At independence in 1966, Botswana maintained its membership to the Rand Monetary Area (RMA), a regional monetary union composed of South Africa, Lesotho, Swaziland and the then South West Africa (now Namibia) that used the rand as a common currency; in turn, the rand was pegged to the US dollar. While South Africa, with a much larger economy, had a decisive influence on the exchange rate policy for the RMA, at the time the arrangement was considered appropriate for Botswana, given its limited resources. However, following subsequent economic and political developments, including the desire for more independent management of domestic economic policies, the authorities in Botswana became increasingly of the view that the country’s continued participation in the RMA was no longer desirable.
In August, 1976. Botswana formally withdrew from the RMA and introduced its own currency, the Pula, which was pegged to the US dollar at P1 = US$ 1.15. This was the same rate at which the rand was pegged to the US dollar, yielding initial parity with the rand. However, in April 1977, the Pula was revalued by 5 percent against the rand in a move aimed both at reducing imported inflationary pressures and at demonstrating the independence of the new currency.
The Pula remained pegged to the US dollar until June 1980, even though South Africa decided to introduce a managed float in January 1979 following the breakdown of the Bretton Woods system of fixed exchange rates. However, by June 1980, significant appreciation of the rand against the US dollar, due to the increase in gold prices, necessitated a change in strategy. In particular, the depreciation of the Pula against the rand, as the rand appreciated against the US dollar, caused inflation in Botswana to accelerate. To moderate the influence of developments in South Africa and achieve a more stable relationship of the Pula vis-à-vis the rand, the Pula was pegged to a basket of currencies comprising the rand and the SDR.
The choice of the peg currencies for the fixed Pula exchange rate was guided by trade patterns and the need to include the major currencies used in international trade and payments. A fixed peg regime was also considered appropriate for the relatively small, undiversified Botswana economy that was unlikely to sustain a floating currency. With a large inflow of foreign exchange from mineral exports, it was likely that the Pula, if allowed to float freely, would appreciate substantially, a manifestation of the so-called ‘Dutch Disease’ which, potentially, could be detrimental to industrial development and long-run growth prospects for the economy, where substantial mineral earnings would cause the exchange rate to appreciate to levels that diminish the competitiveness of other sectors.
Botswana’s choice of an exchange rate regime was largely consistent with the preference among developing countries for intermediate exchange rate frameworks, which capture the positive aspects of the two extremes of fixed and flexible currency arrangements. For Botswana, a fixed basket peg enabled occasional adjustments to alternatively support the competitiveness of tradeable goods produced or the objective of price stability, or to change the currency composition of the basket in line with evolving conditions relating to the direction of trade. Thus, from 1980 the exchange rate was adjusted intermittently, as both an anti-inflation tool and to promote domestic industry competitiveness. However, from the early 1990s, the export competitiveness objective became more dominant. This was also against the background of an enhanced monetary policy framework that increasingly became more effective in mitigating inflationary pressures.
The first major Pula devaluation of 10 percent, took place in May 1982 to alleviate the impact of the oil shock that precipitated a global recession in 1981 and subsequent collapse of demand for diamonds. At the time, the depressed diamond market led to the imposition of a quota on Botswana’s diamond sales, resulting in a sharp decrease in exports and, consequently, a balance of payments crisis, including a significant decline in foreign exchange reserves to only 3.5 months of import cover in March 1982. Notably, the adjustment measures adopted in 1982 cut across the three main macroeconomic policies, an indication of policy coordination at a time of crisis.
Subsequently, the collapse of the rand due to economic sanctions and disinvestment in protest over the apartheid regime resulted in further devaluations of the Pula, by 5 percent in July 1984 and 15 percent in January 1985, in order to maintain viability and competitiveness of local producers. This objective also motivated the later devaluations, of 5 percent in each instance, in 1990 and 1991. In between, the Pula had been revalued by 5 percent in June 1989 to mitigate inflationary pressures as the sharp depreciation against the major currencies threatened high inflation in South Africa and, in turn, imported inflation into Botswana.
In addition to adjusting the value of the Pula, the relative weights were also changed several times to reflect the relevant trade patterns. One such adjustment was the introduction of the Zimbabwean dollar in the Pula basket in recognition of significant trade relationship with Zimbabwe. This, however, was short-lived as the Zimbabwean dollar was dropped from the basket in 1994 due to changed trade flows which meant that its inclusion was no longer warranted. Overall, given the larger weight of the rand in the Pula basket, the local currency has over time depreciated substantially against the SDR and US dollar as the rand had depreciated. On the other hand, the variance in the rand/Pula exchange rate has been relatively small.
In May 2005, Botswana introduced a major change in exchange rate policy that entailed the adoption of the current framework, which is based on a crawling band mechanism where the rate of crawl is based on the differential between the Bank of Botswana’s inflation objective, and forecast inflation in trading partner countries.