BoB dumps yearly inflation targeting

Brian Benza
Staff Writer | Wednesday February 27, 2008 00:00

Presenting the 2008 monetary policy statement in Gaborone on Monday, BoB Governor Linah Mohohlo announced that the bank has also abandoned tasking itself with setting and achieving an annual inflation objective, arguing that  the price stability objective can only be achieved in the medium term (a rolling three year period), in recognition of the time lag for monetary policy to impact  on price developments.

This abandonment of a short-term horizon in inflation rate targeting comes against the background of the bank having failed to achieve its 4 to 7 percent target in 2007. The annual inflation rate stood at 8.1 percent in December 2007.

Rather, Mohohlo said the annual inflation rate will be tamed to between 3 to 6 percent in the medium term, although it is anticipated to converge to the to the objective as early as 2009. However, although the Governor forecasts on inflation are buoyant, she said there remained numerous upside risks that could scuttle efforts to stabilise prices.

'Overall, the outlook is that domestic inflation will, on average, be just above 8 percent in the first quarter of 2008, and fall close to 6 percent towards the end of the year. There are, however, upside risks to this outlook due to the possible large increase in administered prices, which include power tariffs and BHC.

'Moreover, any large increase in civil servants' salaries will impact on aggregate demand. The salary increases are also likely to be emulated by the private sector as they seek to maintain remuneration differentials, and this will add to domestic demand as well as production costs and consequently inflationary pressures' she said. The Botswana Power Corporation (BPC) has already indicated that it will pass any further increase in costs to the consumer if South Africa's Eskom goes ahead with its plans to increase tariffs by 14.2 percent in the 2008/09 financial year.

More inflationary pressures in 2008, which are likely to make Mohohlo's targets more unachievable, are to emanate from rising oil and food prices, both of which Botswana is a large net importer of. In the past 14 months, the oil price has risen 79 percent and there seems to be no indication that this trend will slow down in the near future.

Meanwhile, the International Food Policy Research Institute has reported that the world is eating more than it produces and food prices may climb because of expansion of farming for fuel and climate change, risking social unrest.

Inflation imported from South Africa is also expected to keep monetary authorities because projections are that there will be a rapid rate of price increases there in the first three months of this year.

More inflationary pressures were also expected to stem from the continued movements of the pula against trading partners' currencies.

But the Governor said the rate of the crawl of the exchange rate is not expected to result in a substantial nominal exchange rate adjustment during 2008, thus there should be no inflationary pressure resulting from the crawl of the pula exchange rate. In the past, some economic pundits have been critical of the central bank's exchange rate regime due to the negative effects the movements have on inflation and national revenue. It is believed that the primary external influence on domestic inflation is imported from South Africa from where Botswana imports most of her needs, mainly food (90 percent).

On the other hand, analysts say a model exchange rate management system should be pulling the pula in the opposite direction against the US dollar as Botswana's foreign exchange revenues are predominantly in US dollar terms.

Therefore, the continued appreciation of the pula against the greenback will cut down on the US dollar-based revenues. On the other hand, credit growth (both sector and government expenditure) is almost sure to continue to put pressure on aggregate demand and consequently inflation, if a decision not to increase interest rates is not taken soon.

'These trends are partly a result of a significant increase in private sector and government projects that contribute to the forecast improvement in real economic activity, which in turn pose an upside risk to inflation,' Mohohlo added.

Giving a review of trends in 2007, Mohohlo said inflation decelerated in the first half of the year, from 8.5 percent in December 2006 to 6.4 percent in June 2007, and was within the central bank's annual objective of 4-7 percent.

But in the second half, due to the faster increase in food and administered prices, tides changed as inflation rose gradually to 8.1 percent in December 2007.

Apart from food and administered prices, firmer domestic demand also contributed to the reversal of trends in the second period of the year, with higher output growth mainly attributable to strong performance in the manufacturing, trade, hotels and restaurants, transport and communications sectors.

The faster GDP growth was also partially related to the growth of both credit to the private sector and government expenditure.

Year-on-year growth in credit to the private sector rose from 18.8 percent in December 2006 to 24.3 percent in December 2007.