This first research study to investigate the efficiency of the foreign exchange market in Botswana, by Gofaone Matebejane, Gaotlhobogwe Motlaleng and James Juana, titled “Foreign Exchange Market Efficiency in Botswana” has found that “the foreign exchange market is efficient at least in the weak form”. The study uses the 15-year data from 2000 to 2015.
An efficient market implies that exchange rates are aligned and does not lead to arbitrage behaviour while an inefficient market implies exchange rates are misaligned which results on arbitrage behaviour.
An efficient market entails that it is not possible for market participants to make above normal profits using past information or following history of the exchange rates. As such, the Botswana exchange rate policy has been a success in terms of “it bringing efficiency in the market as far as the weak form of efficiency is concerned”.
According to the research study, the issue of foreign market efficiency might be attributable to success or failure of some policies and as such filling this research gap can help in improving policies. It is therefore important to know whether foreign exchange market is efficient or not so that proper measures are taken if the market is inefficient.
“An inefficient market implies that exchange rates exchange rates are misaligned which results in arbitrage behaviour”, states the research study.
The efficiency of foreign exchange markets continues to play an imperative role in monetary policy making. The concept of market efficiency means that “markets should fully and instantly reflect all available information to participants”. This implies that it should be impossible for speculators to make excessive profit.
Also, past practices should not have the predictive ability of future prices. Efficiency in markets is distinguished based on the information that is used to form expectations about future prices. The first is the weak form efficiency in which prices reflect all historical information. Secondly, the semi-strong form of efficiency in which prices reflect all publicly available information. Lastly, is the strong form of efficiency in which prices reflect all private and public available information.
According to the research paper, there are two types of efficiency, the operational and allocational efficiency. Operational efficiency is focused on the presence of willing sellers and buyers, supplying and demanding funds and can carry out transactions effectively.
Thus, the efficiency here is in regard to how effective a market is in bringing buyers and sellers together. In this type of efficiency, an efficient market is one in which buyers and sellers can make transactions cheaply.
Allocational efficiency focuses on the ability of security prices to equalize the risk-adjusted rate of return on all securities. When a market is “allocationally efficient” there is an optimal allocation of savings to investment with all participants in the market place benefiting.
The efficient market hypothesis may fail if there are people who continuously make above normal profits from market anomalies. A market anomaly is a behaviour that is deemed to be inconsistent with the efficient market hypothesis and may be used for forecasting. Anomalies that have been documented include mean reversion, overreactions, the calendar effects and trading activities by insiders.
A common anomaly in the foreign exchange market is the calendar effect. The January effect is a hypothesis that in the month of January there is a seasonal anomaly in the market. Here, securities’ prices increase more than in any other month and creates opportunities for investors to buy stocks for lower prices before January and sell them after their value increases.
This effect results in some investors getting above normal returns. Prices of assets in a market are described by a random walk-in which asset prices do not portray any particular pattern.
The efficiency or inefficiency of a foreign exchange market has serious policy implications. “In a market where foreign exchange is inefficient, a model that best predicts exchange can be devised. As a result, an inefficient market makes opportunities available for arbitrageurs and speculators to make more profits in foreign exchange transactions”, states the research paper adding, “for government authorities, market inefficiency allows for a way to determine the best way to influence exchange rates”.
For example, reducing exchange rates volatility and providing an opportunity to assess the consequences of different economic policies. Conversely, in an efficient foreign exchange market, there is minimal need for government intervention.
Like many countries, Botswana’s major exchange rate policy is to achieve a stable exchange rate. Furthermore, it is aimed at maintaining and enhancing the international competitiveness of domestic producers.
A stable exchange rate is aimed at improvement on the balance of payments while enhancement of international competitiveness is aimed at macroeconomic stabilization, for instance, low inflation.
The Botswana exchange rate policy reflects the importance of the need to promote Botswana’s competitiveness as in the economic diversification strategy. As a way of attaining international competitiveness, Botswana saw the need to promote non-traditional exports and import substitution activities. The Botswana exchange rate therefore attempts to shift out the sector of non-tradable goods into tradable goods thereby boosting output, employment and profits of the non-tradable goods.
Similar to many developing countries, Botswana adopted the intermediate exchange rate regime in an attempt to alleviate the vulnerability to volatility of an independent float as well as the straitjacket of the fixed of the fixed exchange rate. The intermediate exchange rate regime enables Botswana to benefit from the two extreme exchange rate mechanisms.
Another important goal of the Botswana exchange rate policy is to maintain a stable real exchange rate with the country’s major trading partners. As a result of this objective, the authorities strongly monitor the relative inflation performance between Botswana, the SDR and South Africa.
In cases where the inflation differential is considered to be unfavourable to the attainment of the real exchange rate stability, then the authorities put in place corrective interventions in an attempt to restore the given exchange rate objective.
However, the corrective measures are not only limited to the exchange rate mechanism but also consist of monetary policy action to an inflation objective. In most cases, the monetary policy is often preferred over the exchange rate mechanism.
A substantial change in the exchange rate policy was in 2005 when the crawling peg system was adopted. The rate of the crawl was based on the differential between the Bank of Botswana’s inflation objective and the inflation forecast in trading partners.
