Knowing the future and Revising the Diamond Projections

Knowing the future and Revising the Diamond Projections

‘De Beers and the Ministry of Minerals Energy and Water Resources should  release, in approximate figures,  the new diamond resource assessment because it will remove uncertainty  about what President Khama meant about Botswana reaming a ‘significant diamond producer’ until 2050 and will help private investors in Botswana make better informed decisions.’

In late 2008, in wake of the financial meltdown,  the worst since the Great Depression of the 1930’s,  Her Majesty Queen Elizabeth, paid a visit to the London School of Economics and posed the incredibly embarrassing question to the assembled economists  ‘how was it that none of you  could see this coming?’She asked. It was a question that could not easily be dismissed because, after all, this was the Queen and she was simply echoing the very question that was on everyone’s lips.  How did the economists get the future so wrong? The number crunchers from the LSE, one of the UK homes of that type of economists who believe they can help mere mortals see the future through their highly sophisticated equations and models looked at their shoes and within a few weeks were spinning all sorts of answers.

Had the Queen gone to Cambridge University she might have come across a few remaining economists who were still literate but not counted amongst the highly numerate charlatans that populate so many universities. Those who were trained by Lord Keynes, the most famous economist of the 20^th century, would certainly have answered what Keynes taught at Cambridge and what every businessman and woman  know-  ‘Mam’, they would almost certainly reply ‘the past is immutable and the future  is unknowable’ This is almost trite but it encapsulates the difficulty that we all face both as people and as businessmen. We make an investment and one it is made that decision cannot be readily changed and we make that investment believing but never really knowing what the future holds cannot be known it offers opportunities. And where we are wrong in our investments and the dice of posterity do not fall in our favour...there is always the bankruptcy court which is market’s way of dealing with fools and uninformed optimists.

In 2008 and 2009 the consensus amongst mainstream economists  was that what was happening to the world was just a financial crisis  stemming from US banks and global investors having mistakenly and with government incentives offered  mortgages to people who did not have the income enough to pay. This is what was called the ‘sub-prime mortgage crisis’. Banks all over the world bought bundles of these American mortgages, often not knowing the laws or even the nature of the asset they were buying, and hence an American financial disaster quickly morphed into a global one.

It was only later, starting in 2010 that some economists began to ask if the 2008 crisis was simply just  a banking crisis then why did it begin amongst the poor and lower income groups in America and why in 2008?  It was then people started to put various bits of the crisis together. The process of analysing what happened in 2008 is by no means complete and hundred of doctoral these are yet to be written. What is known is that there has been a massive shift in the distribution of income in the USA over the last thirty years in favour of the rich and away from those low income workers, ie those who were supposed to pay these sub-prime mortgages. Along with the massive rise in oil and food prices that occurred in 2006/7just  before the 2008 financial meltdown provided the conditions for the economic crisis. No-one saw it coming because no-one was looking at what had happened to the structure of the America economy and those charlatans whose models did not predict what happened were largely looking forward based on one or other variant of what had happened in the past. Driving down the highway looking in the rear vision mirror is never very clever.

Economists Make Mistakes … sometimes big ones!

Late last year I was asked by the Ministry of Minerals to make a presentation on the future of base metal prices. I just giggled. For years I had seen absolutely wrong projections from the IMF, the World Bank and Economist Group on the future of commodity prices. If the economists in any of these  agencies or firms could reasonably predict copper and nickel prices with any accuracy then they would be  very, very rich people and would not be sitting at their work stations  making predictions of the future for a few thousand dollars a month .

We have a similar case with oil prices which should be a lot easier to predict but oil prices have in the last few months slipped from over $110/barrel to under $50 in the last few days. Can anyone find an economist or so called ‘commodity specialist’ who was predicting that the price of oil would halve in 2014? To the best of my knowledge, not a one!  But unlike the far more complex situation with money markets this decline should have been fairly predictable. Between the massive increase in the supply of gas and other hydrocarbons as a result of ‘fracking’ in the US , the collapse of substitute hydro-carbon and fossil fuels eg coal and the weakening global economy there should have been warning bells. But this did not occur.

Is Economics useless?

If your idea of economics is based on believing scurrilous  number crunchers, ie those predicting the future then on the basis of past performance  a saguma will give you results that are probably no worse than most economic forecaster. The famous economist John Kenneth Galbraith once quipped that the only function of ‘economic forecasting was to make astrology look respectable’.  But if your vision of economics is a little humbler, that as a  discipline it exists to help people to understand  what forces shape the world we live in then it is far from useless.

Diamond projections

But there are errors in economics that stem from really bad data and information. Last year I undertook a study for the government about the future of the Botswana economy after diamonds ran out. That of course was based on the assumption that the diamonds would soon run out. I did not try to predict the future but to analyse why the country had not diversified and what would happen when, based on the governments’ own estimates the diamonds would run out by 2027. But those predictions on future diamond production were wrong and superseded in August 2014. All the analysis the government had done which showed that diamond revenue would seriously decline after 2027 were completely wrong. The new resource projections were made by the diamond industry and on  this basis HE President Khama could safely say in the state of the nation address  in 2014 that Botswana will remain a ‘significant  diamond producer’ until the end of the 2050. But President Khama did not elaborate on what  it meant in practice to be a ‘significant producer’- does that mean 5 Mcts o5 25 Mcts per annum as both numbers are significant.

