The weakening of output growth in the third quarter of 1996 was more conspicuous in the non-agricultural goods-producing industries than in the service-providing sectors of the economy. Mining production, and more specifically gold-mining output, declined fairly strongly in the third quarter of 1996. Manufacturing production also lacked vigour in the first three quarters of 1996. Although exports of manufactured products responded positively to the depreciation-induced increase in the competitive strength of South African producers, the response of manufacturing output was rather placid. It seems as if the increases in manufacturing export volumes during 1996 came mostly as a substitute for inventory accumulation and final sales in the domestic market without any meaningful expansion of manufacturing output volumes. The lethargic output performance of the goods-producing industries was to some extent counteracted by slightly more energetic output growth in the services industries. The financial services sector, especially, benefited materially from high activity levels in the bond, equity and other financial markets.
The slowdown in domestic output growth coincided with an actual decline in aggregate gross domestic expenditure, thereby reducing the excess of domestic expenditure over domestic production and narrowing the deficit on the current account of the balance of payments. Growth in all the major components of aggregate final demand slowed down in the third quarter of 1996 and investment in inventories was reduced substantially from the second to the third quarter of 1996. Despite growing at a lower rate, private consumption expenditure was still rising too rapidly and was financed to a significant extent by bank credit extension.
The low savings ratio of the South African economy, which is exacerbated by the rapid expansion of private consumption expenditure, remains a serious cause for concern. The experience of the latest recovery in the economy seems to confirm that the lack of sufficient domestic saving is one of the factors preventing the South African economy from growing on a sustainable basis at a rate of more than 2½ to 3 per cent per year. It would appear that growth beyond this range leads to unsustainable deficits on the current account of the balance of payments. In view of the fickleness of foreign capital movements, it remains risky to rely for too long on the inward movement of international capital to augment domestic saving. To overcome this serious savings constraint on South Africa's long-term economic growth and prosperity, it is important that the government's macroeconomic strategy for growth, employment and redistribution, with its strong emphasis on raising saving and improving macroeconomic stability, be implemented.
Up to the end of the second quarter of 1996, the recovery in economic activity was unable to lift the employment-creating capacity of the economy in a sustainable way. The gains in private-sector employment during the second half of 1994 and the first half of 1995 were reduced by sustained job losses since the middle of 1995. Economic growth without job creation has indeed become a very troubling aspect of the South African economy.
The growth in nominal salaries and wages per worker, which had progressively been brought under control during the first half of the 1990s, started to accelerate in the second half of 1995. Moreover, the growth in labour productivity since the middle of 1995 was not sufficient to prevent a quickening in the rise in nominal unit labour costs. These cost-raising forces began to show their impact, along with that of the weakening rand, when price inflation started to gather renewed momentum in the second quarter of 1996. This emphasised the need for maintaining a consistent and credible counter-inflationary monetary policy. Otherwise, the competitive gains of the recent decline in the exchange rate of the rand would soon be eroded by a spiral of domestic wage and price increases.
The high level of domestic expenditure and the desire to acquire imported intermediate goods and capital equipment before prices could be inflated by the depreciation of the rand, led to a continued upward movement in the value of merchandise imports in the third quarter of 1996. Fortunately, the strong demand for imports coincided with a reorientation of the domestic production structure towards the export market. As could be expected, the currency depreciation had a marked effect on export prices. Total export earnings were also boosted by a sharp rise in the value of net gold exports, contributing to a decline in the deficit on the current account of the balance of payments.
Partly in reaction to the weakening of the rand, but also partly responsible for the slide in the value of the rand, the capital movements to South Africa changed from a net inward flow of funds in the second quarter of 1996 to a net outward flow in the third quarter. There were indications that some of the debt which had been renegotiated in terms of the foreign debt standstill arrangements and which fell due in the third quarter of 1996 was not extended and the proceeds repatriated. Inward investment through the Johannesburg Stock Exchange and the Bond Exchange of South Africa also declined well below levels that were attained in the first half of 1996.
The overall deficit on the balance of payments was responsible for a substantial decline in the gross gold and other foreign reserves of the country. The low level of the foreign reserves contributed to the weakness of the rand and limited the ability of the Reserve Bank to intervene in the foreign exchange market with the objective of stabilising the exchange rate of the rand. The decline in the external value of the rand has by now strengthened the international competitiveness of the South African economy to such an extent that the country should now be more attractive for inward foreign direct investment, provided inflation and cost increases can be contained.
Although it declined slightly during the third quarter of 1996, the still high level of aggregate domestic expenditure contributed to the continued rapid growth in the money supply. The growth rate of the money supply also declined slightly, but the monetary expansion is still too high compared with the long-term growth potential of the economy. It is also too early to judge from the slowdown in money-supply growth whether policy steps that had been taken earlier were successful in sustainably lowering the expansion of the money supply. The persistently high growth in the money supply provided no scope for complacency in the fight against inflation and justified the continued application of counter-inflationary monetary policies.
