Output growth outside the primary sectors of the economy slowed down noticeably. In particular, manufacturing output, which was envisaged to provide the impetus to economic development and employment growth, declined in absolute terms from the second to the third quarter of 1997.

The average level of total real gross domestic product in the first three quarters of 1997 nevertheless was some 2 per cent higher than in the first three quarters of 1996. Current projections point to a growth rate of the South African economy in the calendar year 1997 of between 1½ per cent and 2 per cent, which is considerably lower than had generally been expected at the beginning of the year and is also lower than the average growth rate experienced over the past three calendar years. Although a technical analysis could not provide conclusive evidence that South Africa had entered a downward phase of the business cycle, the economy was definitely not producing at full capacity in the third quarter of 1997 and output growth clearly did not match the economic growth potential of South Africa.

Real gross domestic expenditure in the third quarter of 1997 has declined for the fourth time in the five quarters completed since the third quarter of 1996. As output was still increasing over this period, the decline in aggregate spending facilitated a much better balance between aggregate supply and demand in the South African economy. The proximate causes of the general decline in aggregate expenditure were the persistent expectations of weaker future demand growth and the high carrying cost of inventories, which induced manufacturers and merchants to economise on inventory holdings. Further, whilst still maintaining a relatively high rate of expansion, the growth in real consumption expenditure by general government abated somewhat in the third quarter, thereby also making some contribution to the strengthening of macro balance in the economy.

Consumer sentiment also turned slightly negative in the third quarter and household spending grew weaker. By contrast, real fixed investment expenditure persistently grew at rates higher than aggregate output growth in the first three quarters of 1997. Of particular significance was the gathering strength of private-sector real gross fixed capital formation which has increased at progressively higher growth rates since the first quarter of 1997. These growth rates were, admittedly, rather modest, but the trend movement augured well for future income growth.

The aggregate saving ratio in South Africa deteriorated further in the first three quarters of 1997. The low saving rate of the country remained a structural impediment to sustained, investment-driven, income and employment growth. Intentions to move the economy onto a steeper growth path without an increase in the saving ratio will imply increased reliance on net inflows of capital from outside the country. Excessive reliance on foreign borrowed capital, however, could eventually develop into unsustainable growth in foreign debt, which at some later stage would elicit stern corrective policy steps.

Partly owing to the improvement of macroeconomic balance in South Africa, significant progress was made with the lowering of inflation in recent months. Quarter-to-quarter changes in all the prominent indicators of price inflation moved into the single-digit area in the third quarter of 1997. The downward movement of inflation was, of course, strongly assisted by the relative strength of the rand in the early part of the year. By the same token, the gradual depreciation of the rand against other currencies from about the middle of March 1997 could, therefore, have been a portend of slower progress with the lowering of inflation.

In contrast to the benign counter-inflationary environment created by the relative stability of the rand in the first half of 1997, macroeconomic labour remuneration developments were less supportive of the policy objective of general price stability. The increase over four quarters in total employment costs rose again beyond the ten per cent mark in the second quarter of 1997.

Although inflation-dampening productivity growth in the second quarter was procured through retrenchments in the formal sectors of the economy, the rate of increase in nominal unit labour costs also accelerated. As a consequence, employment in the formal non-agricultural sectors of the economy declined further and the recorded level of formal-sector employment receded to the levels which had been recorded in 1981.

The decline in formal-sector employment occurred in the face of continued, albeit moderate, growth in aggregate output and investment. For employment levels to rise parallel with output growth, it is important that an appropriate configuration of output price changes, productivity growth and macroeconomic wage developments be established. This would ensure a solid platform for investment-driven output and employment growth.

As could be expected, the decline in real gross domestic expenditure in the third quarter of 1997 coexisted with a slight decline in the physical quantity of imported goods. Simultaneously, the physical quantity of merchandise exports declined too, mainly on account of smaller quantities of minerals and agricultural products exported. In the end the deficit on the current account of the balance of payments widened against the backdrop of a slowing economy in the third quarter. Significantly, however, the value of manufactured goods exported continued to increase, most likely because of the strengthened competitiveness of domestic manufacturers in export markets.

The widening of the deficit on the current account of the balance of payments, in conjunction with a sharply reduced net inflow of capital from abroad, resulted in a reduction in South Africa's net holdings of gold and other foreign exchange reserves in the third quarter of 1997. The inward movement of long-term capital in the third quarter was well down from the inflows witnessed in the second quarter when Government was actively mobilising funds in the international capital markets and when the partial privatisation of a parastatal corporation elicited a large inflow of equity capital into the economy. Moreover, outflows of short-term capital accelerated in the third quarter as private banks chose to reduce their foreign short-term liabilities at a time when the exchange rate of the rand and the money market shortage had been declining steadily. The Reserve Bank increased its foreign short-term obligations over the same period in order to bolster the overall level of gross gold and foreign exchange reserves.

