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BoB inflation forecast deemed myopic

BoB Governor: Moses Pelaelo

A research paper released on Monday has exposed Bank of Botswana(BoB)’s inflation forecast model as not having far reaching predictions and its accuracy only relevant for a short time.

The research titled “Evaluation of the Performance of the Bank of Botswana’s Inflation Forecasting Model” was conducted by central bank’s Research & Financial Stability Department
It was authored by Deputy Director, Innocent Molalapata and economists Lesego Molefhe, Lizzy Sediakgotla and Daniel Balondi.

According to the quartet, to support its forward-looking monetary policy framework, BoB produces inflation forecasts using a quarterly projection model, known as the “Core-Model.” The inflation forecast provides guidance on the appropriate monetary policy interventions necessary to achieve and maintain the Bank’s primary objective of price stability, they wrote.

The economists further said it is critical to have a model that produces inflation forecasts that do not deviate significantly from the actual data, without justifiable accounting, as it can misinform policymaking.

“According to the results, on average, the Bank’s Model has a good forecasting accuracy in the short term, however the model has a low predictive power of medium-term inflation movements, reflecting higher uncertainty associated with economic events in the distant future. Regarding prediction bias, the Model tends to under-predict inflation, which is a result of changing economic conditions domestically and externally,” said the quartet.

The four brains merged to produce a paper titled “Evaluation of the Performance of the Bank of Botswana’s Inflation Forecasting Model” which sought to evaluate the performance of the central bank’s inflation forecasting model over a 10-year period, from December 2008, a period of the Great Recession, to December 2018.

While they were putting the central bank policy practice under the knife, the objectives of the study are to assess the Model’s forecast bias by employing the Mean Forecast Error and determination of the size of the forecast error using the Mean Absolute Forecast Error (MAFE).

The researchers explained that BoB uses a forward-looking monetary policy framework that is guided by a forecasting and policy analysis system (FPAS). According to them, the FPAS is the Bank’s main policy analysis and forecasting framework while the Core-Model, which forms part of the FPAS, is used to produce medium-term forecasts for macroeconomic variables, such as inflation and the output gap.

“The CoreModel is based on Botswana’s monetary policy transmission mechanism. It captures the essential macroeconomic relationships, primarily the impact of monetary policy on output and inflation. The model provides a comprehensive view on future economic developments and possible policy actions necessary to achieve the Bank’s inflation objective.

It also explores possible alternative scenarios to the baseline forecast. Given the Bank’s forward looking monetary policy framework, forecasts from the Core-Model are used as input into deliberations of monetary policy formulation and direction by the Monetary Policy Committee (MPC),” further explained the economists.

Going sharp in their analysis knife, the economists said the Core-Model is calibrated in accordance with the behaviour of key relationships in the monetary policy transmission process, therefore the model output is expected to be a close match to actual data, assuming an adequately functioning transmission mechanism, ceteris paribus.

However, according to the four experts, it is not easy to have a model that is able to produce forecasts that accurately fit actual or realised data due to, among others, future unanticipated changes in the structure of the economy; model misspecification; historical data measurement errors; inaccurate parameter estimation or calibration; volatility in the analysed variables; inappropriate policy design and decision; as well as domestic and external shocks in the economy.

As the quartet’s thesis was reminiscent of the monetary policy practice dating back to the Great Recession, they said some of the shocks are generated by financial imbalances, as was evident during the 2008/9 global financial crisis, as well as lack of congruence of monetary, financial stability and fiscal policies towards achieving macroeconomic stability.

“Meanwhile, a model that produces an inflation forecast path that deviates significantly from the actual data, without justifiable accounting, is not desirable as it can misinform policy making. In practice, it is essential for forecasts to be approximate to observe values as that provides reliable information that can be useful in guiding policy formulation and implementation.

In this context, it is important to assess the forecasting ability of the Core-Model regularly in order to identify and attend to discrepancies, if any, and where necessary, enhance its forecasting ability,” said the four researchers.

When delving into the ‘Forecast Errors for Headline Inflation’ the four brains said statistically, on average, with the exception of the first two periods, BoB has consistently under predicted both short-term and medium-term headline inflation for the period December 2008 to December 2018.

