- Title
- Exchange rate misalignment and capital flight risks in a small open economy: the case of Botswana
- Creator
- Bosupeng, Mpho
- Relation
- University of Newcastle Research Higher Degree Thesis
- Resource Type
- thesis
- Date
- 2019
- Description
- Masters Research - Master of Philosophy (MPhil)
- Description
- Botswana is a small, upper middle-income economy in sub-Saharan Africa, dependent on its mining sector. Its principal export commodity is diamonds and prudent natural resource management policies have propelled its economy to grow significantly compared to other resource-rich countries. In addition, political stability is one of Botswana’s key features. Nonetheless, the country faces major economic problems. First, the capital-intensive mining sector has not reduced the persistent unemployment in Botswana. Second, the country has the third highest HIV prevalence in the world, which increases fiscal pressures. In addition, previous studies indicate an important structural problem, namely, that Botswana’s currency (the pula) is overvalued. They also indicate that the substantial mining revenue plays a role in this overvaluation. Hence, the important issue considered in this study is the effects of exchange rate misalignment on the economy. The extant literature shows unequivocally that exchange rate overvaluation can increase capital flight, misallocate resources, abate economic efficiency and induce unfavourable downward spirals of trade and exchange rate controls. This study evaluates the impact of exchange rate misalignment on capital flight from Botswana over the period 1980–2015. The country aims to attract capital inflows to develop economic sectors other than mining. Botswana is unique because unlike other developing economies, it used only the fixed exchange rate regime since 1976. There has been no exchange rate regime change and the country has experienced significant undervaluation and overvaluation of the currency. It is conceivable that such misalignment has an impact on outward capital flight in Botswana. Botswana needs capital inflows for economic diversification, therefore, it is imperative to determine the impact of misalignment on capital flight from Botswana. This study empirically investigates the impact of exchange rate misalignment on capital flight from Botswana. The examination contributes to the literature in two important ways. First, previous studies posit that the pula is overvalued but there is no study that evaluates the impact of exchange rate misalignment on capital flight from Botswana. The present study aims to fill this gap. The results of this study are important for implementing macroeconomic policies that support capital inflows for economic diversification in Botswana. Further, the World Bank (2019) indicates that Botswana’s diamond mines will be depleted by 2030. In the absence of diamonds, Botswana’s economic growth will decline drastically. Correcting exchange rate misalignment is necessary for early economic diversification and sustainable economic growth without diamonds. Second, this investigation extends Gouider and Nouira’s (2014) methodological approach to misalignment. Gouider and Nouira (2014) defined overvaluation and undervaluation as either positive or negative misalignment without any thresholds. The lack of thresholds in Gouider and Nouira’s (2014) study implies that minor deviations of REER misalignment were included in the estimations. This study uses thresholds to capture only significant REER misalignment. This approach is important for determining which level of misalignment initiates high capital flight as an early warning indicator. This will curb substantial capital outflows, which are needed desperately for economic diversification in Botswana. The use of thresholds in this study allows policymakers to take informed actions in correcting misalignment, for example devaluing the currency. The results show that Botswana should tolerate overvaluation of the pula of only up to 5%. The present study uses the autoregressive distributed lag (ARDL) bounds testing approach to cointegration and the Toda and Yamamoto (1995) approach to Granger causality to determine the relationship between economic variables. The empirical tests of this study indicate that Botswana’s exchange rate fundamentals are terms of trade, GDP growth, aid inflows, trade openness and external debt. Botswana’s REER deviated strongly from the equilibrium REER in the 1980s. Further, the results of the causality test show that this misalignment was caused by current account imbalances. Exchange rate misalignment was not attributable to unsustainable fiscal and monetary policies. Generally, Botswana experienced inward capital flight in the 1980–2015 period. The most important determinant of the country’s outward capital flight is trade openness, which indicates that exportable commodities are falsely invoiced, leading to net capital outflows. Overvaluation of the pula causes capital flight, while undervaluation is a minor determinant of capital flight. In addition, the results suggest that in the long-run, when the currency is overvalued, the volume of capital flight through trade misinvoicing declines and increasing foreign reserves does not reduce capital flight. However, when the currency is undervalued, the volume of capital flight through trade misinvoicing increases and foreign reserves reduce outward capital flight. Based on the results from the current study, the following policy measures are recommended for the sustainable growth of Botswana’s economy. First, the government needs to formulate trade regulations and monitor commodity imports and exports. Second, Botswana should implement capital controls to limit capital smuggling and maintain monetary autonomy. Third, the government should strive to enhance the quality and the size of the domestic stock exchange. Most importantly, the government should accelerate economic diversification projects to reduce reliance on a single commodity. The country should also maintain stable reserves to support its currency in case of a financial crisis.
- Subject
- overvaluation; undervaluation; capital flight; exchange rate misalignment; trade misinvoicing; Botswana
- Identifier
- http://hdl.handle.net/1959.13/1406140
- Identifier
- uon:35597
- Rights
- Copyright 2019 Mpho Bosupeng
- Language
- eng
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