Exchange Rate Policy

Exchange rate policy provides the framework for determining the external value of the national currency of Botswana, the Pula. As set out in the Bank of Botswana Act (Cap 55:01, section 21), decisions relating to this framework are made by the President of Botswana on the recommendation of the Minister of Finance in consultation with the Bank.

Exchange rate Policy Regime

Classification and Choice of Exchange Rate Policy Regimes

A. Introduction
An exchange rate policy regime outlines how a country manages its domestic currency in relation to foreign currencies. These regimes range from flexible system or floating arrangements, where market forces (demand and supply) determine the currency’s value, to fixed system or hard peg arrangements, where a currency is pegged to another currency or a basket of currencies. In between the fully flexible and the fully fixed, there are managed frameworks, which involve periodic interventions by the monetary authority (central bank) to stabilise the currency. The following classifications of exchange rate frameworks have been widely discussed in literature:

 B. Exchange Rate Frameworks
Free-Floating: In a free-floating exchange rate regime, the value of the domestic currency is entirely determined by the supply and demand of the currency in the foreign exchange markets, without the intervention by the government or central bank. This means the exchange rate fluctuates freely based on market conditions, which include economic fundamentals, investor sentiment and trade balances. As such, there is greater autonomy for monetary policy, as the central bank’s intervention in the foreign exchange market to maintain the value of the currency is not required. However, a free-floating exchange rate can lead to speculative attacks and requires deep, liquid financial markets to absorb external shocks without causing large fluctuations in the exchange rate.

Managed Float: A managed float exchange rate system is a hybrid framework where currency values are primarily determined by market forces, but the central bank intervenes periodically to stabilise excessive fluctuations. The central bank intervenes in the foreign exchange market to smooth out volatility, stabilise the currency, or to address external sector imbalances during periods of excessive volatility. Although the exchange rate remains largely market-determined, the central bank, when warranted, intervenes to limit short-term fluctuations or to achieve broader economic objectives, such as controlling inflation or stabilising the financial system. While the framework offers stability and reduces sudden shocks, it also risks market distortions if interventions are too frequent or unpredictable.

Crawling Bands: Under a crawling band framework, the currency is allowed to fluctuate within a predetermined range or band (a set margin of fluctuation) around a central rate, with the band periodically adjusted. The central bank sets an upper and lower limit for the exchange rate and intervenes if the currency moves beyond these boundaries. The width of the band typically depends on the country’s economic conditions and the flexibility needed to adjust to external shocks. The key feature of a crawling band framework is that exchange rate flexibility is controlled by the width of the band. While still offering a degree of flexibility, this system imposes constraints on monetary policy, as maintaining the exchange rate within the band requires consistent management of foreign exchange reserves and policy measures. It is commonly used in economies transitioning from a fixed to a more flexible exchange rate system, such as those aiming to control inflation or maintain competitiveness.

Crawling Peg: A crawling peg is a system where the value of domestic currency is determined by linking it to a basket of currencies or a single currency and is allowed to adjust gradually at a fixed rate over time, in response to certain quantitative indicators, such as inflation differentials between trading partners. The currency is adjusted by small amounts over time, either in a pre-announced manner or based on forward-looking expectations, such as projected inflation. The gradual adjustment helps prevent sudden currency misalignments and allows for controlled depreciation or appreciation. Although maintaining a crawling peg provides stability, it may limit monetary policy autonomy because the authorities must ensure the domestic currency stays aligned with the peg, by intervening in the market by buying and selling foreign currencies.

Pegged Exchange Rates within Horizontal Bands: A pegged exchange rate within horizontal bands involves maintaining the value of the domestic currency within a narrow margin (typically ±1 percent) of a fixed central rate. The central rate acts as a reference point, and the exchange rate is kept within this range by the country’s monetary authorities. The central bank intervenes in the foreign exchange market if the currency approaches the upper or lower limits of the band to maintain stability. The degree of monetary policy discretion in this system depends on the width of the band. The narrower the band, the less flexibility there is for domestic monetary policy. This framework offers a balance between exchange rate predictability and limited flexibility, helping to control inflation and support trade competitiveness. However, it requires sufficient foreign exchange reserves for intervention and can be vulnerable to speculative attacks if the market perceives the peg as unsustainable.

Currency Board Arrangement: A currency board arrangement is a system where there is a legal commitment to exchange the domestic currency for a specified foreign currency at a fixed exchange rate. This arrangement is supported by strict regulations, which limit the issuing authority’s actions to ensure the fulfilment of this commitment. In practice, this means the domestic currency is only issued against foreign exchange and remains fully backed by foreign assets. As a result, traditional central bank functions, such as controlling the money supply and acting as a lender of last resort, are eliminated, leaving very little room for discretionary monetary policy.

