By Cavan Osborne, portfolio manager, Old Mutual Investment Group
Key takeouts
- Botswana’s diamond mining industry, the backbone of its economy, faces challenges from the rising popularity of lab-grown diamonds.
- Lab diamonds have captured 15% to 20% of the market due to their affordability and quality, leading to a sharp decline in natural diamond prices.
- The drop in diamond revenues has forced the government to deplete its investment reserves, reducing the country’s growth outlook and putting social benefits at risk.
- Botswana’s listed companies, particularly banks, are reporting record profits, driven by high interest rates.
One of Africa’s most politically and economically stable countries, Botswana, has been dealt a few curve balls in the recent past, from collapsing diamond sales (which is the mainstay of the economy) to trade issues. Unpacking the diamond challenge first, just in the first quarter of this year, mining’s contribution to gross domestic product (GDP) was down 25%, dragging the overall GDP to a decline of 5%. Further, a trade war with South Africa has elevated food prices, leading to higher-than-normal inflation.
These challenging times have contributed to the Botswana Democratic Party losing power after 58 years in the October presidential elections.
Botswana is a low inflation country
Botswana is one of the largest global producers of high-quality diamonds, the type used for jewellery rather than industrial use. Laboratory-grown diamonds have been around for some time, but it seems they are finally gaining traction in the jewellery segment. This ‘increased supply’ has led to the price of natural stones falling sharply, and this will have a negative effect on countries like Botswana that produce natural stones. Ten years back, lab-grown diamonds sold for just less than natural stones, now they typically sell for 80% to 90% less, as technology has improved, bringing manufacturing costs down. Lab-grown diamonds are chemically and visually the same as mined diamonds. They are created by replicating the same pressure, temperatures and use of gasses, but the process takes a few weeks rather than a billion years. These diamonds come in the same colours and with the same flaws as the natural ones.
Interestingly, while natural diamond pricing increases exponentially with size, lab diamond price per carat only increases marginally with size. There are two ways in which these lab diamonds are manufactured. The one method puts pure carbon under pressure creating a crystallisation, and the other takes a slice of a natural diamond and uses microwave technology to bake and grow the natural diamond’s DNA. Don’t ask me how! I took that one course in crystallography at university, and growing diamonds was not part of the syllabus back then. If it had been maybe I would be a diamond farmer today rather than an investment manager.
The lab-grown diamonds have grown market share significantly over the past decade or so, increasing from around 1% in 2015 to between 15% and 20% currently. This could be attributed to the big difference in selling price between types of stones. A two-carat natural diamond sells for around $14,000, while a lab equivalent sells for around $1,000. However, reports indicate that lab diamond prices have bottomed out because selling prices are now very close to production costs. China is the leading producer of lab diamonds.
Diamond mining accounts around for 4% of Botswana’s employment, 30% of its GDP and 85% of its exports. So, the pricing of natural diamonds matters. The recent drop in revenue from diamonds has led to Botswana tapping into its Government Investment Account (GIA). Botswanans have long enjoyed some of the best social benefits in Africa such as education (including offshore study), healthcare, pension and feeding programmes. The GIA has fallen from 19bn pula in May 2023 to just 4bn pula. The growth outlook for Botswana has been cut from 4% to 1%. There are concerns about the depletion of reserves and the state may need to reduce social grants.
Botswana has historically been a good example of sharing resource spoils across the nation, rather than being concentrated in the hands of the elite. It does appear though, that with the mainstay of diamonds being under pressure, Botswana is being exposed as not promoting local industry sufficiently to sustain the economy into the long term. This is often known as the resource curse, and it leaves a country vulnerable.
This realisation is one of the drivers of the trade war with South Africa. Botswana is upset about the trade imbalance with most goods being imported from South Africa, with very little trade going the other way. So, Botswana has banned the import of many fresh products like tomatoes and potatoes. Potatoes are selling for three times more in Botswana than across the border in South Africa. Fast food meal deals, promote a side of chicken nuggets rather than fries. Botswana farmers are not able to meet local demand and in the short term, the locals are suffering the high prices because of limited local suppliers. Some political differences have probably also contributed to the trade war, centred around views on Zimbabwe.
But there are still some good stories to tell from Botswana. Many companies listed on the Botswana Stock Exchange are all reporting record profit levels. Banks are the most valuable listed companies, with FNB Botswana being the highest at $1bn. Like most African banks, Botswana banks are benefitting from the high interest rates. Even the consumer business of Sechaba (beer and soft drinks) and Sefalana (diversified but largely food retail and wholesale) are enjoying strong revenue.
Pension reforms underway
Botswana is also in the middle of a pension fund reform. At the end of 2023, local pension funds needed 38% local exposure, which must now increase to 50% by the end of 2027. Already the local banks have seen flows back into the country. FNB Botswana reported a 30% increase in deposits, attributing much of this growth to the onshoring of pension money. With a population of around 2.5 million people, the potential profit pool in Botswana has a ceiling (when compared to countries like South Africa with 60 million and Kenya with 55 million). So, with limited local investment options, the increase in local requirements for pension funds means that asset prices in Botswana are likely to be supported and that rates on government treasuries are likely to remain low. The two largest banks in Botswana are already trading at healthy levels when compared to market leaders in some other African countries.
The leaders of the country have a tough job ahead of them. While listed businesses are performing well, it’s important for the economy that the mining sector performs. The biggest uncertainty of whether lab-grown diamonds will turn out to be a fad or not is not the best place to be in.
This article was first published by Old Mutual Investment Group.