The economists further elaborated that the bias is more pronounced in the medium-term forecasts, precisely from the 5th quarter to the 8th quarter. Under-prediction of short-term inflation (for four quarters) is, however, relatively small at around 0.05 percentage points on average, while medium term inflation forecasts have on average been 0.69 percentage points lower than actual inflation, they said.

Last week, after maintaining the Bank Rate at 3.75 percent, BoB changed its inflation forecast of October which projected inflation to revert back to the objective range in the third quarter of 2021. The fresh inflation forecast which was done last week during an MPC meeting is that inflation will revert to the objective range of 3-6 percent sooner, in the second quarter of next year.

According to Head of Research & Financial Stability Department, Tshokologo Kganetsano, the quick reversion of inflation is due to the increase in transport fares, adjustment in fuel prices and postal office tariffs. However RMB Botswana researchers who use a model different than that of BoB, said the effect of Kganetsano’s stated price movements is unlikely to see inflation average beyond 3 percent in 2021. They expect price growth to register an average of 1.9 percent in 2020 and 2.5 percent in 2021.

The demand side is expected to act as a drag on inflation in 2021 as the bulk of Botswana’s work force will be faced with unemployment challenges as businesses continue to reel from the effects of the pandemic, said the researchers. The RMB Botswana researchers said they expect the effect of upside pressures on the headline figure to remain limited, coupled with an uncertain economic outlook as a result of the disruption caused by covid-19.

RMB Botswana explained that the model they use is a “bottom-up approach” which is based on the baskets and data from Statistics Botswana. “We track each basket and stress it according to any recent or upcoming developments-so in the case of transport, we observe international prices and the likelihood of BERA will adjust local prices. If the likelihood is high enough, then we factor into the model.

Basically we do this for all the baskets and since they are weighing according to what Stats Bots provides, we are then able to provide an annual forecast. This is then done according to different scenarios-in the case some of our expectations don’t happen or we have surprise announcements. As the year goes along, we keep amending to incorporate any changes. For longer term forecasts, beyond two years, we use a regression and make adjustments to the outcome based on our research houses expectations as well as regional outlooks,” explained a researcher at RMB Botswana after their inflation forecast.

The other side of the coin

The four researchers who studied Botswana’s Performance of BoB’s inflation forecasting model have reached to a conclusion that, according to the results from a rolling four-year sample of forecast errors using MAFE, the forecasting performance of the model used by BoB has improved with time.

According to the research quartet, the innovations in the model structure, constant engagements between the Modelling Team and Monetary Policy Technical Committee members and Sector Specialists, as well as capacity building programmes on modelling and forecasting which the Bank continues to invest heavily in.

In the conclusion paragraph, the four economists said BoB’s forecasting framework has a high level of precision, particularly in the short term. However precision of the inflation forecasts in the medium term is limited by increased uncertainty associated with the longer horizon, they further stated in the report.

The researchers said BoB is not addressing the issue of the forecasts being less far reaching, but this is partly addressed by updates of forecasts for successive MPC meetings and Monetary Policy Reports (MPRs). They said continual efforts are being made to improve the inflation forecast performance in both the short- and medium-term.

“As part of ongoing improvements to the forecasting ability, since the last half of 2017, an assumption on the rate of crawl for the ensuing year is made, compared to the earlier approach in which the rate of crawl was assumed to be constant,” said the researchers.

The four researcher further advised that going forward it is crucial for BoB to continue to invest in capacity improvements to facilitate updating of the model (and its calibration) to reflect the evolving structure of the economy through infusion of relevant methods and skills inputs.

Another advice was in recognition of the influence of administered prices on inflation, the four saying it is important for BoB to broaden relations with all stakeholders in order to be informed of impending changes in administrative prices, to inform both forecasts and policy posture.

“Engagement of the MPC by the forecasting team in the formulation of initial conditions, external assumptions and alternative scenarios must be strengthened further and should include a discussion of the policy rate.

Finally, where possible, BoB should strive to address impediments to monetary policy transmission, particularly the credit channel, to enhance the effectiveness of the transmission of monetary policy. High precision and reliable forecasts are important for the transparency and predictability of monetary policy, which enhances policy credibility,” said the researchers.

Business

New study reveals why youth entrepreneurs are failing

21st July 2022
Youth

The recent study on youth entrepreneurship in Botswana has identified difficult access to funding, land, machinery, lack of entrepreneurial mindset and proper training as serious challenges that continue to hamper youth entrepreneurship development in this country.

