Current Exchange Rate Framework

The significant appreciation of the REER in the early 2000s (see chart) due to the combination of an appreciation of the Nominal Effective Exchange Rate (NEER) and higher inflation in Botswana compared to trading partner countries was considered unfavourable for export competitiveness, which is needed to achieve the national objective of economic diversification. To reverse the appreciation of the REER, two consecutive devaluations of 7.5 percent and 12 percent, were implemented in February 2004 and May 2005, respectively.

A new exchange rate framework, the crawling band exchange rate mechanism, was introduced in May 2005 with the objective of enabling an automatic nominal adjustment of the Pula exchange rate with a view of maintaining REER stability and avoiding the need for sizeable discrete adjustments as had been the case in the past. Once a crawling peg/band system is in place, discrete devaluations and revaluations should be avoided as they undermine the credibility of the crawling peg/band mechanism and are also a reflection of policy failures in other areas. Maintaining a credible crawling peg/band mechanism imposes certain constraints on other economic policies, such as monetary and fiscal policies. These policies have to complement the exchange rate policy, failing which it would be difficult to sustain the crawling peg/band mechanism regime and might call for the reintroduction of discrete adjustments. Table 1 shows the different rates of crawl since the crawling band exchange rate mechanism was introduced in 2005.

Table 1: Rate of Crawl

Source: Bank of Botswana

The crawling band exchange rate regime is implemented through continuous and gradual adjustment (crawling) of the trade weighted NEER of the Pula to correct for any misalignment of the exchange rate. The rate of crawl is based on the forecast inflation differential between Botswana and her trading partner countries. The rate of crawl is thus determined using a forward-looking approach and is revised annually. In this forward-looking arrangement, the authorities periodically determine the rate of crawl for the subsequent period. From May 2005 to December 2015, the REER exhibited an appreciating trend because Botswana’s inflation was generally higher than the average inflation of its trading partners. During this period, a downward crawl was implemented; however, the positive inflation differential between Botswana and its trading partners more than offset the impact of the downward crawl adopted by the authorities. From 2016 – 2019, domestic inflation was marginally lower than the average inflation for trading partners, therefore, small upward rates of crawl were implemented, and the REER was relatively stable. However, in 2020, in response to the adverse impact of COVID-19 containment measures on economic activity, an annual downward rate of crawl was implemented effective May 2020. Consistent with the policy objective of maintaining a stable REER of the Pula, downward rates of crawl were implemented in 2021 through to 2023 with the aim of offsetting the projected positive inflation differential between Botswana and trading partner countries.

In addition to adjusting the rate of crawl, the relative weights were also changed several times to reflect the relevant trade patterns. Chart 2 shows how the weight of the South African rand and the SDR evolved over time. In accordance with established tradition, the parameters for the Pula exchange rate (weights and the crawl rate) are reviewed semi-annually to ensure continuing alignment or complementary with other macroeconomic policies, and changes are communicated to the public through press releases.

Source: Bank of Botswana