Bhutan and Botswana share a number ofsimilarities. The two countries, land locked small states,have grown rapidly over the past few decades, boosted bysustained, large-scale inflows of foreign exchange.Botswana’s annual real growth rate averaged 9 percent overthe past 40 years, driven by diamond exploration, whereasBhutan has taken full advantage of generous foreign aidinflows to achieve an average growth rate of 8 percent peryear for the past 30 years. However, after decades of rapidgrowth, the production base of both countries remains verynarrow and the economy continues to directly or indirectlydependent on government demand. Job creation, particularlyfor the youths, is an important policy issue. Despite thesesimilarities, Bhutan and Botswana exhibit an interestingcontrast with regard to the management of volatile foreignexchange inflows, and its macroeconomic consequences.Notwithstanding the serious impact of the recent globalcrisis, today Botswana’s external position remains solid,guarded by sizable international reserves and low externaldebt. In contrast, Bhutan has accumulated large externaldebt and its international reserves are under significantpressure. This paper discusses Bhutan and Botswana’sexperiences with managing volatile foreign exchange inflows.It assesses the nature and domestic economic consequences ofvolatile flows, and analyzes the policy measures that havebeen used to respond to revenue volatility. The structure ofthe paper is as follows. Section two analyzes Botswana’sexperience of managing large, volatile diamond exportearnings. Section three reviews more recent experience ofBhutan. Section four draws policy lessons from theexperience of two countries. Finally section five concludesthe paper.
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