**1. Introduction**

Botswana is a small, upper middle-income economy in sub-Saharan Africa, dependent on its mining sector. Its principal export commodity is diamonds and prudent natural resource managemen<sup>t</sup> policies have propelled its economy to grow significantly compared to other resource-rich countries. In addition, political stability is one of Botswana's key features. Nonetheless, the country faces major economic problems. First, the capital-intensive mining sector has not reduced the persistent unemployment in Botswana. Second, the country has the third highest HIV prevalence in world, which increases fiscal pressures (Deléchat and Gaertner 2008; Hillboom 2008; Limi 2006; Matlho et al. 2019). In addition, previous studies indicate an important structural problem, namely, that Botswana's currency (the pula) is overvalued (Iyke and Odhiambo 2016; Limi 2006; Pegg 2010; Taye 2012). Limi (2006) and Pegg (2010) indicate that the substantial mining revenue plays a role in this overvaluation. Lindgren and Wicklund (2018) posit that diamond prices and business confidence in Botswana have a negative correlation with the domestic exchange rate. Hence, the important issue considered in this study is the e ffects of exchange rate misalignment on the economy.

The extant literature shows that exchange rate overvaluation can increase capital flight, misallocate resources, abate economic e fficiency and induce unfavourable downward spirals of trade and exchange rate controls (Cuddington 1986; Dornbusch 1984; Edwards 1989; Pfe ffermann 1985; World Bank 1984). 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 undervaluation as either positive or negative misalignment without any thresholds. The lack of thresholds in Gouider and Nouira (2014) study implies that insignificant real e ffective exchange rate (REER) misalignments were included in the estimations. This study uses thresholds to capture only significant REER misalignment. This approach is important for determining which level of misalignment initiates high capital flight as an early warning indicator. This will curb substantial capital outflows, which are needed desperately for economic diversification in Botswana. The use of thresholds in this study allows policymakers to take informed actions in correcting misalignment, for example devaluing the currency. The results show that Botswana should tolerate overvaluation of the pula of only up to 5%. The present study uses the autoregressive distributed lag (ARDL) bounds testing approach to cointegration and the Toda and Yamamoto (1995) approach to Granger causality to determine the relationship between economic variables. This paper is organised as follows. Section 2 reviews the literature on exchange rate misalignment and capital flight. Section 3 presents the methodology used to achieve research objectives. Section 4 presents the results of the empirical models and discussions. Section 5 summarizes the results, reviews the objectives and provides policy implications. It also identifies areas for further investigation and study limitations.