Clearly the earlier diamond projections upon which Botswana’s 10^th National Development Plan were based were completely wrong and they were wrong not because De Beers suddenly discovered a massive new mine but because there is no financial interest in informing the diamond  market that there are far more diamonds in Botswana as it will only serve to depress world prices. But there are  bigger  development issues for Botswana. The new  resource assessment is almost certainly very good news for Botswana as it means there will be no imminent decline in diamond revenues after 2027. For the sake of Botswana I am happy to report that my earlier assessment was completely wrong. But equally the new resource assessment mean for an entire generation the heat is now off the policy makers and as a result no-one will ever think seriously about undertaking the sort of economic reform measures that are needed to drive economic diversification.

 But because the resource assessment is not public the good news about the future of the country is also not public and hence it is vital that the government release the future diamond production projections to 2050 because all private investment in Botswana ultimately rests on this number. De Beers and the Ministry of Minerals Energy and Water Resources should  release, in approximate figures,  this new diamond resource assessment because it will remove uncertainty  about what President Khama actually meant about ‘significant diamond producer’ and will help private investors make better informed decisions about investment. The future, as Keynes said, is unknowable but there is no reason to make the job of business more difficult by not publicising this most important of Botswana’s statistics.  

These are the views of the author and not necessarily those of any institution with which he may be affiliated.

 

 

 

 

 

  

 

 

 

Diamond Beneficiation in Decline in Namibia and South Africa and Stagnant in Botswana

Diamond Beneficiation in Decline in Namibia and South Africa and Stagnant in Botswana

The wages of diamond cutters in Botswana and India are not  dissimilar yet in India there are 800,000 cutters and in Botswana only 3,750. The difference between the two countries stems largely from the productivity of workers. De Beers in its 2014 Diamond Insight Report has said that the cost of cutting in 2013 ranged from $60-120/ct in Botswana while in India the range varies from $10-50 per carat. In other words in the smaller diamonds, Botswana is six times more expensive than India and for the larger more expensive stones, it is almost three times as expensive because of low productivity, low cost of ancillary services as well as the number of working days in the year - 232 in Botswana  as opposed to  over 280 days  in India.  That is the reason that Botswana is limited to commercially cutting stones of one carat rough and above.

The only bit of good news is that at the top end Botswana is becoming a slightly cheaper place to produce than was the case five years ago. But the other two smaller southern African diamond producing countries which are trying to beneficiate diamonds ie Namibia and South Africa are actually more expensive locations than Botswana and it is for that reason along with the supply of rough and what the industry considers draconian beneficiation requirements etc. are also very important issues here) that employment in South Africa has almost halved in the last five years in diamond cutting from 1,800 workers in 2008 to 1,000 in 2013. The situation in Namibia is almost as bad with employment falling from 1,500 in 2008 to 970 in 2013. In other words, with the exception of Botswana diamond beneficiation is going backwards in the main producing countries of Southern Africa. Indeed the costs of cutting in both Namibia ($60-140/ct) and South Africa (130-150/ct) are higher and tend to be rising faster than in  Botswana.  But the increase in beneficiation and the increase in employment is mandated under a 2006 agreement between De Beers and the Government of Botswana.   

If the world’s ‘diamantaire’ had their way no cutting or polishing would occur in Botswana and Southern Africa at all. The answer as to why cutting occurs in Africa is as De Beers politely puts it in its publication because of ‘government policy’. In other words if you are a De Beers sightholder and you want Botswana or Namibian or South African rough diamonds then you have to process some of them here. How much? So far the answer is not very much at all. In 2013 about  23 million carats of rough were produced in Botswana and if the Statistics Botswana figures are to be believed the total volume of polished exports was a mere 273,000 carats in 2013. Assuming it takes 2.5 carats of rough to produce 1 carat of polished diamonds Botswana is in effect exporting 3% of its rough produce. While the value of cut diamond exports has been rising from Botswana the volume of diamond production has been more or less stagnant over the last five years of the De Beers agreement,  

At first the results of the efforts of diamond beneficiation i.e. 3% of production looks very unimpressive until you consider that because of the low productivity in Botswana and the fact that 80% of diamonds coming out of the ground are very small (ie less than 0.2 carat) most diamonds have to be processed in low cost centres like Mumbai and Surat in India where there are 800,000 Indians working cutting diamonds. Jewellery and cut diamonds is India’s biggest manufacturing sector and it exists because the Indians have been able to produce cut diamonds cheaply and because they have access to Africa’s diamonds. The Indians emphasize the former and ,dangerously,  tend to take for granted the latter.

The employment numbers, costs and the general direction of beneficiation are not encouraging in Namibia and South Africa. In Botswana the results are better but require a real reassessment by all governments as to what is being done throughout Southern Africa. Both Zimbabwe and Angola also have serious aspirations to cut and polish diamonds as well. The failure of diamond beneficiation is a direct result of the failure of industrial policy to address the fundamental issues of productivity in these infant industries. In Botswana for example there is not even a diamond school to train cutters and polishers who have been trained by individual firms in the industry. But a school is the least of the issues. It is necessary to come to terms with workers and unions on the productivity issue or the potential benefits of diamond beneficiation will be lost to India permanently. Industrial policy in Africa has helped to create infant industries but has rarely if ever had sufficient focus on the boring, expensive and very ‘un-sexy’ issues of nurturing the infant industry to become globally competitive.