Although this system provides strong exchange rate stability, controls inflation, and enhances investor confidence, it also restricts a country’s ability to respond to economic shocks, as it cannot freely adjust interest rates or print money.

Exchange Arrangements with No Separate Legal Tender: Exchange arrangements with no separate legal tender refer to systems where the currency of another country is used as the sole legal tender (formal dollarisation), or where a country is part of a monetary or currency union that shares a common legal tender. Adopting such a system means the country completely relinquishes control of its domestic monetary policy to another country, and the central bank loses its authority to issue currency and transfers monetary decisions to the issuing country or the union’s central authority.

C. Choosing an Exchange Rate Arrangement
Several factors influence a country’s choice of the exchange rate regime. A thorough analysis of the key factors in selecting an exchange rate arrangement (Table below), as recommended by the IMF, helps countries to determine the best exchange rate system. For example, the IMF states that an adequate level of foreign exchange reserves, which enable direct interventions in the foreign exchange market, is necessary to maintain an exchange rate peg or keep the exchange rate within narrow bands.

Furthermore, the size of an economy influences the exchange rate arrangement, with larger economies typically benefiting from flexible exchange rates due to their greater capacity to manage monetary policy independently, and in contrast, smaller economies may struggle to maintain a fully independent monetary policy and may opt for a fixed exchange rate or a combination of a float with capital flow management measures. The type and frequency of economic shocks, whether external or domestic, also shape the decision on exchange rate arrangements. External shocks, such as fluctuations in global commodity prices or changes in international capital flows, may require more flexible exchange rates to absorb the impact and maintain competitiveness. Real shocks, such as changes in terms of trade, can lead to exchange rate depreciation, aiding the domestic industry.
 

Source: IMF

Botswana has been implementing the crawling peg framework since May 2005. In this system, the Bank of Botswana buys and sells foreign currencies to the market, at demand, to maintain the desired value of the domestic currency. As such, the country must maintain a significant amount of foreign exchange reserves. However, Botswana’s foreign exchange reserves have been declining at a rapid rate, and this trend is expected to continue in the short-to-medium-term. The foreign exchange reserves are estimated at 6.5 months of import cover as at December 2024. The decline in reserves, coupled with the sluggish recovery of the diamond market and elevated import levels, poses a challenge to the long-term sustainability of the crawling peg system.

Given this situation, Botswana may need to consider transitioning to other exchange rate arrangements. Essentially, a more flexible exchange rate system would, in the current circumstances of effective foreign exchange shortage, allow the Pula to depreciate in line with the declining reserves, reducing the relative requirements for foreign currency in exchange for any Pula amount and, thus, help to preserve the official foreign exchange reserves. A range of available intermediate options for Botswana include the crawling bands regime, the managed float, and a free-floating regime, as explained in Part B, and considering the other factors illustrated and discussed in Part C.
 

Botswana’s Exchange Rate Policy

Botswana’s exchange rate policy is aimed at maintaining the level of competitiveness of local producers of tradeable goods and services in both international and domestic markets. By extension, the policy supports the national objective of economic diversification, together with the associated industrial development and employment creation objectives. The Pula exchange rate, therefore, is determined on the basis of a peg to a basket of currencies, the choice of which is guided by the trade pattern and currencies used in international trade and payments. It is pegged to a trade-weighted basket of currencies that comprise the South African rand and the International Monetary Fund’s unit of account, the Special Drawing Rights (SDR). Pegging to a basket of currencies rather than a single currency means that movements in the Pula exchange rate are not subject to an extreme influence of exceptional volatility of any single currency.

An important goal of the exchange rate policy is the stabilisation of the real effective exchange rate (REER) in relation to Botswana’s main trading partners. While movements in bilateral exchange rates are important, the policy focus has been on the composite trade-weighted effective exchange rate, with a desire to attain a stable REER. In line with this objective, the authorities closely monitor the relative inflation performance between Botswana and her trading partners.

Through its history since the introduction of the Pula in 1976, exchange rate policy in Botswana has undergone several major changes, with the current framework introduced in May 2005. Basics of exchange rate policy provides users with explanations of major concepts and essential terminology.

• History of exchange rate policy in Botswana
• Current framework
• Basics of exchange rate policy
• Chronology

The statistics section of the website also included a wide range of exchange rate-related data, including an interactive search facility that allows users to list and graph the value the Pula against major currencies for selected periods.

• Historical data series