Of Botswana’s economic philosophy and raising rates

Mphoeng Mphoeng | Monday June 27, 2022 06:00

First and foremost, what does this mean for you and me? In simple terms, it means most of your loans just got half a percent more expensive.

That is, if the loan interest rate you were being charged by your bank was 7% it will now be 7.5% meaning you will be paying more every month.

Why did Bank of Botswana do this despite everyone in the economy feeling like they’re struggling? That's a little more complicated...

So economic theory says central banks need to manage the balance between money in the economy and inflation.

Those of you old enough to remember will know that before 2010, Botswana tended to have inflation in the regions of 10-15% and the bank rate tended to be above 10%. When inflation is high (in theory) it should mean the economy is growing and doing well and there's too much money, projects and investments in the system. In order to bring this down to 3-6% target, the BoB (or any other central bank) would then raise rates to reduce people who can afford loans and therefore demand for houses, cars and projects.

This should reduce the prices of these items and inflation should drop.

From around 2016 we then had a period where inflation was below 3-6% which implied the economy was struggling and demand for products was low. BoB was then forced to drop rates to historic lows to encourage you to take loans and invest in projects, houses, cars and personal loans. The idea behind this move was that there would be increased demand so this would increase prices and hence increase inflation back into the 3% to 6% regions. (Also note that this period was also the worst performing time of the Botswana economy in 30 years with the economy struggling with high unemployment and low GDP growth, so reducing rates was supposed to counter these as well).

So in theory, when looking at the current situation where local inflation is now above the 10% and expected to stay there possibly for the foreseeable future, the response of increasing interest rates by BoB is correct since it should reduce people with projects and who can afford loans and reduce demand for products and drop prices of these hence reducing inflation (because most Batswana also have variable loans, this also means you should be paying more for loans from your salary and reduce the cash you have therefore reducing your spending power which reduces overall demand for products in the economy and reduces inflation). In theory.

The only problem is since the 2008 Global Financial Crisis (and now COVID and the Russia Ukraine war), it seems our economic systems have been broken. Unfortunately most countries are still struggling economically so the inflation isn't implying a booming economy as it should normally.

This means effectively by raising rates, BoB (and most central banks such as the US and RSA have both raised recently) you're decreasing demand and putting the brakes on an economy that is already struggling which seems counter-intuitive. By raising rates, you're effectively likely to make the current economic hole deeper. This means if we purely look at theory you're right and might not have a choice but to raise rates, but in practice you are making the situation on the ground even worse for your economy and citizens.

This is why since 2008 there has been debate internationally about getting more creative in terms of monetary and fiscal policy with theories like Modern Monetary Theory (MMT) gaining traction. This theory has been pushed into mainstream politics by political candidates such as Bernie Sanders who campaigned advocating for it in 2019.

The proponents of MMT are saying central banks should not just be inflation targeting i.e. just worrying about managing inflation. MMT encourages the government and central to worry about growth and unemployment and if that means continuing to pump more money in the economy and having short term inflation, so be it. They argue that in a country like Botswana, we should loosen fiscal policy rules like the limitations we have on government debt-to-GDP ratio and the number and size of budget deficits the country runs.

They argue that at this point, a country like Botswana should be pumping money into the economy for things that will improve our competitiveness and future growth like infrastructure, education and research and development capabilities (in the case of Botswana it might be pumping money into infrastructure, education and R&D that pushes policies such as developing the mining, agriculture and tourism value chains).

So in Botswana's case, the argument would be to leave interest rates low, let the people borrow and be productive and invest and we will worry about inflation in the future so we don't depress the economy.

To me this kind of makes sense because the inflation we are seeing is a result of disruptions in normal business because of COVID-19 and Russia war rather than the economy doing well. That said, while MMT is gaining popularity, it hasn't been tested well enough academically and this reduces the number of policymakers willing to jump onto the band wagon.

My hope is that as a country and central bank, we will start to hear more innovative conversations about it going forward because we have to admit that the “normal” inflation targeting we subscribe to, seems counter-intuitive at this present moment.

So in conclusion, whilst BoB made the correct call of raising rates in theory, practically it may kill efforts in the economy to shake off the sluggishness of COVID-19 and the Russia/Ukraine war and we therefore need to find other alternative, less textbook ways of working going forward.

*Mphoeng is a director at MP Consultants, a local citizen-owned corporate finance, economics and business consultancy. Previously, he worked for the University of Botswana as a Lecturer in Accounting and Finance, Botswana Investment Fund Management (BIFM), Standard Chartered Bank and Bank of Botswana