Often there is contradictory policies that serve to weaken beneficiation. On the one hand governments want beneficiation but in the case of Botswana they also want diamond trading independent of De Beers so the buyers from state owned Okavango Diamonds which currently sells some 13% of national production is exempted from the beneficiation obligations and its buyers can simply take their diamonds elsewhere for cutting. This figure is set to rise to 25% over time. Many diamantaire reason - why buy from De Beers and be forced to operate an inefficient factory in Botswana when you can buy from Okavango or Lucara and  just send your diamonds to India for cutting. The thinner the profit margins for cutting become the more the complaints mount from De Beers siteholders. But it is one thing to complain, quite another to give up a secure De Beers site which assures constant supply of diamonds for  profitable Asian factories.

The unfortunate response of some policy makers to the low productivity and stunted development of this infant industry, is as so frequently the case, to merely look for more value added activities such as jewellery making rather than doing the hard graft of addressing productivity issues in the cutting and polishing industry. This involves working with firms and workers to develop appropriate ways of addressing the productivity and cost issues which in turn involves money which governments are unwilling to provide. This is the hard tedious work of day to day industrial policy and there are no simple or pat answers to raising productivity and becoming internationally competitive but if successful it is an activity that could create employment for tens of thousands of African workers.   

But perhaps the most difficult and useful question is how do you deal with the unions and the workers? If you listen to some of the employers they simply wish the unions would go away and they be allowed to increase productivity and take all the increase in profits. Such an approach is unworkable and what is needed is a way of assuring that part of any increase in productivity goes to the workers Without such a productivity sharing arrangement and a partnership between unions and employers,  industrial policy will not work in the diamond cutting sector.  

From a short term perspective the best outcome would be exactly what the world’s diamantaire expect, that the infant African industries will go into terminal decline, as appears to be the case already in Namibia and South Africa, and India will resume its ‘rightful place’ as the natural home of diamond cutting and polishing of Africa’s diamonds. In Africa this outcome will be a political disaster and no thinking ‘diamantaire’, whether Asian or European should wish for as the complete failure of beneficiation as it may well prompt a knee jerk inward looking reaction from African governments when it comes to dealing with diamond trade.

These are the views of the author professor Roman Grynberg and not necessarily those of any institution with which he may be affiliated

 

 

An OPEC for Diamonds- Could it Work?

Would a  ‘cartel-lite’ or ODEC for Diamonds work?

If HE. President Khama’s recent state of the Nation address is anywhere near correct then diamond production in Botswana  will continue at globally significant levels until at least 2050. Industry sources suggest that Botswana’s  production at the main mines at Jwaneng and Orapa could, in theory, continue at similar levels to 2050 but this ultimately will depend on prices and the costs of extraction. Given the P25 billion in expansion announced by Debswana in Maun last week costs of extraction will no doubt rise and while production may continue government revenues will surely decline. The obvious question is whether there is another  way that Botswana  and other diamond producing countries can delay the decline in revenue for at least a few more years.

According to the estimates presented by Dr Rob Davies from Zimbabwe recently at a conference in Gaborone there is scope for Botswana to  have a ‘gentleman’s agreement’ with other major producers to  slow production of diamonds even further than has been the case. With diamonds as with other commodities the only problem in the market is to find a gentleman with whom you can have an agreement.  In what is probably the first public estimates ever it was found that a 1% increase in price of rough diamonds will only result in 0.45% decrease in demand for rough diamonds. Unsurprisingly Dr Davies results show  that the demand for rough diamonds is what economists call ‘inelastic’ i.e. unresponsive to changes in price. This means that it is possible to decrease production and simultaneously increase profits and government revenue at the same time because consumers will not stop buying. Dr Davies estimated that 25% decrease in production would eventually yield a 16% increase in government revenues. 

Planned Contractions?

It was certainly noticed by the International Monetary Fund in its recent 2014 publication on Botswana that the country has become the ‘swing producer’ in the world diamond market. This is in fact not strictly the case and while Botswana is by far the biggest producer in the De Beers  zone i.e Botswana, Namibia and South Africa all have undergone significant decreases in production since the onset of the ‘Great Recession’ which began in 2008. Production was dramatically cut in Botswana from the 30 Mct plus production which was common before the economic crisis to much more modest levels. In 2013 production was a around 23 Mcts.  But the decrease in supply from the De Beers zone in the post 2009 period  was helped by the natural decline of diamond production in what were previously substantial low value producers like Australia. If the Kimberly statistics are to be  believed, then total world production of diamonds peaked in 2005, long before the Great Recession,  at 176 Mcts and declined sharply during the recession but has never recovered and in 2013 was 130 Mcts or 26% off its peak.

 But while Botswana diamond production went through the most dramatic of decreases simply because it was the largest producer in the De Beers zone, similar patterns of decreasing diamond production were experienced in Namibia and South Africa. Irrespective of the origins, the decline in production has given rise to  some of the most spectacular price results seen in the rough diamond market for decades. Unit export values for Botswana rough diamond rose at the their fastest rate since the early 1980’s. This is hardly what economists expect; for prices to rise so rapidly during one of the most sluggish periods of  economic growth on record since the great depression of the 1930’s. And yet what it took was simply an act of restricting supply to the market in a perfectly legal way ie. by keeping the stones in the ground. Part of the observed  decline was of course the natural decline of diamond mines in Australia and other locations.

No gentlemen in diamonds?