The study conducted by Alliance for African Partnership (AAP) in collaboration with University of Botswana has confirmed that despite the government and private sector multi-billion pula entrepreneurship development initiatives, many young people in Botswana continue to fail to grow their businesses into sustainable and successful companies that can help reduce unemployment.

University of Botswana researchers Gaofetege Ganamotse and Rudolph Boy who compiled findings in the 2022 study report for Botswana stated that as part of the study interviews were conducted with successful youth entrepreneurs to understand their critical success factors.

According to the researchers other participants were community leaders, business mentors, Ministry of Trade and Industry, Ministry of Youth, Gender, Sport and Culture, financial institutions, higher education institutions, non-governmental institutions, policymakers, private organizations, and support structures such as legal and technical experts and accountants who were interviewed to understand how they facilitate successful youth entrepreneurship.

The researchers said they found that although Botswana government is perceived as the most supportive to businesses when compared to other governments in sub-Saharan Africa, youth entrepreneurs still face challenges when accessing government funding. “Several finance-related challenges were identified by youth entrepreneurs. Some respondents lamented the lack of access to start-up finance, whereas others mentioned lack of access to infrastructure.”

The researchers stated that in Botswana entrepreneurship is not yet perceived as a field or career of choice by many youth “Participants in the study emphasized that the many youth are more of necessity entrepreneurs, seeing business venturing as a “fall back. Other facilitators mentioned that some youth do not display creativity, mind-blowing innovative solutions, and business management skills. Some youth entrepreneurs like to take shortcuts like selling sweets or muffins.”

According to the researchers, some of the youth do not display perseverance when they are faced with adversity in business. “Young people lack of an entrepreneurial mindset is a common challenge among youth in business. Some have a mindset focused on free services, handouts, and rapid gains. They want overnight success. As such, they give up easily when faced with challenges. On the other hand, some participants argue that they may opt for quick wins because they do not have access to any land, machinery, offices, and vehicles.”

The researchers stated that most youth involved in business ventures do not have the necessary training or skills to maintain a business. “Poor financial management has also been cited as one of the challenges for youth entrepreneurs, such as using profit for personal reasons rather than investing in the business. Also some are not being able to separate their livelihood from their businesses.

Lastly, youth entrepreneurs reported a lack of experience as one of the challenges. For example, the experience of running a business with projections, sticking to the projections, having an accounting system, maintaining a clean and clear billing system, and sound administration system.”

According to the researchers, the participants in the study emphasized that there is fragmentation within the entrepreneurial ecosystem, whereby there is replication of business activities without any differentiation. “There is no integration of the ecosystem players. As such, they end up with duplicate programs targeting the same objectives. The financial sector recommended that there is a need for an intermediary body that will bring all the ecosystem actors together and serve as a “one-stop shop” for entrepreneurs and build mentorship programs that accommodate the business lifecycle from inception to growth.”

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Business

BHC yearend financial results impressive

18th July 2022
BHC

Botswana Housing Corporation (BHC) is said to have recorded an operating surplus of P61 Million, an improvement compared to the previous year. The housing, office and other building needs giant met with stakeholders recently to share how the business has been.

The P61 million is a significant increase against the P6 million operating loss realized in the prior year. Profit before income tax also increased significantly from P2 million in the prior year to P72 million which resulted in an overall increase in surplus after tax from P1 million prior year to P64 million for the year under review.

Chief of Finance Officer, Diratsagae Kgamanyane disclosed; “This growth in surplus was driven mainly by rental revenue that increased by 15% from P209 million to P240 million and reduction in expenditure from P272 million to P214 million on the back of cost containment.”
He further stated that sales of high margin investment properties also contributed significantly to the growth in surplus as well as impairment reversals on receivables amounting to P25 million.

It is said that the Corporation recorded a total revenue of P702 million, an 8% decrease when compared to the P760 million recorded in the prior year. “Sales revenue which is one of the major revenue streams returned impressive margins, contributing to the overall growth in the gross margin,” added Kgamanyane.

