Date: 03/09/2009
Source: South African Reserve Bank
Title: SARB: Mnyande: Remarks by the Chief Economist and Executive GM of the South African Reserve Bank, at the release of the September
2009 Quarterly Bulletin and Annual Report 2008/9, Pretoria

The 2009 Annual Economic Report is part of the Annual Report of the Bank,
and reviews the global and domestic economic developments of the past year,
putting it in a longer-term perspective. Similarly, the Quarterly Bulletin
reports on the most recent quarterly, and in some cases monthly, economic
events in the local and international arena, the focus being on the latest
quarter. These two documents are released today, and together provide the
economic context, both longer-term and shorter-term, within which the South
African Reserve Bank has had to operate. The emphasis in my remarks today
will be on the Annual Economic Report, although some of the information in
the Quarterly Bulletin will also be touched upon, as well as elements of the
"Report on Monetary Policy" in the Annual Report.

In September 2008, the global economic situation had already become quite
serious. The past year brought an intensification of the global recession
and a marked deterioration in domestic economic activity.

Economic growth in the advanced economies, which had already been slowing
for more than a year, was stunted, and real production and imports
contracted markedly towards the end of 2008 and in the first half of 2009.
This contraction immediately spread to developing countries as demand for
their exports fell, resulting in declining production volumes and prices,
and a highly synchronised global recession.

In the wake of a severe recession in the global economic activity, commodity
prices - many of which had reached record-high levels in the first half of
2008 - declined abruptly in the second half of the year. This, together with
the widening of output gaps, contributed to a moderation of inflationary
pressures in most parts of the world. With the spectre of inflation being
far less prominent, the focus of economic policy shifted towards
stabilization of the financial system, and support for growth and
employment.

International organisations and forums such as the Group of Twenty (G-20)
played a key role in harmonising such policies. Accordingly, fiscal and
monetary policies were eased considerably - in many instances to settings
that were previously unheard of.

Given trade and financial linkages, virtually none of the systematically
important countries has been left unscathed by this global recession.
Nevertheless, the contraction in real global production expected for 2009 -
some 1,4 per cent - would still leave the volume of world production 34 per
cent higher than in 2000. Broadly similar numbers hold for South Africa.

For Africa as a whole, real growth since 2000 has, on balance, been even
better: allowing for a projected increase of 1,8 per cent in real production
in 2009, the continent's real output would be 61 per cent higher than in
2000. A low base level of income, significantly improved economic policies,
relatively high prices of exported commodities and generally favourable
climatic conditions in recent years have contributed to the robust progress
made by the African continent over the past nine years.

Turning to a somewhat more detailed analysis of the South African economy:
The Bank has continued its analysis on the business cycle and in the
Quarterly Bulletin released today there is an article providing the results
of the most recent exercise to identify the turning point of the business
cycle. It must be pointed out that the Bank works with growth cycles and
therefore identifies turning points on the basis of deviation from trend. So
it is possible to have a downswing even if economic activity is still
expanding: simply put, a downswing is a period when activity contracts or
expands at a slower rate than its trend rate of expansion.

Using an analysis of numerous economic indicators, including the composite
coincident business cycle indicator, the current diffusion index, the
historical diffusion index and key individual indicators, an upper turning
point of the growth cycle was identified. This shows that South Africa's
longest business cycle upswing on record, with its starting point in
September 1999, formally came to an end 99 months later in November 2007. As
a consequence, officially we have been in the downward phase of a growth
cycle since December 2007.

In the course of 2008 the economy lost momentum, ultimately recording
negative growth from the fourth quarter of the year. First it was held back
by interruptions in electricity supply and later by a general cooling off of
final consumption expenditure by households, partly related to high debt
levels, tighter interest rate policies and reduced consumer confidence. This
loss of momentum was exacerbated by export volumes, which fell markedly
towards the end of 2008 and in the first half of 2009, resulting in the
first contractions in real gross domestic product in a decade. Facing
declining sales, firms also reduced their real inventory levels considerably
during the past year.