So could Botswana and other diamond producers limit production even further to increase returns? In theory yes, but in practice there are several caveats. Any further restrictions in supply and increases in price could result in even greater incentives to substitute, often illegally, synthetic diamonds  which are undetectable to the naked eye for mined diamonds in the production of jewellery. The anecdotal evidence, despite what some of the diamond bourses want to believe, is that  nefarious penetration of the diamond market for smaller stones is already occurring in a significant way. While global production  is declining China is now the world’s biggest producer by far with no mines to speak of and production estimated at around 6-10 billion carats of industrial diamonds.

But even if the world’s’ diamantaires’ are  even willing or let alone able to  keep the synthetics out of the value chain for a few more years there is the perennial problem of any such ‘cartel-lite’ approach to managing the diamond markets – it is the problem of chisellers.  A cartel whether light or heavy version like the Central Selling Organisation  run by so successfully by De Beers until fifteen years ago,  is that they are like a marriage between pathological philanderers where the parties want the marriage but everyone wants to cheat ie, chisel on their partners. The nice thing about diamonds is  that  mined diamonds are really scarce in nature and hence the possibility that when the countries inside the tent decide to cut production that someone outside will just ramp up production as happens so frequently with OPEC and the oil industry is just not there… well at least not entirely.

No Russian Free Riders – Bring Putin in!

Russia has for the last several years just kept its production relatively static but being the world’s largest producer by volume  any agreement to keep the diamonds in the ground would need an agreement between Russia and Botswana at very least. Together Russia and Botswana make up some 45% of global production.  Including Namibia and South Africa would strengthen the arrangement and bring the share of world trade to 55% but the real interlopers at the margin are Zimbabwe ( 10mcts in 2013), Angola(9mcts) and DRC (15mcts) which are significant diamond producers but whose borders are so porous and whose regulatory systems are so opaque that any agreement by them to restrict production would be of  no commercial value.  Even though promises  about output levels from these countries are virtually meaningless it is important that if such an arrangement is ever developed that they are inside rather than ‘outside the tent’.  The only other producers of any significance Australia (11mcts in 2013)and  Canada (10.5 mcts) would almost certainly never agree to join such an arrangement.

A production restricting ‘cartel lite’ arrangement that focused on the larger diamonds( i.e. grater than melee size ,0.2 carat)  and an agreement to limit these rarer but more valuable  stones may have a significant effect on the market and would not require De Beers, Alrosa or BHP-Billiton to involve themselves in what would, at a commercial level be an illegal cartel, that would result in legal action by both the EU and the USA. However, this  would be a perfectly legal inter-governmental agreement to conserve a scarce resource which all countries have the right under WTO rules to do.

An obvious threat to such an arrangement would be new entrants e.g. like the diamond discoveries in Zimbabwe over the last decade. However, new and significant  discoveries of diamonds are actually quite rare and the industry consensus is that  few major additions to mined supply are expected.

The final possible threat to this sort of arrangement might come from the ‘grand diamantaire’ -those billionaires further down the value chain, who because of their own diamond stocks and massive financial resources were able to destabilize the De Beers control of the diamond market in the early 1990’s. At the time De Beers cartel was able to discipline anyone who got in their way. But those days are now long gone and these ‘grand diamantaires’  must constitute the most serious threat to any supply restricting arrangement. Could they successfully destabilize the market as Lev Leviev did in the 1990’s. If Botswana and Russia were to co-operate then the answer is probably not. 

For Botswana this arrangement might work to delay the inevitable decline in diamond revenues for five or ten years. But in diamond deals  there are no sure thing and whether an ‘ODEC’ (Organization of Diamond Exporting Countries) that keeps diamonds in the ground succeeds would have a good deal of luck involved- as is always the case with diamonds.

These are the views of the author and not necessarily those of any institution with which he may be affiliated.    

After Diamonds we shall live like Swazis

After Diamonds we shall live like Swazis

 

Virtually every economist who has studied the country, and there are literally hundreds of them,  have told Botswana what every Batswana already knows in their heart of hearts- that despite the marketing slogan, diamonds are not forever. One day the great diamond mines at Jwaneng and Orapa will close and then what will happen  if   the country has not diversified its exports then Botswana will simply become much poorer. But how much poorer and when? If the modelling estimates that have been presented this week by BIDPA and BOCCIM are anywhere near correct then our GDP/ capita will fall by approximately 48%. What does that mean in practical terms? At present Botswana’s GDP/capita which is the standard measure used by economists to measure a country’s income is US$ 7,300 in 2013 according to the World Bank. If our GDP/capita fell by roughly 48% as the modelling estimates suggest we will live slightly better than Swazis who have a GDP per capita of US3,100.

Now what the modellers have done is work out what would happen to Botswana if the diamonds come to an end. Fortunately this is not going to happen any time soon and most of the estimates indicate that we will be producing some diamonds until 2050. While diamond production will continue the estimates are that a very large portion of the diamond revenue will start to fall off after 2027. Much of the effect of the decline in diamond revenue will be felt by Botswana after that date and it is no doubt part of the reason why the government has moved to establish a fund for future generations which will see savings rise substantially in the coming years.

Beware of good news merchants

The first response to telling people bad news (‘you are going to die a long and painful death’, for example) is usually complete denial. The second response, as I know at my peril,  is to ‘shoot the messenger’ if you can.  One senior economist in government has told me that ‘your work is completely wrong - how can GDP per capita fall by 48% if the diamond mining sector  is only responsible for some 20% of Botswana’s GDP’.   The answer is pretty straight forward – diamonds might only add 20% to Botswana’s GDP but they are over 80% of foreign exchange earnings. Without foreign exchange earnings the whole economy will grind to a halt. Another banking economist  told me that these results fly in the face of all the future projections from the international financial institutions which say that Botswana will have future economic growth rates of 4%- no need for a fund for future generations or these projections that simply panic people. All this assumes that the diamonds will be there… but they are not forever. 

