The current international financial crisis erupted in July 1997 in Thailand when the pegging of the Thai baht to the US dollar was abandoned. Capital withdrawals — causing the exchange rate and financial asset prices in Thailand to decline sharply — elicited a policy response that was meant to restore financial stability, but this response also slowed down economic activity in the Thai economy. Doubts arose about the sustainability of exchange rate arrangements elsewhere and spillover effects were soon felt in other Asian countries, notably Indonesia, Korea, Malaysia and the Philippines. Growth in Japan also turned negative in late 1997 and remained negative in the first half of 1998.
The turmoil in Asian financial markets and the recession in Japan contributed to a slowdown in global economic growth in the second half of 1997 and in 1998. Financial markets became even more unsettled in 1998 when the Russian government announced a number of emergency measures which included the depreciation of the rouble and a unilateral restructuring of external and domestic debt. Capital flows continued to be redirected to the advanced economies of the world, aggravating the external financing difficulties of emerging-market economies, such as Brazil, where sharp increases in interest rates were required to stem the drain on international reserves. Commodity prices continued to fall in 1998, in part as a result of reduced demand in Japan and the other Asian countries affected by the crisis. This led to significant declines in the export earnings of commodity-producing countries and further increases in the external financing needs of these economies.
The growth inhibiting problems of the developing economies, for instance over-valued exchange rates, low commodity prices, weak financial systems, and unsustainable fiscal and balance-of-payments deficits, have been identified as the reasons for the loss of confidence in emerging markets. South Africa — where macroeconomic stability is not in doubt and the financial system is fundamentally sound — could not escape the spillover effects of the Asian crisis. Some of the reasons why Asian contagion affected monetary and economic conditions in South Africa were the low domestic savings ratio, the inability to attract sustained inflows of foreign direct investment, the high ratio of short-term external debt to international reserves, the paucity of international reserves and falling commodity prices. The principal elements that transmitted the crisis to South Africa were heavy selling of fixed-interest securities by non-resident portfolio investors which caused an unavoidable rise, of 725 basis points from June to August 1998, in bank lending rates. This had the potential to limit economic activity in the short run.
The real gross domestic product, which had been growing at a subdued pace prior to the onset of the crisis, declined abruptly in the third quarter when business confidence was negatively influenced by the international financial turmoil and export demand was curtailed by the recession in Asia. Apart from the services sectors, where the telecommunications and financial services sectors contributed to positive growth in output, fairly steep rates of decline were recorded in the real value added by the other sectors of economic activity. More specifically, production in the manufacturing sector declined sharply as domestic consumer demand for durable goods declined and the international economy slowed down. Mining output also contracted in the third quarter, partly because of the weak export demand for commodities, whereas agricultural output shrank as a result of a much smaller maize crop.
The decline in the third quarter notwithstanding, year-on-year output growth in gross domestic product during the first three quarters of 1998 was still positive at about ½ per cent. Largely because of the low base established in the third quarter, projections point to growth of less than ½ per cent for the whole of 1998. This growth rate is considerably lower than had been expected generally at the beginning of 1998. It also implies a sharp decline in the real income per capita of the South African population in 1998.
In sharp contrast to the decline in real gross domestic production, growth in real gross domestic expenditure accelerated in the third quarter of 1998. All the components of gross final demand, i.e. private consumption, government consumption and fixed investment, continued to increase, but at a slower pace than in the second quarter. The year-on-year growth of real government consumption expenditure and fixed capital expenditure, especially in the public sector, nevertheless persisted at high levels. Household expenditure on non-durable goods and services maintained a sturdy pace, but deep cuts were made in the purchases of durable and semi-durable household goods. The principal reason for the acceleration in real gross domestic expenditure was the decline in inventory holdings during the third quarter of 1998, which was considerably smaller than the decline recorded in the second quarter.
Expectations of weak growth in demand, the high carrying cost of inventories and ongoing improvements in cost-management techniques prompted manufacturers and traders to further economise on their inventory holdings.
Overall growth in factor remuneration slowed down in the third quarter. As is typical during periods of slack economic activity, the growth in gross operating surpluses slowed down more than the growth in labour remuneration, thus raising labour's share in the overall value of production. Corporate saving relative to gross domestic product declined in the process. Together with very modest household savings and increased dissaving by general government, lower corporate saving contributed to a further deterioration in the domestic savings ratio.
Economic growth without job creation has been a troubling aspect of the South African economy over the past two to three years. A small increase in aggregate employment occurred in the second quarter of 1998, but overall employment in 1998 was still well below the levels attained in 1996. The weak employment growth notwithstanding, nominal remuneration per worker continued to increase in 1998 along with a sharp rise in wage-related strikes and work stoppages.
