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These indications were evident from
In February 1996 and in the second quarter of 1998 there were also other forces at work which were perceived to be potentially destabilising and which made the economy vulnerable to exogenous and endogenous shocks. These forces included:
From February 1996 and in the second quarter of 1998 financial market participants started to attach less significance to the positive than to the negative aspects of the South African economy and began to realise profits by selling in a highly buoyant bond market. During both episodes, occurrences external to or independent of the domestic economy triggered this change in the attitude of non-resident investors: in February 1996 it was the alleged ill-health of the President and the potential threat to political stability and in the second quarter of 1998 it was the financial problems experienced in a number of emerging-market economies in Southeast Asia and in the Russian Federation.
The unexpected contraction of the net inflow of portfolio investment in the second quarter of 1998, much akin to events in early 1996, led to an increase in the demand for foreign exchange, thereby putting downward pressure on the exchange rate of the rand. As the Reserve Bank made foreign exchange available to meet the excess demand for foreign currency, the daily liquidity requirement of the private banks in the domestic money market increased, generally causing a sharp rise in money market interest rates and in the lending rates of the private banks. This tightening of monetary conditions eventually succeeded in halting the fall in the external value of the rand, but at the cost of a substantially higher level of interest rates. As was the case in 1996 when high interest rates curbed growth in domestic spending, it is reasonable to expect that aggregate output and expenditure are likely to grow more slowly in 1998 than would have been the case had there been no currency crisis.
The turn of events in the second quarter of 1998 also showed once again that although macroeconomic and financial policies may be inherently sound, a country is not immune to either a deterioration in investors' confidence or to large changes in the movements of international capital. These experiences have also demonstrated that changes in the monetary policy stance should not be seen as the only defence mechanism against the whims of foreign investors. In 1996 the announcement of the macroeconomic strategy for Growth, Employment and Redistribution (GEAR) made a major contribution towards stabilising the rand. In 1998, the implementation of the outstanding reform measures might help to make the economy more resilient to external shocks and attract sustained inflows of foreign direct investment capital.
Even prior to the outbreak of the currency crisis, economic growth had tended to be weak. This trend continued in the second quarter of 1998 when the seasonally adjusted real gross domestic product recorded an annualised growth rate of about ½ per cent for the fourth quarter in succession. There was growth only in the tertiary and agricultural sectors of the economy; the combined real value added by the mining and secondary sectors declined from the first to the second quarter of 1998. Year-on-year growth in real gross domestic product was also just ½ per cent in the first half of 1998, signalling that growth for the calendar year as a whole will be less than had been expected at the beginning of the year.
Growth in real gross domestic expenditure, which has been erratic since the second half of 1995, changed direction once again in the second quarter of 1998 when an increase followed the decline in the first quarter. This was mainly due to an increase in fixed investment spending, particularly by Telkom which is using the capital injection from privatisation proceeds to expand the telecommunications network. Real consumption, by both private households and general government, increased at lower rates in the second quarter of 1998 than in the first, and the paring down of inventory levels continued.
Although the growth in real capital expenditure accelerated in the second quarter of 1998, the ratio of fixed investment to gross domestic product is still below the levels indicated by GEAR. At its current level, the fixed investment ratio in the South African economy is too low to sustain high rates of economic growth and employment creation. Higher rates of return on invested capital are probably required to improve the rate of capital formation and to move the economy onto a higher growth path.
The low savings ratio in South Africa is a perennial concern. Despite a small improvement in the second quarter of 1998, domestic saving, at its current level, is still inadequate to finance the investment required for sustained high economic growth. Given the unpredictability of international capital movements it is risky to rely on foreign portfolio capital inflows to compensate for the paucity of domestic saving. In view of the need for higher new fixed-capital formation, current expenditure by private households and general government must be contained in the interest of a better national savings effort.
Employment in the non-agricultural sectors of the economy continued to decline in 1997 and the first quarter of 1998, with the public and the private sectors both shedding jobs. Nonetheless, growth in nominal remuneration per worker in the non-agricultural sectors of the economy accelerated in the first quarter of 1998, after it had shown signs of moderating in the course of 1997. This quickening in the growth of labour costs, along with the recent depreciation of the rand and the increase in mortgage rates, is likely to end the decline in price inflation which has been recorded over the past year or so. Inflation will probably rise further in the second half of the year, despite the weak state of the economy. The extent to which this is likely to happen will be decided mostly by the success or failure of steps taken to contain increases in the cost of production in the domestic economy.
The problems of employment creation and rising unemployment will be discussed at the Presidential Jobs Summit on 30 October 1998. The objective of the Summit is to get government, the business sector and the trade unions together to seek solutions for the problem of unemployment and to discuss methods to increase the labour absorption capacity of the South African economy. To facilitate the discussions at the Summit, government has released an Employment Strategy Framework which proposes, among other things, relaxing the rigidities in the labour market that hinder employment creation, and taking additional measures to improve the employability of the population.