In a similar vein one ‘futurologist’ in Pretoria said  at a workshop I attended last week said that African countries do not have to worry about mining i.e. digging holes in the ground because Africa’s economies are now so diversified. Many of these good news merchants peddle the same economics as I got here in Gaborone but the brutal reality in Botswana and throughout Africa is that digging holes in the ground is what underpins everything else in the African economies and those who forget it imperil future generations who have to live with the consequences of those who do not understand the economic consequences of resource depletion.

Export of Die!

Is there really anything that Botswana can do to avert the dramatic declines in income and living standards that are expected with the end of diamonds. The answer is and has always been that the only way to avert this disaster is through diversification- not diversification of GDP but of exports. In other words when the diamonds run out Botswana  needs other sectors that will generate the foreign exchange the country will need to buy imports. But ever since the opening of the Jwaneng diamond mine in 1982 the government has maintained a policy of export diversification but without success. Botswana’s exports are now even  more dependent upon diamonds now than they were 30 years ago in no small part because of the cutting and polishing  of diamonds is now our largest manufacturing sector with exports of P6.8 billion of cut and polished diamonds in 2013.

The reasons that  Botswana has failed to diversify its export sector for over 30 years is complex but it is certainly not for want of trying or throwing money at the problem. The Financial Assistance Policy for over 20 years spent tens of millions of pula subsidizing industry to employ people to almost no sustainable effect until it was finally ended in 2000. The unavoidable fact is that industry in Botswana has been uncompetitive on  a cost basis and there has never  been sufficient attention ever paid to the very un-sexy job of increasing the nation’s productivity and lowering production costs.

BIDPA ( a national think tank) and BOCCIM ( the chamber of Commerce)commissioned an international cost study of where our costs are highest by doing a comparison between 9 SADC countries and three Asian countries (India, China and Malaysia). What was found was that the area with the biggest cost disadvantage was in the area of highly skilled labour costs, professionals and management. What was found, much to our surprise, was that at the bottom end of the wage scale amongst those who earn the lowest wages,  that their wages were on average lower than that of India. The conclusion of the work was that if Botswana does not lower salaries at the top end, lower company tax rates for exporters to meet our competitors in Africa and dramatically improve transport costs then export oriented firms will never locate there.

Botswana can compete!

There is absolutely no reason that within the context of the 60 million people in the SACU market  that Botswana cannot be a strong and competitive exporter. There is no doubt that South Africa, in both the case of Botswana’s attempts to export electricity and automobiles, has  acted to undermine our efforts but the nation can diversify  if there is  the recognition and the will to face a  national emergency that is at hand and recognize that living standards will drop massively unless we become competitive. This is an incredibly unpopular message and everything I know about people in denial, tells me that it will be forgotten almost immediately the report is received. But if policy makers do not like this message that those on high salaries need to sacrifice current high living standards to be internationally competitive so that the next generation will be able prosper then just wait 20 years or so and market forces will give you no choice once the diamonds run out … because the diamonds, like our current living standards, are not forever.

These are the Professor Roman Grynberg and not necessarily any institution with which he may be affiliated

Botswana's Diamond Fund for Future Generations

Botswana’s New Fund for Future Generations

 

The amount that will be saved, based on 2014 revenues, would be about P5.3 billion ($600 million) in that year and will increase as diamond prices rise in pula terms and so by 2026 when government revenues from diamond mining fall off, could create a fund for future generations worth approximately P120 billion($13 billion), depending of the drawdown rules and rates of return.

 They say that the best kept secrets are always in plain sight, especially for those who look, but never read. So it is with the most profound change in Botswana’s economic policy for decades. No-one really noticed or perhaps didn’t even read what was contained in the Ministry of Finance and Development Planning Budget Strategy document. The strategy paper in paragraph 26 said that Botswana would set aside and save 40% of mining revenue for future generations. The IMF has long been pushing for precisely this sort of policy for a number of years to help Botswana prepare for a post –diamond future and every once in a while the IMF, despite its best efforts, actually gets it right. Of course if you actually believe that the next generation of Batswana , which will have no diamonds,  will be richer than the present generation then the IMF advice is clearly wrong.  But this is certainly one of those cases where the Fund has got it right. This is an unprecedented change in policy and for those who are deeply concerned with Botswana’s post-diamond future it is welcome news and the only reasonable reaction is that it is a good move that should have been implemented 32 years ago when the Jwaneng diamond mine opened and changed the face of Botswana.

 

The amount that will be saved, based on 2014 revenues, would be about P5.3 billion in that year and will increase as diamond prices rise in pula terms and so by 2026 when government revenues from diamond mining fall off, could create a fund for future generations worth approximately P120 billion, depending of the drawdown rules and rates of return. It is understood that it is the government’s intention is to create an annuity type fund where the country will receive a sustainable dividend that will continue long after the diamonds are gone. This type of sovereign wealth fund is used by the best managed resource rich countries like Norway and Qatar that fully realize that their oil and gas revenues will be gone one day and given the amount of money in question know that they need to give the next generation a chance to benefit. What both Qatar and Norway understood was that if they simply took all the huge amount of revenues derived from their natural resources they would end with unsustainable and irrational investments in infrastructure as has happened in so many countries that have abundant natural resources and have not restrained expenditure.

