Diamonds in the Rough

Can a bejewelled sovereign credit be sustained?

Can a bejewelled sovereign credit be sustained?

For the last few weeks, the world of mining and metals has been fixated on thus-far-rebuffed, efforts by BHP to purchase its rival Anglo-American for $42 billion, in what would be the largest takeover in the sector in years. But this blog is concerned with the politics of such a transaction, particularly they may impact the country of Botswana. Despite its name, the historic core of Anglo-American’s assets are in fact in Africa, particularly in South Africa but also in its neighbour Botswana to the north, whose economy is dominated by Anglo-American subsidiary De Beers, the global diamond giant, which some have accused of having spent decades effectively running a price-fixing and marketing cartel to keep its shiny carbon output at sky-high prices.

But for Botswana, diamonds have provided an economic engine and a strong support base for the economy. In fact, it is the only country in Africa to have a credit rating in the ‘A’s’ from any of the three major ratings agencies: Moody’s, Fitch, and S&P Global, with the former ranking it A3. That is higher than the agency rates Spain, Italy, or South Korea, and in line with its ratings for Portugal and Malta. While Botswana’s rating from S&P is one level lower at BBB+, this is still four notches higher than the next-highest-rated country on the African continent, Morocco at BB+.

Diamonds have helped Botswana earn foreign currency, while also avoiding significant external debts. Debt-to-GDP is low, estimated at just 24% of GDP by the end of 2023. Government reserves are also fairly comfortable with reserve levels at US $4.8 billion as of June 2023, albeit a notable decline from their peak of US$10.3 billion in 2008. Nevertheless, this is comfortable, with imports averaging just under $500 million per month.

Botswana's foreign currency earnings are likely to increase, thanks to an agreement struck on July 1, 2023, for a new 10-year agreement with De Beers. It’s worth breaking down the relationship at this stage, because of its complexities.

Botswana holds a 15% shareholding in De Beers, with the rest held by Anglo-American. The recent deal extended the licenses for De Beers’ mines in the country, though these are largely jointly owned 50-50 between De Beers and Debswana, a wholly Botswana government-owned corporation. Under the new deal, De Beers buys 75% of their output and 25% goes to another wholly Botswana government-owned company, the Okavango Diamond Company. Okavango will market them separately to De Beers, or sell them to the company, exposing it to market prices. De Beers also agreed to contribute $75 million to see a new ‘sovereign wealth fund’ for Botswana, Diamonds for Development, to which it vaguely stated it would potentially contribute another $750 million over the life of the deal.

But, Botswana is already being impacted by the BHP-Anglo-American deal. On May 14, Anglo-American announced that it would seek to sell De Beers to raise funds to help it fend off BHP's take-over attempts. The government of South Africa — which is Anglo-American's largest shareholder given its Public Investment Corporation's seven percent stake — has backed the sale. Anglo-American may be a troubled mining company with a market capitalisation that before BHP pounced was down more than 50% in two years, but if De Beers is a standalone company, then it will no longer benefit from having a parent that is diversified into other sectors.

The outlook for diamond prices is mixed, in large part thanks to the development of lab-grown diamonds in recent years. They are aesthetically and chemically 100% the same as the environmentally disastrous process of digging up diamonds from the earth.

The only people who can tell the difference between a lab-grown diamond and a mined one are those in possession of infrared spectroscopy tools, which even many of the most high-end jewellers find cost-prohibitive, leaving them to rely on labs instead. But even these are in theory fallible, as they check for impurities that happen in the natural diamond growing process that diamond labs will likely grow increasingly good at mimicking. The alternative is to use ultraviolet radiation, a test box marketed as ‘DiamondView’ by none other than – you guessed it – DeBeers. One will set you back upwards of $35,000. For that price, you can get this 3.14-carat VS1 vintage diamond engagement ring (or as many as ten diamonds of such quality grown in a lab, if you can source them directly).

That’s because diamonds may be valued for their clarity, but the market is valued for its opacity. There is no standard index of prices, and while this blog does not give financial advice, it is usually recommended that you always negotiate hard when buying the world’s hardest stones, regardless of whether they are mined or lab-grown. Some sellers of natural diamond jewellery will even give you a ‘travel version,’ i.e. a lab-grown copy of your mined goods for free when buying an engagement ring. Prices for the mined ones are estimated to have fallen around 20% last year as a result of the lab boom.

Are diamonds forever? Botswana sure hopes so.

This price dynamic is particularly important for Botswana. Diamonds account for half of government revenue, and 80% of the country’s foreign currency earnings. They are also a major source of employment, though this is often because the mines where they are found in the country are also in key coal basins. And Botswana is doubling down on coal mining and coal-fired power while also developing coal-to-fuel plants, even as the ESG agenda abhors all these things, and financing is increasingly hard to come by.

Are diamonds forever? Botswana sure hopes so, but I would be nervous to bet the house, or in this case, the country on it.

Botswana needs diversification and while ideally, this would come outside mining entirely and thus away from Anglo-American or a new combined entity with BHP, amid all these corporate machinations it’s worth keeping in mind that Africa’s sovereign finance success story could fall apart far faster than its credit rating indicates.