Botswana turns negative on fiscal risks

Botswana’s outlook has been dropped to negative from stable by S&P Global Ratings, on deteriorating fiscal metrics, on the back of the coronavirus disease 2019 (COVID-19) crisis.

The rating agency has however maintained Botswana’s long- and short-term foreign and local currency sovereign credit ratings at BB+/A-2, due to strong governance.

Botswana’s economy is expected to contract by about 10% in 2020, reflecting the past land potential future intermittent lockdowns in the capital city for the remainder of the year.

S&P considers the 2020 economic underperformance as a one-off event, and projects an economic rebound of 6% in 2021.

The aggregate diamond industry accounts for about a quarter of Botswana’s gross domestic product (GDP).

S&P forecasts that diamond production will contract by 25% in 2020, after an already challenging 2019.

Lower diamond prices led to an unexpectedly high current account deficit in fiscal 2019 – declining by 6% as demand subsided for rough diamonds in China and the US.

Production levels fell in 2019 to 23.2 million carats from 24.1 million carats in 2018, due to planned repairs in Botswana’s major mines.

The country’s diamond production decreased by 68% to 1.8 million carats in the second quarter of 2020 due to the lockdown and the implementation of COVID-19 safety measures.

Diamond production and prices will likely pick up only in 2021 to 2022, after falling by about 10%, according to the Zimnisky Global Rough Diamond Index.

Performance of non-mining sectors declined in the first quarter of 2020 by 5% to 6%, compared to 2019, except agriculture, which improved 7%, recovering from a severe drought in 2019.

Domestic demand has been more muted in the first quarter of 2020, increasing by a mere 2% compared with 7% to 8% growth between 2017 and 2019.

However, the public sector’s salary and minimum wage increases adopted in 2019 should come into effect in the third quarter and could help boost consumption toward the end of 2020.

S&P expects unemployment to remain above 20% through 2023, largely concentrated among young people.

Botswana is set to post twin deficits in the next two years. S&P initially projected a 2.5% fiscal deficit for 2020 to 2021 on the back of muted but positive real GDP growth of 2.6%, prior to the pandemic’s onset.

S&P now estimates that Botswana will post a general government deficit of about 8.0% of GDP in the 2020 fiscal year, after posting a deficit of 4.9% in 2019.

The rating agency expects the fiscal deficit to narrow to 1.8% of GDP in the 2022 to 2023 fiscal year.

Botswana’s government is expected to largely finance an estimated $1.3 billion (P15 billion) deficit in the 2020 fiscal year through domestic and concessional borrowings.

S&P expects the mix to rebalance toward domestic debt because the government is planning to increase its domestic bond program to P30 billion from P15 billion.

Hence, the rating agency estimates that gross general government debt relative to GDP will increase materially, averaging 25% over 2020 to 2023.

Approximately 55% of gross government debt is external, of which more than 75% is variable rate loans with multilateral and bilateral lenders, while the remaining 45% is domestic debt.

As a result, S&P estimates that interest-servicing costs will not exceed 5% of revenue between 2020 and 2023.

The rating agency estimates that current account receipts will decline by about 25% in 2020, compared to 2019. The tourism sector, which is an important source of external receipts, about 10% export receipts in 2019, will recover only slowly, according to S&P

S&P expects the country to close the 2020 fiscal year with a current account deficit of about 12% of GDP, compared with 7.9% in 2019.

The rating agency projects that the current account deficit will average 7% through to 2023.

This is on the back of lower diamond exports, which account for 90% of goods exports – and tourism, which generally accounts for 10% of export receipts.

As a result, Botswana’s gross external financing needs will increase from the mid-50% range of current account receipts plus useable reserves in 2018 to average at 78% over 2020 to 2023.

Since foreign direct investments and external debt borrowing is low, financing of the current account partly relies on central bank reserves.

S&P forecast reserves will drop below $5 billion in 2020, but recover somewhat toward the end of the forecast period.

On the upside, Botswana’s rating is supported by its stable and predictable institutional framework. Its monetary policy framework underpins macroeconomic stability, supported by the crawling peg exchange regime against the South African rand.

The central bank has broad operational independence and the crawling peg exchange rate regime offers flexibility.

The Bank of Botswana implemented two downward re-adjustments to the annual rate of crawl by 1.51% in January and 2.87% in May 2020 to support its export base. This is against a weaker South African rand, which accounts for 45% of the currency basket.

The peg helps control inflation, which S&P forecasts will remain below the central bank’s 3% to 6% target in fiscal 2020.

Inflation averaged 1.9% in the first seven months of 2020 on the back of lower fuel prices.

S&P expects the central bank to continue with its accommodative monetary stance after cutting its benchmark rate by 50 basis points in April to 4.25% to boost lending.

The Bank of Botswana also injected P1.6 billion into the banking sector by reducing reserve requirements.

Although the banking sector accounts for 50% of the country’s GDP, S&P expects credit growth average 5% in 2020. This is despite additional liquidity injected through the reduction of the primary reserve requirements to 2.5%.

In S&P’s view, concentration in the household lending segment remains a key credit risk for banks because of the relatively high household leverage – which represents 20% of GDP.

Nonperforming loans declined further to 4.5% at end of June 2020 from 4.8% at year-end 2019, on the back of improved recoveries in the corporate book.

The government of Botswana has also introduced some stimulus measures with a relief fund of P2 billion or 1% of GDP and P1.1 billion of loan guarantees to support businesses.

S&P could consider downgrading the rating if Botswana’s fiscal trajectory remained weak, beyond the initial impact of the pandemic.

The rating agency would uplift the rating to stable if Botswana restores its fiscal balance to more manageable levels through fiscal discipline and an upturn in the global diamond market.

This comes after Moody’s dropped Botswana’s outlook from stable to negative, on deteriorating fiscal metrics, earlier in 2020.

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