 

While this is a positive move for all those who realize that a poorer Botswana will be left to our children if this is not done. There should be no illusion, one does not save without sacrifice and so there are many questions that need to be answered by the Ministry of Finance and Development Planning to assure that this is a genuine sovereign wealth fund, beyond the immediate financial and political needs of the country. The key issue is who will run it and under what rules and how can those rules be changed. I have seen a similar fund destroyed in Papua New Guinea by an unscrupulous Prime Minister who simply changed the rules so as to be able to use any amount of money he wanted. Some countries have gone so far as to imbed the fund for future generations into their constitution so that only a constitutional amendment can allow a government to use and abuse these funds.

A need to protect the people

Clearly a fund so large needs to be managed by a combination of outside independent financial advisers and relevant officials from the MFDP and the Bank of Botswana. Botswana already has what some people commonly call a sovereign wealth fund – the Pula Fund, administered by the Bank of Botswana. During the ‘Great Recession’ which began in 2008 the Pula Fund was heavily drawn down so as to prop up the nation’s foreign exchange reserves. The Pula Fund, despite the hype, is not a real sovereign wealth fund, it is merely a buffer fund and while this is useful it does not assure that wealth is transferred from this generation to the next.. If there is to be a fund for future generations then it cannot be used in such a manner or it will simply collapse in the face of the economic crisis that will occur in the period after 2026 when the diamond revenues go into serious decline.

The billions that will go into the fund for future generations will need independent people to manage it and it must report to government and parliament directly so as to assure that some future government, that may be less committed to sustainability and sound economic management, does not raid the fund as is regrettably common practice.

The Old Botswana Model has stopped working

What seems entirely missing is the economic question of why the government is doing this at this point in the country’s economic history, rather than 32 years ago when it would have had much bigger and better results. The economic model of Botswana since the opening of Jwaneng has always been that the government takes that diamond revenue and invests it in infrastructure and human resources. This creates an educated workforce operating in a modern environment which can adapt to what the world throws at Botswana. The need for a pool of inter-generational financial resources was never seen as necessary as long as the export sector diversified and there were prospects for Batswana other than diamonds. This unfortunately has never eventuated.

The simple fact is that much of the new government investments in infrastructure and education at the beginning of Jwaneng made a good deal of sense, but as time went on the high yielding investments in infrastructure and in education disappeared and there was progressively more investment in projects that were, to be polite, economically marginal, e.g., giant but empty police stations, standards bodies with buildings big enough to house 2 jumbo jets and investments in yet more tertiary education institutions, while thousands of graduates remain effectively unemployed as interns.

  Who will pay for this fund?

The really important question is where will the billions come from to pay for this fund? It is fine to save money, but someone always pays. Here the government is about as up-front as any government can be with what is a very sensitive matter. The resources will come out of a more prudent policy on wages and salaries in the public service. The Budget Strategy Paper states ‘The implementation of the fiscal rule will therefore require measures to control and manage expenditure, especially the wage bill’. Those who welcome this unambiguously also emphasize that some of the government’s less effective pet projects will have to be abandoned and there will now have to be a more rigorous project evaluation. This is extraordinarily naive. One can only hope that this view is right; but in the real world it is usually the deeply political projects and not necessarily the sensible economic ones that will go ahead- fund or no fund.

The ones who will pay will in part be the public servants who will receive lower real wages and the public at large. The hardest thing to imagine is that you are overpaid. But the simple reality of Botswana’s economy is that salaries of professionals and managers are simply too high for any export-oriented diversification to occur. It is one of the big ticket items explaining why Botswana has never diversified. This is an incredibly unpopular thing to say, but its unpopularity does not make it less true. Professional salaries are the part of what makes Botswana so highly uncompetitive. Restraint in the public sector salaries is an important part of addressing this issue, but also breaking up the ‘professional cartels’ that limit competition from foreign lawyers, accountants, architects and engineers needs to occur in order for Botswana to become internationally competitive. It is not the wages at the bottom of the pay scale, which are lower than that of India, that are the problem, but the salaries at the top are amongst the highest in the region.

The only negative thing that can be said of the government’s proposed fund for future generations is that it is simply too little and too late in Botswana’s economic history to stave off a major fiscal crisis that will surely come around 2026, when diamond revenues fall drastically. But it will provide the country with some cover.

 

BIDPA, together with BOCCIM, will be organizing a conference on November 13th which will be discussing Botswana’s future after diamonds. Some of these issues will be addressed at this meeting.

 These are the views of the author and not necessarily those of any institution with which he may be affiliated.

Governance in the Mining Sector -Mozambique and Botswana

Governance, Shmuverance

Last week the EU and US ambassadors in South Africa were reported to have  at the Ernst and Young  Strategic Growth Forum Africa 2014, saying that their private sector was really looking for places to invest but was highly concerned about good governance. The  EU ambassador to South Africa Roeland van de Geer was reported to have said last week “Governance, the political will and the political climate is incredibly important, and there is an increased interest in investing outside the EU in countries that are transparent and open. Money will go where it’s welcome,” he noted during a panel discussion at the EY Strategic Growth Forum Africa 2014. US ambassador to South Africa Patrick Gaspard was reported to have added that a combination of good governance and effective regulation in any State culminated in the “perfect storm” for attracting investment.

