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The slowdown in output growth suggested that the upturn in the economy, which has been in progress since 1993, could have been drawing to a close, or that the upper turning-point of the business cycle might already have been passed. The composite coincident business cycle indicator has been showing a gradually downward tendency since the middle of 1995. Contradicting these signs of an imminent downturn of the business cycle, was the relative strength of output growth in the secondary sectors of the economy during the first quarter of 1997. Manufacturing output, especially, not only maintained the upward momentum that had developed since the final quarter of 1996, but even accelerated quite substantially in the first quarter of 1997. What is more, the recent generally upward trend in the backlog of unfilled orders might have been pointing towards a continuation of manufacturing output growth in the remainder of 1997. It is conceivable that the resilience of manufacturing output growth might be a stabilising factor in 1997. 

The decline in the level of total real domestic production in the first quarter of 1997 coincided with a continuation of the actual decline in real gross domestic expenditure which has been evident since the third quarter of 1996. Inventory levels were reduced in the first quarter of 1997 and the growth in real private consumption expenditure continued to decelerate. A decline in aggregate personal disposable income began to restrain the recurrent spending of private households. Real fixed investment expenditure still increased in the first quarter of 1997, but like private consumption expenditure, at a much reduced rate. In this instance too, the behaviour of the manufacturing sector was at variance with the general trend: whereas growth in real fixed investment in most sectors of the economy slowed down, that in the manufacturing sector exhibited a sturdy increase, although these capital outlays were not necessarily employment-enhancing. 

Real government consumption expenditure increased at a rapid rate in the first quarter of 1997, thereby contributing to a decline in the already very low savings ratio of the economy. With little incentive being provided to private-sector entities to strengthen their saving propensities, the low national savings ratio is likely to prevail for some time to come. As the savings ratio is evidently inadequate to finance a higher rate of productive investment, the South African economy is becoming more and more dependent on inward flows of foreign investment capital to bolster its output and employment-creating capacity.

The strengthening of output growth in the non-agricultural sectors of the economy in the second half of 1996 had a positive influence on the overall level of formal-sector employment. Total employment accordingly increased in the fourth quarter of 1996. Although this rise in employment was not nearly sufficient to make any inroads on the total level of unemployment in the economy, it was the first such increase since a series of quarterly increases in total employment had come to an end in the fourth quarter of 1995. Significantly, the rise in employment in the fourth quarter of 1996 occurred entirely in the private sector of the economy. Equally significant was that this rise in employment, like the previous increases recorded from the end of 1994 to the end of 1995, generally coincided with slowdowns in the rate of growth of nominal unit labour costs. 

Price inflation accelerated in the second half of 1996 in response to the depreciation of the rand from the middle of February 1996 and the stronger growth in the cost of labour per unit of output from the third quarter of 1995. Some moderation in quarter-to-quarter production price and consumer price inflation then became evident in the first quarter of 1997 as the rand started to appreciate against other currencies and the growth in nominal unit labour costs slowed down in the fourth quarter of 1996. It is, however, still unclear whether this pause in the upward movement of prices will be sustained in the forthcoming quarters and whether the general downward trend in inflation, which had been evident since the early 1990s, will be resumed. The outcome of the round of wage negotiations currently in progress will be important for the near-term evolution of price inflation. 

The decline in the level of overall domestic economic activity resulted in a decline in the value and the volume of imports in the first quarter of 1997. Unfortunately, the value and the volume of exports of merchandise goods declined even more, mostly because of an unexpected decrease in the quantity of relatively price-insensitive goods exported. The decline in total export earnings was exacerbated by a decline in the dollar and the rand price of gold, with the result that the deficit on the current account of the balance of payments, which had been declining steadily since the second quarter of 1996, widened again in the first quarter of 1997. 

The net inflow of capital, which became positive in the fourth quarter of 1996, gained further momentum and became considerably larger than the absolute value of the deficit on the current account of the balance of payments in the first quarter of 1997. Unlike the fourth quarter of 1996, when the inflow of capital consisted overwhelmingly of financing facilities with a short maturity, the inflow of capital in the first quarter of 1997 was mostly classified as long-term capital. 