By contrast, real final consumption expenditure by government continued to
rise during the period under review as the number of civil servants
increased and real non-wage expenditure, such as procurement of military
equipment and hospital and education supplies, expanded.

Importantly, real fixed capital formation - the last of the final demand
components - rose apace as infrastructure expenditure by public corporations
and general government gained further momentum, more than fully compensating
for lower expenditure on residential buildings by households and other
private-sector institutions. Overall fixed capital formation accordingly
increased to almost 25 per cent of gross domestic product in the first half
of 2009; this was the highest ratio in more than 25 years. The bulk of the
infrastructure expenditure had been planned over many years with a view to
removing bottlenecks and raising productivity, while the actual flow of
spending was, in hindsight, well timed from a countercyclical perspective.

Viewed from the production side, over the past year the strongest
contractions in real value added were recorded by the manufacturing and
mining sectors, as both domestic and export demand weakened abruptly.
Reasonably favourable weather conditions in key parts of South Africa
resulted in fairly high production levels in agriculture, while the large
public infrastructure projects supported output in the construction sector.
In the trade, transport, real-estate and financial services sectors, weak
demand conditions were reflected in a decline in real value added.

The weaker economic conditions were also felt in the labour market, with a
notable decline in the number of jobs in the economy.

As capital formation was stepped up over the past years it bolstered
imports, resulting in comparatively large trade and current-account deficits
on the balance of payments. Declining real consumption and large-scale
inventory reductions led to a sharper contraction in imports than in
exports, particularly in the first half of 2009. As a consequence, the
current-account deficit narrowed markedly. The current account deficit in
the first half of 2009 was just more than 5 per cent of gross domestic
product, down from around 71⁄2 per cent in 2008. Quarterly numbers show a
deficit of only 3,2 per cent for the second quarter of 2009. The lower
deficit was due to factors such as the recording of a trade surplus and
lower net service, income and current transfer payments to the rest of the
world.

At the same time, financial capital continued to flow into the country in a
variety of forms and in amounts that more than fully neutralised the deficit
on the current account. In the second half of 2008 the intensification of
turmoil in global financial markets was accompanied by large net outflows of
portfolio capital in the wake of increased risk aversion among international
investors. The simultaneous neutralising capital inflows (or other balance
of payments inflows) could not all be identified, resulting in a significant
increase in the level of unrecorded transactions during the second half of
2008. Coincidentally, this was a period which marked the peak of the global
financial crisis, accompanied by failure and bankruptcy of large financial
institutions. These transactions have trended steadily upward from 2005 to
2008, rising from 1,3 per cent of gross domestic product for the whole of
2005 to 4 per cent of gross domestic product in 2008.

As the global financial system stabilised, unrecorded transactions declined
noticeably to 0,7 per cent of gross domestic product during the first half
of 2009 when debit transactions again exceeded credit transactions. The
smaller ratio compares favourably with a long term annual average of 0,6 per
cent since 1994, when the South African economy opened its trade with the
rest of the world.

Interesting to note is that on a quarterly basis, the positive values
recorded under unrecorded transactions since the second quarter of 2008 most
recently reversed to register a negative value, indicating a moderate
unidentified outflow through the balance of payments. The change in the
direction of unrecorded flows from positive to negative in the second
quarter of 2009 is a good indication that proactive measures taken by the
Bank to minimise the omission of certain transactions are fruitful, since a
persistently large or small figure in one direction (positive or negative)
may imply continuous systematic errors in the compilation of the balance of
payments statement.

On a net basis, South Africa again attracted an inflow of portfolio capital
in the first half of 2009 as global risk aversion eased, while foreign
direct investment inflows continued, particularly into mining and
telecommunications enterprises. Overall, the balance of payments continued
to record modest surpluses, which were reflected in further accumulation of
foreign-currency reserves by the Bank.

The exchange rate of the rand depreciated considerably in 2008, reflecting
large trade and current-account deficits, and later in the year the net
disposal of domestic securities by non-resident investors. From early in
2009 to date the rand, on balance, has recovered part of its earlier losses,
supported by factors such as renewed interest in South African investments
by non-residents and a narrowing deficit on the current account.

