Further progress towards financial stabilityLike many other emerging-market economies, South Africa was severely affected by financial turbulence in international financial markets during 1998. After having experienced net purchases of domestic bonds by non-residents to the amount of R37,3 billion in the four years up to April 1998, foreigners subsequently reduced their holdings of South African bonds by no less than R26,1 billion in the last eight months of 1998. As could be expected, this reversal in foreign investors' sentiment towards South Africa over a short period of time, placed pressure on the external value of the rand and forced the Reserve Bank to adopt a more restrictive monetary policy stance. The adverse developments on the capital account of the balance of payments were aggravated by a sharp deterioration in the current account balance from a deficit at a seasonally adjusted and annualised level of R6,2 billion in the first half of 1998 to R20,7 billion in the second half. This happened at a time when real domestic economic activity was slowing down. In contrast with normal cyclical behaviour in terms of which the volume of imports decreases along with lower economic activity, imports actually continued to rise sharply during 1998. Strong domestic final demand for goods and services, mainly in the form of substantial expansions in fixed investment by public entities, supported the growth in imports in 1998. At the same time, the prices of imported goods rose sharply because of the depreciation of the rand, whereas exports were adversely affected by a fall in global demand and by lower international commodity prices.Under these circumstances three macro-economic financial adjustments could not be avoided, namely:the exchange rate of the rand had to depreciate;domestic liquidity had to contract; anddomestic interest rates had to rise to higher levels.In support of orderly conditions, the Reserve Bank intervened in the foreign exchange and money markets without preventing these essential adjustments from taking place. The more flexible repurchase system, introduced in March 1998 with the specific purpose of accommodating periodic volatile situations in the financial markets, proved to be of great value in these uncertain and volatile circumstances.The turmoil in the international financial markets was primarily transmitted to the South African economy through transactions on the Bond Exchange. The withdrawal by non-residents of portfolio investment from the country created shortages in the market for foreign exchange and caused the average effective exchange rate of the rand to depreciate by 14,2 per cent from the end of April 1998 to October 1998. In total, the South African financial markets weathered the storm reasonably well and conditions in the money, capital and foreign exchange markets reverted back to greater stability in recent months. During January and February 1999, non-residents increased their holdings of South African bonds by R2,4 billion, and overall liquidity in the money market increased again.The rise in the prices of imported goods resulting from the depreciation of the rand, had a relatively small effect on domestic prices on this occasion and the average production price inflation came to 3,5 per cent in 1998 -- the lowest level in 28 years. The core inflation rate, i.e. the price index monitored closely by the Reserve Bank in implementing monetary policy, rose by less than one percentage point when measured over twelve months, namely from 6,9 per cent in March 1998 to 7,8 per cent in January 1999. When core inflation is calculated from quarter to quarter, the seasonally adjusted and annualised rate of increase fell from 11,1 per cent in the second quarter of 1998 to 4,3 per cent in the fourth quarter. Overall consumer price inflation, measured over a twelve-month period, however, increased from 5 per cent in April 1998 to 9,4 per cent in November 1998, before declining again to 8,9 per cent in January 1999. Although these rates of price increases are still well above those of most of