Responding politely and with all due respect to their excellencies, their conclusions  regarding the importance of corruption in determining investment seem to be at variance with the facts on the ground.  There is no doubt that the appetite for corruption varies from country to country and firm to firm and US and EU firms are under strict national laws such as the Foreign Corrupt Practices Act in the US not to offer bribes or involve themselves in corrupt practices when operating abroad. There is no way that large mining companies want to do business in the eastern Congo but there are people who will help. That is precisely why in every capital or every country in Africa and throughout large parts of the world you will find ‘brown bag men’ who are paid ‘commissions or finder fees’ to act as ‘agents’ for large transnationals and pay the bribes to corrupt officials, something that could not be done directly. In this way the good and the virtuous Americans and Europeans do not have to do precisely what businesses from Latin America and Asia have no compunctions or even national legal restraints in doing. Thus the commissions paid to the brown bag men are efficient ways  to operate in environments where their governments and share holders do not wish to dirty their hands with the reality of daily business.

Of Botswana and Mozambique

Perhaps no contrast is sharper than that between Botswana and Mozambique. On the Transparency International Index Botswana ranks as the least corrupt country in Africa with a position of 30^th in the Transparency International Index but  Mozambique on the other hand ranks as 119^th out of 177. It has minimal budget openness and while it is a  beautiful country, with fine food  and wonderful people  it is just not a country that has  developed a  reputation for the probity of its officials and ministers.

Corruption exists everywhere and Batswana complain bitterly about corruption in the country but they are simply not used to the sort of grand malfeasance found in Mozambique. It is simply on another plain, another dimension altogether from the corruption found in Botswana. Perhaps the best example from Mozambique of the nature of that country’s  corruption problem is the murder of Mr Orlando José, who was Director of Audit, Intelligence and Investigation of Mozambique. His responsibility had included the internal investigation of customs services. He was killed on 26 April 2010, only three hours after announcing on national television that three imported luxury cars had been impounded in Maputo for various illegalities. Regrettably the death of Mr Jose is not the only case in Mozambique’s struggle against corruption. The violence and level of corruption in Mozambique is simply off Botswana’s scale.

 Location, Location, Location!

If one believes their excellencies, and you have to be very young to do so, then all the good governance loving resource firms of the  developed world would be investing in Botswana and not touching Mozambique with a proverbial barge pole.  Yet the opposite is of course the case. Mozambique is experiencing a massive boom in foreign direct investment and it is expected that Mozambique will have a growth rate of 8.3% this year, up from 7.1% the previous year Why, one asks in  Botswana  which is not only highly placed by Transparency International but also by  Canada’s  Fraser Institute  which ranks it very highly as a place to do be involved in mining activities. So why is Botswana getting very little FDI and Mozambique is booming?

Botswana has Africa’s biggest deposits of coal,  with an estimated resource of some 212 billion tonnes though the known reserves are much smaller. Yet it is the smaller coal fields in Mozambique that are being developed by the Brazilian giant Vale and exports are expected to reach 50 million tonnes per annum within a decade. The answer is location, it will cost Botswana USD10 billion to build a heavy duty railway from the Eastern Kalahari coal fields to the Indian Ocean and then if we are lucky we will have to pay USD20 per tonne to get Botswana’s coal to Mozambique. Being landlocked is a real drain on the development of Botswana.  For that sort of money you can put up with a whole lot of corrupt officials and so the choice is obvious, the rich deposits of the eastern Kalahari are still in the ground while Mozambique’s coal is already on the market. On top of the coal Mozambique has huge off-shore gas fields which being developed by, you guessed it, European firms like ENI and American firms like Anadarko. 

To give primacy to the role of corruption in dissuading investors from exploring and developing highly profitable natural resources is simply disingenuous. But equally underestimating the potential longer term effects of severe corruption is commercial folly. Companies enter many countries expecting to deal with corrupt officials. But sometimes they find the level of corruption is such that it is simply not worth the effort of staying and they leave, no matter how rich the resource or the market. This departure of foreign investors happens frequently and often quite publicly in countries like Nigeria.

These are the views of the author and not necessarily those of any institution with which he may be affiliated.

 

 

 

 

 

 

 

A Tale of Two Breweries- The Limits of Sovereign Industrial Policy in a Globalized Market

(This story is from 2012/2013 and illustrates the, at times, predatory nature of industrial policy in Southern Africa)

 

It is with great sadness I found that Botswana has a structural deficit in the trade of beer. Year in, year out Botswana  imports much more beer than we export and the deficit is growing exponentially. In fact in 2011, according to CSO statistics, we imported Pula 124 million of beer up from a mere Pula 3.6 million in 2007. Exports on the other hand were a mere Pula 30 million, up from  Pula 0.5 million in 2007. Now the interesting question is why on earth Botswana imports that much beer? Is it because the local brewer Kalagadi Breweries Limited (KBL) which is a subsidiary of the global giant SAB-Miller  can’t keep up with demand for its chief brand  St Louis. Hardly! The reason is because its only real competitor ie Heineken Diageo which is in a strategic alliance with Namibian Breweries (NBL) has been making serious inroads into the local market. If you listen to KBL the only reason has been because of the way in which the alcohol levy was applied which gave the biggest import- Windhoek of which many Batswana are very fond. The alcohol levy used to be imposed on the import price of beer and on the retail price which gave NBL a massive price advantage over KBL. The other alternative explanation is that for years KBL has basically become a lazy monopoly in the market and could get away with one local brand St Louis* and really had to do nothing else until NBL and the alcohol levy shook the market.   