Steeply rising prices of oil and other international commodities, a
depreciating exchange value of the rand, and rapidly increasing food prices
bolstered inflation in the first eight months of 2008. Both producer price
and consumer price inflation peaked in August 2008, and subsequently trended
lower as their earlier drivers reversed and as the relatively tight monetary
policies maintained in 2007 and 2008 began to bear fruit.

Up to the middle of 2008 inflation expectations were fuelled by a range of
factors, such as energy prices, which rose to extraordinary high levels, and
ever-higher actual inflation data. To stem, and eventually reverse, this
worsening of inflation and inflation expectations, monetary policy was
tightened further in the first half of 2008, continuing a process that was
started as early as mid-2006. By December 2008, however, lower inflation and
clear signs of a marked widening of the output gap prompted the Monetary
Policy Committee (MPC) of the Bank to reduce the repurchase rate for the
first time since 2005. Further reductions followed in the first eight months
of 2009, bringing the cumulative decrease in the repurchase rate to 5
percentage points.

Growth in the money supply and in bank loans and advances to the domestic
private sector decelerated further in 2008 and the first half of 2009, as
recessionary pressures intensified. While impaired advances rose
significantly under these circumstances, the banks remained well
capitalised, as confirmed by the Registrar of Banks and detailed in the Bank
Supervision 2008 Annual Report. The money market also continued to function
normally and without any disruption in liquidity flows.

The fixed property market remained subdued during the period under review,
with nominal house prices, for instance, recording year-on-year decreases in
recent months. Share prices declined steeply from peak values reached in May
2008 as economic activity slowed and commodity prices worsened. However,
share prices - usually a leading indicator - recovered part of their earlier
losses from early 2009 onwards. Interest rates on bonds declined in the
second half of 2008, but trended higher in 2009 to date, partly on account
of the increase in bond issues by the public sector.

During the year under review fiscal policy became expansionary, partly due
to automatic stabilisers and partly due to deliberate policy actions. Fiscal
prudence in earlier years, leading to a well-contained level of government
debt and debt-service cost, created the scope for government to move from a
national government surplus in 2007/08 to a modest deficit in 2008/09, and a
fairly large projected deficit in 2009/10. The fiscal steps taken were set
to support economic growth, combat economic hardship, unemployment and
poverty, and build infrastructure with a view to enhancing the future
strength and robustness of the economy. The impact of the movement to a more
stimulatory fiscal stance was, of course, reinforced by the significant
easing of monetary policy, and referred to earlier, which commenced in
December 2008.

In conclusion, it is therefore clear that, as is the case in numerous other
countries, the South African monetary and fiscal policy settings are
currently very expansionary. In our view if sustained in more normal times,
this policy mix could easily sow the seeds of the next economic dislocation.
Accordingly, the same international forums that promoted co-ordinated action
to counter the global economic crisis are already discussing so-called exit
strategies, with a view to returning to normal policy settings in an orderly
way without jeopardising the economic recovery.

As the 2009 Annual General Meeting of Shareholders of the Bank approaches,
there are a number of encouraging signs in the economy - some "green shoots"
in the language that has become popular most recently. Internationally the
contraction in activity has made way for a sideways movement or for moderate
increases in production in several of the large developed economies, while
growth in China and India has recently been quite robust. Prices of key
South African export commodities have held up well, while the infrastructure
drive is also supporting current activity and will help to boost our future
productive capacity. For the first time since the early 1980s our fixed
capital formation ratio has risen to around 25 per cent of GDP. Many of the
projects underlying this ratio will continue for several years, stimulating
employment and income. The broader fiscal and monetary policy settings are
also currently such that economic activity, employment and confidence will
benefit significantly. At the same time, inflation is moderating and
projected to inch lower to within the inflation target range. The Bank as an
institution - and the country - look forward to economic recovery, alongside
well-contained inflation.