As could be expected, the disturbances in the foreign exchange market had serious consequences for South Africa's transactions with the rest of the world. The large net inflows of capital which had been recorded from the second half of 1994, were affected by leads and lags in foreign payments and receipts which led to a substantial outflow of short-term capital. At first this was largely offset by inflows of long-term capital. From the beginning of March these inflows began to subside and later turned into net outflows of long-term capital in April 1996. These speculative capital outflows could, however, easily switch around again should the exchange rate of the rand stabilise.
Although the deficit on the current account shrank significantly in the first quarter of 1996 owing to a substantial increase in merchandise and net gold exports, this could not prevent a decrease in the gross and net gold and other foreign reserves in the first four months of 1996. Both volume and price increases contributed to a further rise in merchandise imports and net service and transfer payments to non-residents. In view of the relatively high price elasticity for imported goods and manufactured exports of South Africa, the foreign reserves should in future benefit from the depreciation of the rand provided that this advantage is not wiped out by increases in production costs.
The depreciation of the rand also led to a substantial increase in the turnover in the South African foreign exchange market and forced the Reserve Bank to change its intervention policy in this market. From the middle of February 1996 the Bank became a net seller of foreign exchange to the market in order to ensure that the adjustment of the rand to a lower level would be as smooth as possible. In undertaking these transactions, the Bank did not attempt to defend a particular level of the exchange rate, but rather endeavoured to support an orderly correction in the market. In addition, the Reserve Bank had to increase its participation in the forward exchange market in an attempt to restore orderly conditions, which resulted in an increase in the Bank's net oversold foreign currency open position.
The depreciation of the rand furthermore arrested the downward movement in interest rates which had taken place in the eight months up to January 1996. Long-term rates reacted quickly to the uncertain conditions in the foreign exchange market, while the response of short-term rates was delayed. The slope of the yield curve accordingly steepened considerably during February and March 1996. The increase in Bank rate on 29 April 1996 by one percentage point led to corresponding increases in short-term yields, while having comparatively little effect on long-term yields. At the end of April 1996 the yield curve was therefore not only substantially higher than in January 1996, but also much flatter.
The increased volatility in the bond and derivative markets arising from the weakening in the exchange rate of the rand and fluctuations in interest rates, caused the activity in these markets to rise to new heights. The depreciation of the rand also benefited the prices of commodity and rand-hedged shares. In May 1996, however, the prices of listed industrial shares declined sharply, while the prices of gold-mining shares remained relatively stable. The decrease in the net foreign assets of the Reserve Bank contributed to a tightening in the money market.
The depreciation of the rand will inevitably also influence the rate of inflation of the country. Although current available information on consumer and production prices in 1996 still do not reflect the effects of the depreciation of the rand, prices of many imported goods can be expected to rise in due course, while prices of locally produced goods and services will, with some time lags, be affected. Indeed, there is a real danger that inflation resulting from the depreciation could eventually destroy more wealth and job opportunities than the initial gains arising from the lower value of the rand if appropriate policy measures are not pursued.
The upward pressures on price inflation will be assisted by the recent reacceleration in the growth of money supply. After having shown a distinct downward movement in the second half of 1995, the rate of increase in nearly all the various monetary aggregates (with the exception of M1A) started to rise relatively rapidly towards the end of 1995. Expected changes in interest rates and major adjustments in the share and bond markets at that time, encouraged private-sector entities to shift their funds to call, other short- and medium-term deposits. Although the private sector's preference for depository type investments intensified during the first quarter of 1996, the more rapid growth in money supply was nonetheless primarily demand driven.
The main counterpart of the increase in money supply continued to be credit extension to the private sector. Moreover, in the first quarter of 1996 the rate of increase in credit extended to private enterprises and households accelerated sharply, inter alia because of the depreciation of the rand. The uncertainty in the foreign exchange market resulted in a switching from foreign to domestic financing of trade transactions to avoid the risk of the vagaries of the external value of the rand. A persistently strong demand for machinery and equipment and consumer durables was also financed by means of instalment-sales credit, leasing finance, mortgages and other loans and advances. In addition, affirmative action and the easy availability of credit, promoted the extension of bank credit at a stage when interest rates were already high.
Despite the sustained strong demand for bank credit, real gross domestic expenditure actually declined in the first quarter of 1996, largely because of a substantial decrease in inventory accumulation. The net addition to stocks at constant prices in the first quarter of 1996 was nearly half of the level in the preceding quarter. The slower build-up of inventories was particularly evident in the mining, manufacturing and commercial sectors.
After having increased at relatively high rates, the growth in real private consumption expenditure in the first quarter of 1996 slowed down. This lower rate of increase was brought about by more modest growth in durable consumption expenditure and a slowdown in the growth of non-durable consumption expenditure at constant prices. Real household outlays on semi-durable goods and real consumption expenditure by general government were relatively buoyant in the first quarter of 1996. The growth in the consumption expenditure by general government at constant prices nevertheless came to less than 1 per cent in the fiscal year 1995/1996 and contributed to a further fall in the public-sector borrowing requirement if extraordinary transfers are not taken into account.
The increase in total real gross domestic fixed investment, which had shown signs of slowing down in the fourth quarter of 1995, increased again at a high annualised rate of 7 per cent in the first quarter of 1996. Large capital outlays by public corporations on infrastructural developments were mainly responsible for the more rapid expansion in capital formation. The growth in investment expenditure by the private sector, however, continued to slacken with the completion of some of the major capital projects. A classification of the real fixed investment by the private sector according to economic sector nevertheless shows that capital outlays were fairly widespread in the first quarter: all the production sectors, apart from financial services, reported higher real capital formation figures.
Even with the decline in domestic demand, the rate of growth in domestic output rose strongly in the first quarter. A firm external demand for South African goods and services and favourable agricultural conditions led to a sharp rise in the growth of real gross domestic product from the fourth quarter of 1995 to the first quarter of 1996. From the beginning of the upturn in economic activity in the second quarter of 1993, the growth in real domestic output has averaged 3 per cent per annum, which is somewhat higher than the rate of increase in the population.
Employment growth continued to respond very slowly to the upturn in economic activity, mainly because of the rationalisation of labour by many employers who attempted to reduce unit labour costs and to improve competitiveness. The employment cycle, however, seemed to have reached a lower turning point in the second quarter of 1994, but employment growth was weak and could still not prevent a further increase in unemployment. The upturn in the employment cycle was also accompanied by moderately lower wage growth and further high increases in labour productivity. This resulted in a decline in real unit labour costs during 1995.