The pula-dollar exchange rate and the purchasing power parity in Botswana

For the small open economy of Botswana the PPP theory is validated in both the absolute and relative version for the Pula-Dollar exchange rate during the sample period 1992 third quarter to 2002 fourth quarter. The Pula-Dollar exchange rate is determined by the long-term trends in Botswana’s Consumer Price Index (CPI) and the USA’s CPI. The influence of the USA CPI is considerable. In the long-run there is no trade off between export competitiveness through devaluation and inflation. But as the speed of adjustment in the short-term towards long-term is slow, there is some flexibility for the exchange rate policy. The monetary policy can be used in the short-run to counter the inflation. There is no real appreciation of the Pula in the long run. This contradicts the portfolio balance theory which advocates that for a trade account surplus economy like Botswana the real exchange rate will appreciate through the limited demand for foreign assets. The lesson for the exchange rate policy for Botswana may be that it is better to keep more flexible the Pula-Dollar exchange rate than keeping it totally fixed.