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 to 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.

 

reer-chart

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, domestic inflation has been marginally lower than the average inflation for trading partners, therefore, a small upward rate of crawl was implemented, and the REER has remained stable ever since.