Rising nominal labour remuneration usually leads to higher inflation through cost-induced price pressures, which are reinforced by the aggregate demand pressures arising from the increased spending power of employed workers. However, domestically generated inflation in the first half of 1998 was contained by solid increases in labour productivity and some absorption of production costs by domestic producers. Nonetheless, the rise in the general price level accelerated as the depreciation of the rand raised prices and these effects were passed through the price formation processes. The increases in mortgage interest rates also pushed the consumer price index higher.
The high level of domestic expenditure and efforts by importers to pre-empt expected increases in import prices following the depreciation of the rand, led to a sharp upward movement in merchandise imports and a concomitant widening of the deficit on the current account of the balance of payments. At the same time, the value of merchandise exports and net gold exports improved too, but to a lesser extent than the increase in the value of merchandise imports. Together with a decline in net service payments to the rest of the world, the growth in export earnings contained the deficit on the current account of the balance of payments to approximately 2½ per cent of gross domestic product in the third quarter of 1998.
For the first time since the fourth quarter of 1996, the country experienced an outflow of capital during the third quarter of 1998. Both long- and short-term capital moved out of the country. To a large extent these outflows were related to the turbulence in the international financial markets which prompted non-residents to sell South African fixed-interest securities, and the weakening of the rand which caused an increase in the use of domestic, instead of foreign credit sources for trade financing. Foreign trade financing of international transactions was effectively discouraged by the high cost of forward cover.
The rand came under downward pressure from May to August 1998 as the international financial situation was affected by the troubles in emerging markets and the unilateral debt restructuring in Russia. Policy steps taken by the Reserve Bank, particularly those that permitted interest rates to rise along with market pressures and the decision that the exchange rate of the rand should find its own level, brought some stability back to the domestic foreign-exchange market. In fact, confidence was restored to such an extent that the rand appreciated by almost 14 per cent from 28 August 1998 to 25 November.
The growth in the broad and the narrower monetary aggregates, and in total domestic credit extension as well, showed signs of abating towards the end of the third quarter of 1998. For the whole of the quarter, monetary and credit growth was still strong and definitely not consistent with the objective of low inflation in the long run. Furthermore, the possibility that past rapid money growth could impact on future inflation continued to lurk in the background, compelling the Reserve Bank to maintain a cautious position regarding the easing of monetary policy. The tightening of monetary conditions following the destabilisation of the domestic securities markets, unavoidably led to higher interest rates and contributed to the decline in aggregate output in the third quarter. The slowdown in the growth in output was part of the inescapable adjustment process that was necessary for the restoration of financial stability.
Money market interest rates firmed until the middle of September because of the unsettled state of international financial markets, the weakness of the rand and renewed fears of inflation at that time. A gradual decline followed, which was endorsed by the Reserve Bank around the middle of October. The Bank then reduced the daily underprovision of liquidity to the banks and later began to provide the full amount of the banks' daily liquidity needs. The repurchase rate of the Reserve Bank started to decline and on 24 November 1998 was some 200 basis points lower than on 13 October. This decline in the cost of funding allowed the banks to lower their prime overdraft rates on two occasions by one percentage point at a time.
The raising of funds by the public sector in the primary bond market was lower in the first half of the current fiscal year than in the first half of the previous fiscal year. Private-sector companies, in turn, raised only a small amount of new capital in the primary debt market, focusing almost entirely on bank credit extension and the primary market for equity capital to meet their financing requirements.
The South African financial markets underwent a period of major adjustment from May to August 1998 when emerging markets around the world were under pressure and the stability of the global financial system was questioned at times. The adjustment process was triggered by the net selling of fixed-interest securities by non-resident investors from May 1998. Yields on long-term government bonds, which had been drifting downwards in the first four months of the year, rose strongly to their highest average monthly level ever — exceeding the averages registered in December 1985 after the announcement of the foreign-debt standstill. As has occurred in other emerging markets, equity values declined sharply — the average price level of all classes of shares in September 1998 was some 39 per cent lower than in May. Bond and share prices then recovered somewhat in October and November. Nonetheless, the dollar value of South African listed shares declined by 26 per cent between December 1997 and October 1998. Non-resident investors, however, continued to increase their equity holdings in listed companies during the first ten months of 1998, ostensibly in complete disregard of the decline in asset values.
The overall public-sector borrowing requirement, in absolute value and relative to gross domestic product, declined in the first half of fiscal 1998/1999 in comparison with the same period in the previous fiscal year. Similarly, the deficit before borrowing and debt repayment on the Exchequer account as a ratio of gross domestic product, decreased from the first half of fiscal 1997/1998 to the first half of fiscal 1998/1999.
The Minister of Finance increased the projected deficit on the national government's budget for the current fiscal year from 3,5 per cent of gross domestic product to 3,9 per cent when the Adjustments Budget was submitted to Parliament on 2 November 1998. This increase does not signal a deviation from government's deficit reduction programme. As spelt out in the Medium Term Expenditure Framework, government remains firmly committed to containing the budget deficit to 3 per cent of gross domestic product, but one fiscal year later than originally envisaged.