He further stated professional fees revenue line declined significantly by 64% to P5 million from P14 million in the prior year which attributed to suspension of planned projects by their clients due to Covid-19 pandemic. “Facilities Management revenue decreased by P 24 million from P69 million recorded in prior year to P45 million due to reduction in projects,” Kgamanyane said.

The Corporation’s strength is on its investment properties portfolio that stood at P1.4 billion at the end of the reporting period. “The Corporation continues its strategy to diversify revenue streams despite both facilities management income and professional fees being challenged by the prevailing economic conditions that have seen its major clients curtailing spending,” added the CEO.

On the one hand, the Corporation’s Strategic Performance which intended to build 12 300 houses by 2023 has so far managed to build 4 830 houses under their SHHA funding scheme, 1 240 houses for commercial or external use which includes use by government and 1 970 houses to rent to individuals.

BHC Acting CEO Pascaline Sefawe noted that; BHC’s planned projects are said to include building 336 flat units in Gaborone Block 7 at approximately P224 million, 100 units in Maun at approximately P78 million, 13 units in Phakalane at approximately P26 million, 212 units in Kazungula at approximately P160 million, 96 units at approximately P42 million in Francistown and 84 units at approximately P61 million in Letlhakane. Emphasing; “People tend to accuse us of only building houses in Gaborone, so here we are, including other areas in our planned projects.”

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Business

Commercial banks to cash big on high interest rates on loans

18th July 2022
Commercial-banks

Researchers from some government owned regulatory institutions in the financial sector have projected that the banking sector’s profitability could increase, following Bank of Botswana Monetary Policy Committee recent decision to increase monetary policy rate.

In its bid to manage inflation, Bank of Botswana Monetary Policy Committee last month increased monetary policy rate by 0.50 percent from 1.65 percent to 2.15 percent, a development which resulted with commercial banking sector increasing interest rate in lending to household and companies. As a result of BoB adjustment of Monetary Policy Rate, from 1.65 percent to 2.15 percent commercial banks increased prime lending rate from 5.76 percent to 6.26 percent.

Researchers from Bank of Botswana, the Non-Bank Financial Institutions Regulatory Authority, the Financial Intelligence Agency and the Botswana Stock Exchange indicated that due to prospects of high inflation during the second half of 2022, there is a possibility that the Monetary Policy Committee could further increase monetary policy rate in the next meeting in August 25 2022.

Inflation rose from 9.6 percent in April 2022 to 11.9 percent in May 2022, remaining above the Bank of Botswana medium-term objective range of 3 – 6 percent. According to the researchers inflation could increase further and remain high due to factors that include: the potential increase in international commodity prices beyond current forecasts, logistical constraints due to lags in production, the economic and price effects of the ongoing Russia- Ukraine conflict, uncertain COVID-19 profile, domestic risk factors relating to possible regular annual administered price adjustments, short-term unintended consequences of import restrictions resulting with shortages in supplies leading to price increases, as well as second-round effects of the recent increases in administered prices “Furthermore, the likelihood of further increases in domestic fuel prices in response to persistent high international oil prices could add upward pressure to inflation,” said the researchers.

The researchers indicated that Bank of Botswana could be forced to further increase monetary policy rate from the current 2.15 percent if inflation rises persistently. “Should inflation rise persistently this could necessitate an upward adjustment in the policy rate. It is against this background that the interest rate scenario assumes a 1.5 percentage points (moderate scenario) and 2.25 percentage points (severe scenario) upward adjustment in the policy rate,” said the researchers.

The researchers indicated that while any upward adjustment on BoB monetary policy rate and commercial banks prime lending rate result with increase in the cost of borrowing for household and compnies, it increase profitability for the banking sector. “Increases in the policy rate are associated with an overall increase in bank profitability, with resultant increases in the capital adequacy ratio of 0.1 percentage points and 0.2 percentage points for the moderate and severe scenarios, respectively,” said the researchers who added that upward adjustment in monetary policy rate would raise extra capital for the banking sector.

“The increase in profit generally reflects the banking industry’s positive interest rate gap, where interest earning assets exceed interest earning liabilities maturing in the next twelve months. Therefore, an increase of 1.5 percentage points in the policy rate would result in industry gains of P71.7 million (4.1 percent increase), while a 2.25 percentage points increase would lead to a gain of P173.9 million (6.1 percent increase), dominated by large banks,” said the researchers.

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