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Exchange Rate Policy - Current Framework

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While movements in bilateral movements are important, the policy focus has been on the  composite trade-weighted effective exchange rate, with a desire to attain a stable Real Effective Exchange Rate (REER). In this context, 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, therefore, considered inimical 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 then 12 percent, were implemented in February 2004 and May 2005, respectively.

Furthermore, a crawling band exchange rate mechanism was introduced at the time of the second devaluation 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, where 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, therefore, call for the reintroduction of discrete adjustments.

Real Effective Exchange Rate - recent trends
The crawling band exchange rate regime is implemented through continuous adjustment of the trade-weighted NEER of the Pula at a rate of crawl based on the differential between the Bank’s inflation objective and the forecast inflation of trading partner countries. The rate of crawl is thus determined using a forward-looking approach and is revised on a regular basis. In this forward-looking scheme, the authorities periodically determine the rate of crawl for the subsequent period, such as the next six or twelve months. Since the introduction of the crawl, Botswana’s inflation objective has generally been higher than the average inflation of its trading partners and this has necessitated a downward crawl. However, if inflation differentials were to be reversed such that the domestic inflation objective fell below expected inflation in trading partner countries, then an upward crawl could be introduced.

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