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PULA basket weights unchanged

Publishing Date : 13 January, 2020

Author : REARABILWE RAMAPHANE

Pula Basket weights have been retained at 45 percent South African Rand (ZAR) and 55 percent International Monetary Fund (IMF) Special Drawing Rights (SDR), Ministry of Finance and Economic Development has announced.


Botswana’s current exchange rate arrangement is that the Pula (BWP) is pegged to a currency basket comprising the South African rand and the IMF’s SDR, in a forward-looking crawling band mechanism. On a regular basis the Pula Exchange Rate Policy Framework is reviewed with a view to maintain a stable and competitive real effective exchange rate of the country’s currency.


This is provided for  by Section 21 of the Bank of Botswana Act which submits that the framework for determining the external value of the Pula shall be determined by His Excellency the President on the recommendation of the Minister of Finance and Economic Development, after consultation with Bank of Botswana, the country ‘s central bank.


In December 2019 the Ministry of Finance and Bank of Botswana reviewed the exchange rate mechanism, following their recommendation His Excellency the President then approved to maintain the Pula basket weights at 45 percent South African rand and 55 percent SDR coupled with a recommendation to implement an upward rate of crawl of 1.51 percent per annum effective 1st January, 2020.


Explaining the recommended rate of crawl, Permanent Secretary in the Ministry of Finance & Economic Development, Dr Wilfred Mandlebe said this reflects the difference between the Bank’s medium-term inflation objective and the forecast inflation for trading partner countries. “The overall objective of the Country’s exchange rate policy is to achieve and maintain the competitiveness of domestic products and services in the domestic and international markets,” he said.


The basket weights are in line with the country’s estimated trade pattern, while the adopted rate of crawl mirrors the inflation differential between Botswana and its trading partners. Pula Basket weights were adjusted in 2017 from 50-50 ZAR –IMF SDR to the current stance. This was the first time that the weight of the rand in the BWP basket was reduced below 50 percent.


The announcement by the country’s treasury last month means the ZAR will now go into the fourth year trailing behind the IMF Special Drawing Right as far as weight on the pula basket is concerned. The Special Drawing Rights is an international reserve asset, created by the International Monetary Fund in 1969 to supplement its member countries’ official reserves.


So far SDR 204.2 billion which is equivalent to about US$291 billion have been allocated to members, including SDR 182.6 billion allocated in 2009 in the wake of the global financial crisis. The value of the SDR is based on a basket of five currencies the U.S. dollar, the euro, the Chinese renminbi, the Japanese yen, and the British pound sterling.


The SDR was created as a supplementary international reserve asset in the context of the Bretton Woods fixed exchange rate system. The collapse of Bretton Woods’s system in 1973 and the shift of major currencies to floating exchange rate regimes lessened the reliance on the SDR as a global reserve asset. SDR allocations can play a role in providing liquidity and supplementing member countries’ official reserves, as was the case with the 2009 allocations totaling SDR 182.6 billion to IMF members amid the global financial crisis.


The SDR serves as the unit of account of the IMF and some other international organizations. The SDR is neither a currency nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members. SDRs can be exchanged for these currencies. In general a currency basket is a selected group of currencies in which the weighted average is used as a measure of the value or the amount of an obligation.


A currency basket functions as a benchmark for regional currency movements - its composition and weighting depend on its purpose. Colloquially, a currency basket is often referred to as a currency cocktail. Commonly used in contracts as a way of avoiding or minimizing the risk of currency fluctuations.  The European currency unit which was replaced by the euro and the Asian currency unit are examples of currency baskets. However, the most well-known currency basket is the U.S. dollar index: USDX.


The U.S. dollar index started in 1973, and today is a basket of six currencies; the euro, Japanese yen, Canadian dollar, British pound, Swedish krona and Swiss franc. The euro is by far the biggest weighting making up 58 percent of the basket. During the 21st century the index has reached a high of 121 during the tech boom and a low of 71 just prior to the Great Recession.


For a developing country that Botswana is which is still very much on a course of traversing the world for global investors, maintaining a competitive real effective exchange rate of the Pula strikes as an imperative as other investment wooing tools. Equity investors who have exposure to different countries will use a currency basket to smoothen risks. Because their core investment strategies are in the equity markets, they do not want to report any substantial losses in a market they are not experts in. The same can be said for bondholders.


On the other hand, currency traders who have a broad-based view of a single currency will choose to own that currency against a variety of different currencies. For example, traders that are bullish, the U.S. dollar could use the USDX to express this trade. Traders and investors can build their own currency baskets with different weightings depending on their strategy.


The last part of 2015 and most of 2016 was dominated by divergent policy setting where Botswana’s trading partners like South Africa and US were increasing policy rates, whereas other markets like Britain, Europe, China and Japan were on an easing stance. Observers note this  divergent policy settings created some instability for Botswana in a real effective rate perspective as the pula weakened against the SDR basket, primarily the USD – and also inflation was on aggregate lower than the trading partners in the pula basket.


These developments in policy rate and price movements thus related in disruptions to the real effective exchange rate, prompting the adjustment to the administration of the pula basket in 2017. A stable real effective exchange rate for an upcoming economy is observed by experts and economist as one that should benefit a country such as Botswana in the area of trade accounts and balance of payments.

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