Exchange Rate Misalignment and Capital Flight from Botswana: A Cointegration Approach with Risk Thresholds

Abstract

This study investigates the impact of exchange rate misalignment on outward capital flight in Botswana over the period 1980-2015. The study uses the autoregressive distributed lag (ARDL) approach to cointegration and the Toda and Yamamoto (1995) approach to Granger causality. Botswana's currency misalignment was caused by current account imbalances. The most important determinant of capital flight from Botswana is trade openness, which indicates that exportable commodities are misinvoiced leading to net capital outflows. Our main findings show 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 outward capital flight. However, when the currency is undervalued, the volume of capital flight through trade misinvoicing increases and foreign reserves reduce outward capital flight. Investors respond more to prospects of devaluation than to inflation. Botswana should tolerate overvaluation of the pula of only up to 5%. When the pula is overvalued beyond 5%, capital flight increases substantially. The government has to formulate trade regulations and monitor imported and exported commodities. Botswana should also implement capital controls to limit capital smuggling and maintain monetary autonomy. ). 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 (2014) methodological approach to misalignment. Gouider and Nouira (2014) defined overvaluation and underva...