WASHINGTON 26 SEPTEMBER 1999
INTRODUCTION:
At the time of last year’s International Monetary Fund and World Bank annual general meetings, South Africa was still in the midst of the emerging markets crisis. The economic turbulence spread to South Africa in May. At the time, it was generally expected that South African interest rates were about to fall, paving the way for economic improvements.
Instead, the picture changed suddenly. The rand came under speculative attack, losing about 20% of its value over the year. The big inflows of capital, which saw almost R50bn flow into South Africa in portfolio investments in the first half of the year, dr ied up as foreign investors lost their appetite for risk and fled to quality. The Reserve Bank had no option but to pursue restrictive policies. The repo rate moved sharply upwards by about seven percentage points from the beginning of May to 21,85% in Aug ust last year.
Restrictive policy measures were necessary, as foreign investors sold off South African bonds and the current account of the balance of payments deteriorated at the same time. South Africa’s exports were affected negatively by low international commodity p rices, while imports remained high because of public sector investment in infrastructure.
Although the South African economy was technically never in a recession, the setback was severe and sudden. Consumer and business confidence received a blow and South Africa’s unacceptably high unemployment rate deteriorated further. By the end of the firs t quarter of this year, the number of workers employed in the formal economy had declined by 42 000 from a year before.
Fortunately, today we can report that the economy has recovered well from last year’s turbulence. The return to financial stability has enabled banks to reduce their lending rates. Last week, banks announced a 100 basis point cut in their prime and mortgag e lending rates to 15,5%. This reduction leaves prime about 250 basis points below its pre-crisis level. The prime rate peaked at 25,5% about a year ago.
We now expect South Africa to achieve some significant economic growth while inflation remains well under control. Barring any unforseen international shocks, we also expect the balance of payments situation to remain comfortable.
I will now provide you with a more detailed picture of the South African economy, before turning to policy issues and the way forward.
ECONOMIC GROWTH:
Economic activity was already in a downswing in South Africa when the full force of the Asian crisis and the Russian debt moratorium in August 1998 hit home last year. Real gross domestic product (GDP) fell at an annualised rate of 2,3% in the third quarte r of last year, pulling overall growth for the full calendar year down to just half-a-percent. Domestic spending slumped as interest rates soared, and the fall-off in Asian demand for South Africa’s exports, as well as the fall in global commodity prices, also took their toll on GDP.
The country’s economy experienced an unexpectedly big setback, but proved its resilience. There was only one quarter in which GDP actually fell, but it bounced back quickly, albeit at very low rates of growth at first. Fortunately, the economic growth rate has risen progressively over the past three calendar quarters to reach an annualised 1,7% in the second quarter of this year.
Interestingly, the economic downswing differed from the previous two downswings as overall GDP growth remained positive over the period. Technically, South Africa was never in recession.
Still, economic growth has been far too low for a country in which many people live in terrible poverty. But we are nevertheless pleased that we managed to some extent to contain the costs of last year’s global crisis. Economic growth this year could excee d last year’s half-a-percent, and is expected to pick up further next year.
SPENDING AND SAVING:
High interest rates put the squeeze on consumer spending, which in the first quarter this year fell for the first time since the end of 1992 and then remained virtually flat in the second quarter. (All figures are seasonally adjusted quarter-on-quarter ann ualised growth rates, unless otherwise stated.)
When interest rates shot up during the crisis, consumers found that they were too deep in debt and they could not maintain their spending habits. Many people also feared that they might lose their jobs, as companies battled to adjust to the sudden rise in interest rates. As a result, spending on durable goods, such as motor cars, plunged.
Living on credit became such a battle that many South Africans decided to reduce their debts rather than spend more. As a result, the ratio of household debt to household disposable income declined from 61,5% in the first half of last year to 59,5% in the first half of this year.
Overall saving, which has traditionally been one of the weak features of the South African economy, has also improved, rising from 13% of GDP in the fourth quarter of 1998 to 15% in the second quarter of this year. The improved savings performance reflecte d increased saving by households, general government and companies.
South African companies were affected by the adverse business climate, which had a negative effect on capital expenditure in the private sector. Overall capital expenditure in South Africa was also depressed this year by weaker public sector fixed investme nt. Last year, public sector investment surged as a result of spending on telecommunications infrastructure and transport equipment.
Total real spending on gross capital formation fell at an annualised rate of 9,5% in the second quarter of this year, after falling 24,5% in the first quarter of this year. Last year, however, real capital formation still notched up positive growth as a re sult of substantial spending by Telkom and South African Airways.
INFLATION:
South Africa’s inflation performance has been remarkable. Headline consumer inflation fell from an annual rate of 9,4% in November last year to 3,2% in August this year. While this rate is within the informal upper limit for inflation of 5% set by the Rese rve Bank, it is important to note that recent declines in mortgage interest rates dragged the overall number down.