Developments in the international exchange markets during the third quarter of 1997 were profoundly influenced by events in Asia, which had a contagion effect on other financial markets around the world. Structural weaknesses in the economies of a number of Southeast Asian countries which had been simmering for a long time, surfaced towards the end of the second quarter of 1997 and caused most Asian currencies to depreciate sharply against the United States dollar. The rand was not insulated from these events, but owing to the value correction it underwent in 1996 and the healthier state of macroeconomic management in South Africa, it depreciated considerably less against the dollar than the Asian currencies.

The growth in the broadly defined money supply slowed down appreciably in the third quarter of 1997, but was still at a level that exceeded the margin set for acceptable monetary growth over the year as a whole. Guided by expectations of declining long-term interest rates and some relaxation of a relatively tight monetary policy posture, deposit holders increasingly exhibited a preference for longer-term deposits during the first eight months of 1997. This process came to an end in September when a major shift back to short-term deposits took place. It is still too early to judge whether this recent apparent change in liquidity preference should be viewed as a one-time event or whether it formed part of a more permanent realignment of the preferred portfolio composition of the general public.

The credit market witnessed a general slowdown in credit extension and more decisively in credit extension to the non-bank private sector in the third quarter of 1997. This slowdown, along with the slower expansion of M3 and the progress made in reducing inflation, prompted a decision by the Reserve Bank to lower Bank rate on 20 October 1997. Unlike bank credit extension to the non-bank private sector, net credit extension to the government sector increased strongly in the third quarter.

Easy conditions continued to prevail in the money market in the third quarter of 1997. Short-term interest rates were mostly declining to levels well below the prevailing Bank rate. Under these circumstances the Reserve Bank was willing to permit easier liquidity conditions to develop and refrained from influencing the market shortage in any systematic way, apart from specific smoothing operations to prevent unduly large fluctuations in liquidity. In October when the Reserve Bank intervened in order to stabilise the foreign-exchange market, conditions in the money market tightened considerably for a short while. Somewhat tighter conditions than during the third quarter continued to prevail in November.

The mood in the bond market was predominantly bullish in the first nine months of 1997 as yields on long-term government bonds and other long-term fixed interest-bearing stock gradually drifted downwards. Significantly, non-residents' net buying of South African securities shifted during this period from emphasising bond buying in the first quarter of the year to an emphasis on share purchases in the second and third quarters of 1997. In October 1997, non-residents became net sellers of bonds. Thus, during the course of the year South African shares increasingly offered better value than bonds, according to the judgement of non-resident investors.

The positive sentiment in the securities markets was brought to an abrupt end when the poor macroeconomic management of Southeast Asian economies triggered a downward re-rating of bond and share values in financial markets around the world. Share prices declined sharply on the Johannesburg Stock Exchange in October 1997, but in terms of percentages by much less than during the sharp decline of October 1987. In 1987 it took a full twenty-two months for the all-share price index to recover to pre-"crash" heights; in 1997 more than 40 per cent of the initial loss in the value of the index was recovered in a matter of two weeks. In a pattern resembling the movement of share prices, the prices of long-term government bonds also responded to the turbulence in the financial markets and bond yields rose by 131 basis points, but then fell back again to register a net gain of 77 basis points from the low levels recorded immediately prior to the sharp fall in bond prices on 22 October 1997.

The decline in bond and share values in 1987 followed on the heels of a series of reductions in Bank rate and caused the fall in asset values to have little detrimental effect on subsequent domestic private-sector propensities to consume and invest. The eventual impact of the recent decline in asset values on domestic economic developments would also, therefore, depend to an important degree on the policy responses of the financial authorities, domestically and in the world's advanced economies.

The public-sector borrowing requirement relative to gross domestic product in the first half of fiscal 1997/1998 increased in comparison with its counterpart in the first half of the previous fiscal year. However, the deficit before borrowing and debt repayment on the Exchequer Account relative to gross domestic product shrank from the first half of fiscal 1996/1997 to the first half of fiscal 1997/1998. Ominously, a substantial portion of the budgeted deficit of the National Government for fiscal 1997/1998 as a whole has been absorbed in the first half of the fiscal year. This overshoot of the projected deficit was particularly acute at provincial government level.