account (GIA), to fund various needs such as the 2016 Economic Stimulus Plan and budget shortfalls. Frequent withdrawals from the Pula Fund are also made to support the country’s import bill.
While the Pula Fund remains largely stable, rising from P46 billion in December 2019 before the pandemic to P53.7 billion this past July, government’s portion or the GIA has raised alarm. Declining diamond revenues and strong or rising budget expenditure saw the GIA decline to a record low of P2.8 billion in June, indicating a drop of nearly P14 billion over 12 months.
Based on locally sourced data and other sources, the IMF’s detailed recommendations show that it is singing from the same hymn book as the Bank of Botswana (BoB), which recently stepped up its own campaign for the creation of a sovereign wealth fund and protection of the Pula Fund from frequent withdrawals.
The BoB, in its latest annual report, said the Pula Fund had actually not been operating as an SWF and was 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,” BoB executives said.
“Therefore, 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.”
The IMF takes the argument further, explaining that authorities need to develop a new fiscal rule such as a budget expenditure ceiling that would enshrine the government’s commitment to generating fiscal surpluses in the medium term. A new SWF would need to be developed where the savings would be invested and managed.
“Importantly, international experience shows that proper design is essential to ensure that the new framework supports fiscal discipline and does not undermine foreign exchange reserves.
“For instance, a fiscal rule targeting a fiscal surplus is superior to a rule saving a share of mineral revenues.
“And a “financing fund” model, where inflows and outflows are directly related to the budget position, is superior to more ad hoc models,” the IMF researchers said.
Government has run budget deficits since at least 2016-2017, with these deepening over the pandemic years and eroding the GIA to the point where domestic and external debt has been noticeably rising.
“Falling fiscal buffers reflect a declining revenue-to-GDP ratio and sustained expenditure,” the IMF said.
“The budget balance has shifted from a surplus of more than 12 percent of GDP in 2006-2007 to deficits averaging five percent of GDP over the past five years.
“Indeed, total revenues have fallen from more than 40 percent of GDP in 2007 to 28 percent of GDP in 2023.”
Implementation issues and a level of wastage in public fund management have meant that the persistently robust expenditure over the years has largely not resulted in government’s desired developmental objectives, despite the spending occurring in the face of declining mineral revenues.
The IMF’s says like many other resource-rich countries, Botswana struggles to spend its mineral revenues efficiently and a 2023 analysis noted a large gap in infrastructure spending efficiency between Botswana and the most efficient countries with comparable income levels and public capital stock. IMF researchers also say despite generous public spending, the quality of education and the ability of social protection to reduce inequality remain low.
The IMF says Botswana is “very vulnerable to shocks”, given its dependence on “one luxury good faced with erratic global demand and an artificial substitute”. Creating buffers against shocks would strengthen the country’s resilience.
“A SWF could be very helpful to build up an insurance cushion for the budget, helping smooth out public expenditure when diamond prices fluctuate,” the IMF said.
The difference between the Pula Fund and a new SWF would be both the objectives and the rules around withdrawals and deposits. The IMF researchers said while the current Pula Fund has a legal basis in the BoB Act, it is not legally separated from the foreign exchange reserves, and there are no legal provisions requiring monies to be paid into the Fund, nor legal restrictions on drawdowns from it.
“An Act of Parliament, either a new one, or an amendment to the BoB Act, may be needed to
set out the rules for inflows and outflows.
“Under the “financing fund” model, the inflows and outflows are dictated by the budget position rather than by ad hoc transfer rules.
“To be effective, a financing fund must be accompanied by a fiscal rule applying to the budget. “Without a binding budget rule and a clear political commitment to fiscal prudence, it is unlikely that the budget will generate sufficient savings to fund the SWF.”
The political commitment is key to the process, as one of the ways in which a budget surplus can be obtained to finance the SWF will be by reining in the recurrent budget and specifically the civil service wage bill, a long-running concern for the IMF. While government last year initiated some public service and parastatal reforms, these have moved glacially in line with the sensitivities of whole-scale changes in a country with stubborn unemployment and high inequality.
In its latest assessment, the IMF again repeated the call for right-sizing of the civil service as one of the ways to squeeze a surplus out of the budget and improve fiscal efficiencies.
“The public sector wage bill is high by international standards, at 13 percent of GDP,” the researchers noted.
To some extent, however, the Finance Ministry appears to be listening to the recommendations from both the IMF and the BoB.
Finance Minister, Peggy Serame, recently told Parliament that work was ongoing to establish protocols protecting a portion of the Pula Fund from frequent withdrawals.
“There’s a process ongoing and I’m going to ask that I develop a law where we will look at the Pula Fund and see whether it is in right state as a sovereign wealth fund and if it’s not, then we will ask that we ringfence some of that money and no one can touch it without going back to the law,” she said.
As it is unclear when the turnaround in diamonds will occur or how the industry will look when the dust settles, fiscal authorities have some difficult decisions going forward.
Besides the IMF and BoB, they can look to American CEO, Andy Gilman, for encouragement.
“The secret of crisis management is not good vs. bad; it’s preventing the bad from getting worse.”