To thinking beer drinker ( i.e those before the third glass) the immediate response to this should be,  who on earth cares? Well it should matter but not to beer drinkers as long as we are allowed to choose where our beer comes from. But the trade statistics hide a genuinely fascinating story about business and government policy in SACU. The brewery game is dominated by two players in Southern Africa – SAB-Miller and Heineken Diageo which operates with NBL. Basically despite the variety of brands available on the SACU market to suit everyone from your day laborer to the CEO there are really only two commercial choices of breweries available and SAB-Miller remains by far the biggest player in the SACU market.  

But the really interesting beer story is not the Goliath of the industry ie SAB Miller but the David ie Namibian Breweries Limited (NBL). Unlike KBL, NBL is a local Namibian owned company which over many years has had considerable assistance from the Namibian government and has done  what almost no other brewery in Africa has managed to do,  which is to create a recognizable African brand across three continents. It now exports to over 20 countries. The Namibian government helped first by keeping SAB Miller from either buying NBL or establishing a brewery in Namibia in the mid-1990’s. The Namibian government then helped with a range of export promotion activities knowing full well the benefits to the country as a whole of having a globally recognized brand. But most breweries hate exports- they normally considered these junk volume sales because the profit margins are usually low due to  the transport costs of such a low value to weight items. This eats into the slim margins available in an industry that is so heavily taxed by government. But the real difference between KBL and NBL  was that the Namibian brewer had a tiny market of 2 million people in Namibia and it was either grow by export or die.

In Botswana KBL was never under such commercial pressure.  NBL, according to the company’s mangers derives some 60% of sales from exports  and its two biggest export markets are South Africa and Botswana. In 2010 Namibia exported Rand 1.3 billion in beer and it is one of the most important examples of the country's export diversification.

Why has NBL’s Windhoek brand been so successful? In part it has been what the beer marketing people call ‘premiumisation’. NBL took the German colonial origins of Namibia and turned it onto an advantage. The Rheinheitsgebot   which is the 16^th century German beer making standard is used for making Windhoek which assures that only water, hops and barley are used  which assures purity.  This has been a major selling point for Windhoek at the premium end of the market. In Botswana, KBL has, twenty years too late, discovered  that it might be losing the market not just because of price and taxes and has recently introduced a new premium St Louis Export which has started winning awards.   

           The economics of trucking huge volumes of beer across the Namib and the Kalahari from Windhoek to Gauteng and Gaborone is really poor. Because beer is a low value to weight item you simply destroy your profit margins. It is one of the reasons that SAB Miller’s business model in Southern Africa is based on  breweries in each of the countries in which it operates and then those breweries will produce not only the local brand but also the whole stable of SAB Miller products. This model is not unique to SAB Miller and almost all breweries look for local firms to produce their products under license. Guinness, the world famous Irish black beer is produced under license in a score of countries with no access to Liffy water as the basic ingredient for all Guinness purists.

In 2008 NBL saw the enormous advantage of trying to produce its products in South Africa rather than reducing its margins and shipping beer to Gauteng. So when its partners Heineken Diageo decided to establish a Rand 7.7 billion brewery in Sedibeng in Gauteng in the run up to the World Cup, NBL decided to shift a part of its production to Gauteng. The decision over where to establish the brewery was not purely a commercial one. The government of South Africa, according to NBL as well as DTI reports, provided considerable tax concessions to set up in such a high unemployment area. Since 2008, if the Namibian trade statistics are to be believed, both the value and volume of beer exports from Namibia have been flat. NBL says the figures are inaccurate but refused to provide its own. The bigger bottles are now being produced in Sedibeng and for the moment the smaller bottles are still coming  across the Kalahari. But eventually the transport economics dictates that exports from Namibia should diminish greatly.

Since the move to Sedibeng in 2008 there has been a perceptible shift in policy towards competition to NBL in Namibia. In 2010 the government of Namibia authorized the building of a brewery in the country by SAB Miller which it had previously blocked in the 1990’s. The SAB Miller brewery has not yet started construction.

There are at least two lessons from the SACU beer saga. The first is that South African tax concessions only strengthen the natural commercial forces that drive business to areas of high economic density like Gauteng. The government of South Africa might wish to stop aiding the loss of diversification from one of its neighbors. For all the smaller SACU partners all this is part of century long process of Pretoria behaving in a commercially predatory manner and is nothing new. It should also be an object lesson to those in Gaborone designing the current Economic Diversification Drive that foresees the establishment of local firms first that produce for the local market and then is a second and later stage move into exports. The experience of KBL and the whole SABmiller business model simply means that this will never happen because more exports mean less profits for the group as a whole. There is no avoiding the lesson of Namibia that a lean and hungry business helped by government to export can do much better in terms of export diversification than any inward looking approach to diversification. NBL exports ZAR 1.3 billion from Namibia and KBL exports P 30 million  from Botswana – the  numbers speak volumes.

[*According to senior officials from KBL the local Botswana  bee,r St Louis is named after city in the USA, not the French patron saint. Why one asks, would anyone in Botswana name the national beer after a big but relatively uninteresting American city? The response given to me by those officials was that this was done because Batswana like big American cities. This seems curious and if anyone has a better and  more credible explanation it would be appreciated]