The strong demand for money on account of transaction purposes was augmented by an increase in the liquidity preference of the private sector which arose from concerns about political developments, uncertainties about the future course of financial policies and expectations of imminent adjustments in the bond and equity market. Institutional investors, especially, showed a clear preference for larger-than-usual holdings of demand and other short-term deposits. This preference for shorter-term deposits led to an even more rapid growth in the narrowly defined than in the broadly defined monetary aggregates.
Because a prominent part of the increase in private consumption expenditure and corporate capital expenditure was financed by means of domestic credit extension, the credit extended by monetary institutions to the non-bank private sector continued to increase at a high rate in the third quarter. A sizeable portion of the increase in credit extension to the private sector was destined for private households. This was an important factor responsible for the strong growth in private household expenditure in the third quarter of 1996. In a statistical or accounting sense, the potential impact of the growth in credit extended to the private sector on the overall money supply was partly counteracted by declines in the net foreign assets of the monetary sector and in net credit extended by the monetary institutions to the government sector.
The South African financial markets experienced a phase of major adjustment during the first five months of 1996 in response to an upward correction in long-term yields in the American bond market and the steep decline in the exchange rate of the rand since mid-February. Up to October 1996, the markets have not settled down completely, an undertone of uncertainty and nervousness still prevails, and the yields on long-term government bonds and money market rates fluctuated around a relatively flat trajectory. Both local and foreign investors appear to become uncomfortable whenever yields declined to below 15 per cent at a time when inflation is rising and the rand is weak, while the smaller demand for funds effectively prevented rates from rising substantially beyond 16 per cent. As yields on long-term and short-term securities have moved broadly in sympathy since May 1996, the yield curve shifted upwards and downwards with the changing sentiment in the markets, but retained its generally flat shape. The curve drifted downwards from May to September 1996, but was then restored in October to a level that was approximately equal to that of May. The yield curve at the end of October probably still reflected widespread uncertainty about future price movements in the financial markets and fears of a reversal of the progress made with the reduction of inflation.
Money market rates firmed in November, reflecting the persistently high money market shortage, the scarcity of liquid assets eligible for collateral for obtaining loans at the discount window of the Reserve Bank, renewed inflationary fears and the weakness of the rand. This culminated in an increase of one percentage point in Bank rate as from 21 November 1996, followed by a similar rise in the lending rates of banks on the same day.
Money market conditions, which became generally tight during the second quarter of 1996, tightened even further from the end of June 1996 to the end of October. At the end of October the amount of accommodation which the Reserve Bank had to provide to banks reached its highest level since April 1996 as the decline in the Bank's net foreign assets continued to drain liquidity from the market. Throughout the second and third quarters of 1996 the Bank has taken no countervailing steps and allowed a growing money market shortage to generally reflect the underlying imbalance of demand and supply in the market. The Bank only provided temporary assistance on those occasions when market conditions became excessively tight.
Assistance then took the form of adjustments in the portfolio of the Corporation for Public Deposits and foreign currency swap arrangements between the Reserve Bank and private banks. The raising of funds by the public sector in the primary bond market was considerably smaller in the first half of the current fiscal year than the levels in the first half of the previous fiscal year. Private-sector companies raised funds in the primary bond market in the third quarter of 1996 for the first time since the third quarter of 1995. These companies also increased the amount of capital raised through equity issues in the first three quarters of 1996 relative to the amounts raised in the previous year.
The prices of all classes of shares listed on the Johannesburg Stock Exchange showed no distinct upward or downward trend since February 1996. Owing to the depreciation of the rand, the foreign-currency prices of shares declined steeply, causing the net purchases of South African shares by non-residents to decline progressively during the first three quarters of 1996. In October 1996 non-residents became net sellers of shares listed on the Johannesburg Stock Exchange for the first time since December 1994.
Despite a slight deterioration in the borrowing requirement of the overall public sector in the first half of the current fiscal year, there are strong indications that the government is likely to succeed in achieving its objective to reduce the Exchequer deficit before borrowing and debt repayment as a percentage of gross domestic product. The increase in Exchequer issues in the first half of fiscal 1996/1997 was somewhat faster than envisaged by the budget projections in March 1996, but was well below the average increase in the first half of the previous five fiscal years. Fortunately, the increase in Exchequer receipts ran slightly ahead of the budgetary projections. The government also took a major stride forward with the implementation of its macroeconomic strategy when certain tax incentives were made available. To improve tax efficiency, a tax amnesty was announced, which is expected to be more encompassing than previous amnesties.