Core inflation, which excludes mortgage bond rates and is therefore a better signal for monetary policy, has remained sticky in a 7% to 8% range. Core inflation dropped from 8,2% in July this year to 7,9% in August. We are convinced that the core inflation outlook for next year is favourable, although oil prices could have an adverse effect in the immediate term.
CREDIT AND MONEY SUPPLY GROWTH:
Money supply and credit growth, which for awhile had remained stubbornly high despite high real interest rates, fell this year to within the upper limit of the Reserve Bank’s guideline for growth of 10%.
The annual rate of growth in credit has slowed down from a recent peak of 21,7% in August last year to 9,7% in July 1999. It took an unexpectedly long time for the private sector to lose its appetite for credit. We believe the credit and money supply growt h rates remained high as a result of "financial deepening" - the fact that more and more South Africans who previously did not make use of formal banking services are now becoming part of the system. High turnovers on the financial markets could also have helped swell the credit figures.
Nevertheless, now it seems the corner has been turned. To the extent that low credit and money growth is a signpost for future inflation, we are encouraged by the figures.
BALANCE OF PAYMENTS:
The current account balance has improved markedly, from a deficit of about 2,5% of GDP in the last quarter of last year to a surplus of 0,6% in the first quarter of this year, and a small deficit again in the second quarter of 0,4% of GDP. The global econo mic recovery helped South Africa’s exports in the first quarter of this year, but some momentum was lost in the second quarter.
Net inflows of capital have been positive for three consecutive quarters. Portfolio investment into South Africa are flowing strongly again after slowing down to a trickle during last year’s global financial turbulence. Foreign portfolio investment strengt hened from a meagre R1,4bn in the second half of last year to R10,9bn in the first quarter of this year and R26,1bn in the second quarter. The second quarter inflow was the second-highest inflow of portfolio capital ever recorded in any quarter - it was ex ceeded only by the inflows in the first quarter of last year, before the crisis struck.
The overall surplus on the balance of payments has helped the country to improve its foreign exchange reserves. Net reserves improved by about R7,5bn in the first half of this year.
The Reserve Bank also made progress with its plan to reduce its net open foreign currency position (NOFP). The NOFP has declined from $21,7bn at the end of March this year to $16,9bn at the end of August. The Bank aims to continue with this reduction, usin g foreign capital inflows of a medium or long-term nature to reduce the forward book rather than more fickle "hot" capital inflows.
Stability has returned to the foreign exchange market after last year’s turbulence, and the nominal effective exchange rate of the rand has moved in a relatively narrow range for most of the past 12 months.
THE WAY FORWARD:
Last year’s high interest rates were the consequence of global market turbulence. The improving prospects for emerging markets in general have created room for more normal circumstances in South Africa, including appropriate interest rates.
South Africa’s short-term interest rates have declined significantly - a trend which has been justified by the good inflation performance, the decline in money supply and credit growth, and improved international conditions. If necessary, however, we will not hesitate to tighten monetary policy to contain inflationary pressures. Obviously, a wait-and-see period is now necessary after the recent declines in interest rates, especially in view of the looming millenium change. So, our approach is caution, cauti on and more caution.
Perhaps now is a good opportunity to mention that the South African banking system is well prepared for the year 2000 computer problem. While no-one can really tell what will happen to computer systems when the clock strikes midnight on 31 December 1999, t he Reserve Bank and South Africa’s banks should cope comfortably with the millenium change.
The new millenium will bring with it new challenges for monetary policy. We are designing what we believe is the appropriate framework for these challenges. The Reserve Bank is convinced that targeting the exchange rate is an outmoded concept, and hence we are working towards implementing an inflation targeting framework. Inflation targeting is no quick fix, but it should help to anchor inflationary expectations.
A key feature of the South African monetary policy system is the Reserve Bank’s independence. But independence implies accountability and transparency. In fact, I have suggested to the Parliamentary Joint Standing Committee on Finance that we appear regula rly before the committee to demonstrate our accountability to South Africa’s people.
Accountability also implies a high level of transparency over monetary policy decisions. One of the ways in which we are promoting further transparency is by releasing statements when there are changes in monetary policy. We also plan to release statements after meetings of the monetary policy committee, even if there is no change in the policy stance.
The monetary policy committee is a new feature of policy decision making in the Reserve Bank. Its members will be the Governor, the three deputies and senior officials of the Bank. The committee will meet once every six weeks.
South Africa is faced by many challenges: high unemployment, poverty, the homelessness of a significant number of citizens, poor health conditions and poor infrastructure in many communities which result in massive pressures on fiscal policy. As Governor o f the South African Reserve Bank, I am, more than anybody, aware of these problems and challenges for our economy and society.
But I would like to reiterate that the main thrust of monetary policy in South Africa must be the pursuit of financial stability - that is, stability of prices, financial institutions and markets. A monetary policy that maintains financial stability in a c redible and lasting way will make the best overall contribution to improving economic growth, employment and living standards.
Thank you