Keen buying interest was displayed by non-resident investors in the domestic bond and share markets during the first quarter of 1997. Although these "portfolio investments" are classified as long-term capital on grounds of their maturities, they do not always represent a permanent investment in an economy. However, there is good reason to believe that a significant portion of the non-resident purchases of South African bonds in the first quarter of 1997 formed the hedge counterpart of Eurorand bond issues which were made in that quarter. As these Eurorand bonds mostly had a maturity of one year or longer, their hedge counterparts were likely to have a similar duration. Another significant feature of Eurorand bond issues is that they give rise to forward purchases of rand, alternatively forward sales of dollars, thereby improving the balance between sales and purchases in the domestic forward foreign-exchange market. Equally significant, however, was that part of the inflow of funds via the bond and share markets was neutralised by outflows of funds which were related to asset swap transactions.

The surplus on the overall balance of payments in the first quarter of 1997 had as a consequence a sizeable improvement in the gold and foreign reserves of the country for the second calendar quarter in succession. This created a more positive sentiment in the foreign-exchange market and the rand strengthened rather robustly from the end of October 1996 to the end of April 1997. The appreciation of the rand was therefore partly caused by the surplus on the overall balance of payments, but was also causal to the inflow of international capital into the economy. Despite the rise in the foreign exchange value of the rand in the first quarter of 1997, the rand still depreciated in real terms by about 8½ per cent from December 1995 to March 1997, thereby indicating a meaningful gain in the international competitiveness of South African producers over this period.

As is often the case shortly after a rise in Bank rate and in the banks' lending rates, bank credit extension to the private sector accelerated in the first quarter of 1997. The firming of the growth in credit to the private sector was underpinned by the need to finance transactions in an economy where the nominal value of domestic expenditure and activity in financial markets were expanding rapidly. Certain structural factors, such as the absorption of many South Africans into the mainstream of the modern sector of the economy and the further integration of South Africa into the international financial markets, also caused the demand for credit to remain robust. Credit growth was strengthened further by a strong increase in the monetary sector's claims on the government sector, which were not nearly counteracted by the relatively small increase of government deposits with the banking sector. All this contributed to an acceleration in the M3 money supply in the first quarter of 1997 at a rate of increase that was substantially higher than the potential real growth rate of the economy. Such monetary expansion, if left unchecked, would inevitably have serious repercussions on inflation expectations and ultimately on inflation itself.

Conditions in the money market remained tight in the first three months of 1997. Additional liquidity was supplied to the market by a decline in the value of notes and coin in circulation outside the Reserve Bank and through an increase in the net foreign assets of the Reserve Bank, but these were largely neutralised by the liquidity-reducing effect of surpluses stemming from the Bank's forward foreign-exchange transactions. The Reserve Bank generally allowed the market to reflect the tight underlying demand and supply conditions, but was at times prepared to provide assistance when liquidity was perceived to be in short supply. In April and May 1997 money market conditions became considerably less tight, owing mainly to a further improvement in the net foreign assets of the Reserve Bank. In May a strong injection of liquidity arising from the acquisition of an equity interest in Telkom by foreign companies had to be drained from the market by means of open-market and other operations with a similar effect.

As a reflection of the more positive sentiment created by the strengthening of the rand and the improvement in the net foreign assets of the Reserve Bank, market interest rates started to move downwards during the first three months of 1997. The yields on gilts and semi-gilts declined fairly substantially, whereas share prices generally rallied in the first quarter of 1997 and recovered most of the losses incurred in the last months of 1996. Trading in the secondary bond and share markets rose impressively, while non-resident participation relative to overall turnover in these markets showed major advances at the same time. Non-resident participation obviously added to liquidity in these markets, but the presence of non-residents also added some potential extra volatility to price movements in these markets.

The fiscal policy stance of the national government is becoming more supportive of the overall policy objective of maintaining overall financial stability. The deficit on the current revenue and expenditure account of the Central Government, relative to gross domestic product, was further reduced in the fiscal year ended March 1997 and is projected to decline even further in the current fiscal year. A primary surplus, i.e. an excess of current revenue over expenditure when interest charges are not taken into consideration, is forecast for the fiscal year to March 1998. The danger of a persistent rise in the ratio of government debt to gross domestic product and the threat of such a development for overall financial stability, have apparently been put to rest. Nonetheless, the upward trend in tax revenues and total government expenditure relative to gross domestic product is yet to be arrested.