It is well known that the global financial and economic crisis that erupted in the second half of 2008 has had a dramatic impact on Botswana’s government finances. The collapse in diamond exports in late 2008 and early 2009 sharply reduced government revenues from the mining sector. This was compounded by reduced receipts from the second most important revenue source, the Southern African Customs Union (SACU), as trade volumes fell. Combined with increased government spending – largely planned before the crisis but maintained in the face of reduced revenues to produce a fiscal stimulus to the economy – the result was a budget deficit projected at 15% of GDP in 2009/10.
Like many countries, Botswana faces the challenge of balancing fiscal objectives: maintaining a sufficient fiscal stimulus to support economic activity in the face of global weakness, while not running up excessive debt that could cause a long-term sustainability problem.
However, it is not just a question of waiting for the world economy to recover, and expecting that everything will be back to normal. For instance, in the recently released budget figures for 2010/11, mineral revenues are projected to continue falling, even though diamond production and exports are expected to recover.
In Botswana’s case the fiscal problem is compounded by adverse long-term revenue trends. Before the global crisis, diamond production had more or less reached a peak, with a steady decline in output projected between 2020 and 2030. Although this decline has now been pushed out by a few years, due to the combined effect of the global crisis (and reduced production) and ongoing investment to extend the life of the Jwaneng mine, the eventual challenge of declining mineral revenues has not disappeared.
Hence the emphasis on diversifying the economy and government revenue sources. While these are important objectives and should continue to be pursued, they will not solve the long-term fiscal challenge even if they are successful. The reason for this is simple: diamond mining is extremely profitable, and those profits are taxed at an extremely high rate. Hence, government revenues account for a very high proportion of the value of output. As the economy diversifies, the importance of diamond production diminishes, and it is replaced by other economic activities that are neither as profitable nor can be taxed so highly. The average tax rate will therefore fall, and so will government revenues as a share of GDP.
This can be illustrated by a simple example. Suppose that profit in Botswana’s large, low cost diamond mines accounts for 80 percent of revenues. Suppose also that government’s share of those profits (derived from production royalties, profits taxes and dividends from its half share in Debswana), amount to around 80 percent of profits. Government revenues would then account for around 65 percent of the value of the industry’s gross output.
Consider what happens as the economy diversifies, and other industries – whether agriculture, mining, manufacturing or services – grow as diamond production declines. While rates of profit vary from industry to industry, an average rate of profit might be, say, 25 percent of revenues – far below that in diamond mining. And a more normal tax rate would be 25 percent of those profits – again, far below the effective tax rate on Debswana. The outcome in this example is dramatic – government revenues would only account for around 6 percent of the value of gross output, barely one-tenth of the revenues raised from the same value of output produced by Debswana.
The above is an illustrative example, but the numbers are probably not far from reality. And the conclusion is clear: even if the economy successfully diversifies, government revenues will decline as a share of GDP (which is the most relevant measure).
Historically, government has based its budget around an expectation that revenues will be equivalent to around 40 percent of GDP – this was the basis of the Fiscal Rule presented in the mid-term review of NDP 10, which limited spending to 40 percent of GDP on average.
Going forward, the Fiscal Rule needs to be drastically revised. In 2010/11, revenues are expected to be only 27 percent of GDP. This may seem low, but it is typical of middle-income developing countries. Elsewhere in SADC, for instance, government revenues amount to some 25 percent of GDP in South Africa and only 20 percent in Mauritius, both countries with similar levels of income per capita as Botswana.
In the medium to long term, the maximum sustainable level of government spending in Botswana is probably around 30 percent of GDP. Relative to the NDP 9 Fiscal Rule, or to projected spending in 2010/11, this means that Government spending has to shrink by around one-quarter, relative to the size of the economy. Hence the emphasis on “Transformation” in the 2010 Budget Speech – government spending has to become much more efficient, and much more focused on priorities.