The steady growth of real gross final demand, the further reduction in inventories and the depreciation of the rand helped to arrest the widening of the deficit on the current account of the balance of payments that became apparent in the second half of 1997. Weak demand for imports and solid increases in the nominal value of merchandise exports then reduced the deficit on the external current account to a level which was equivalent to less than one per cent of gross domestic product in the second quarter of 1998.
The country experienced a strong inflow of capital, mostly portfolio capital, in the first quarter of 1998, causing international reserves to rise firmly. Although a general re-rating of exchange rate risk associated with emerging markets left its mark on South Africa in May and June 1998, the net capital inflow was still sufficient to keep the overall balance of payments in surplus in the second quarter. There was also an increase in the use of foreign credit lines by the Reserve Bank which resulted in a further strengthening of the country's gross international reserves to a level which, at the end of June 1998, was equivalent to approximately four months' worth of imports of goods and services.
The rand came under downward pressure in May and June 1998 amid general nervousness about prospects for emerging-market economies. The exchange rate declined sharply, aggravated by the activities of international currency speculators. This depreciation of the rand was not without potential benefits as South African producers in the third quarter of 1998 were potentially far more competitive in certain export markets than at the beginning of the year. Rates of return on capital invested in export industries should therefore improve, provided that domestic cost pressures can be contained, thus consolidating the competitive advantages. This could generate more investment in export industries, faster growth in real gross domestic product and possibly also improve the labour absorption capacity of the economy.
Although the growth from quarter to quarter in M3 slowed down in the first two quarters of 1998, the M3 guideline range continued to be substantially overshot. By contrast, growth in domestic credit extension, which had also slowed down in the first quarter, accelerated vigorously in the second quarter. Credit extension to the private sector, the main force behind this acceleration in credit growth in the second quarter, was concentrated mainly in the corporate sector. The component of private-sector credit that continued to grow apace was "other loans and advances", including overdrafts.
Stronger increases in the narrower monetary aggregates than in the broad M3 money supply indicated a rise in the private sector's preference for more liquid depository-type investments. This rise in liquidity preference was, in turn, inspired by high short-term interest rates and the many speculative opportunities presented by the high variability of financial-asset prices.
Conceivably, the strong growth in credit demand by private-sector organisations could have been motivated by exactly the same considerations that called forth the strong demand for call and other short-term bank deposits.
Unlike the situation during the currency crisis of 1996 when money market interest rates took more than three months to react meaningfully to the rise in bond yields, the new repurchase-based auction system presented a greater degree of flexibility for short-term rates to respond quickly to a change in the underlying liquidity conditions. The gradual easing of monetary conditions from the end of 1997 was reversed soon afterwards, when bond yields started to rise from the second half of April 1998 and non-resident investors turned into net sellers of bonds.
The repurchase rate responded quickly to the tightening of monetary conditions and was just over 700 basis points higher towards the end of August 1998 than at its nadir in May. The sharp rise in money market interest rates was reflected in the average cost of funding of the private banks whose prime overdraft rates rose by 725 basis points from June to the end of August 1998.
Bond yields drifted lower in the first four months of 1998 amid growing expectations of a further easing of monetary conditions as inflation continued to fall and the domestic economy remained weak. During this period, non-resident investors were aggressive buyers in the domestic bond market. With the onset of the emerging-market crisis and with non-resident investors mostly selling bonds on a net basis, yields started moving upwards. By August 1998, yields on long-term government bonds were hovering at levels that were considerably higher than in December 1996, completely reversing a sixteen-month long decline in bond yields.
Equity prices which rebounded strongly in the first four months of 1998, after these prices had been declining in the second half of 1997, fell sharply from May onwards, coinciding with the general increase in interest rates. In August 1998, the average price level of all classes of shares was about 1 per cent lower than in December 1997, but the dollar value had declined by 23 per cent as a result of the depreciation of the rand. Nevertheless, there was no evidence of large-scale sales of equities by non-resident investors — in fact, they continued to be net purchasers of listed shares throughout the first eight months of 1998.
Government continued to place high priority on fiscal rectitude and the overall public-sector borrowing requirement was reduced significantly in the quarter from April to June 1998, compared with the corresponding period of the previous year. Good progress was also made in containing the deficit on the Budget of the national government relative to gross domestic product at a level similar to that attained a year earlier. Of particular significance was the sound improvement in the finances of the provincial governments in the early months of the current fiscal year and an improvement in the efficiency of collecting revenue from income tax and value-added tax. Government remains firmly committed to the budget deficit targets set out in GEAR and to limiting tax revenues to a maximum of 25 per cent of gross domestic product.
