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By the end of 1997 the process of macroeconomic consolidation had largely been completed and the economy was in a much healthier state for the resumption of higher growth than at the beginning of 1996. This was evident from:
The adjustment process of the past two years, on the other hand, also had negative short-term effects which were unavoidable if the long-run growth capacity of the economy was to be strengthened. These included:
These short-term adjustment problems were aggravated by the uncertainties created by the economic and financial problems that some East Asian economies encountered during the past year and by the sharp decline in the price of gold. Economic activity consequently slackened and the growth in the real gross domestic product declined from slightly more than 3 per cent in 1996 to only 1½ per cent in 1997. In the second half of 1997 output growth slowed down even more and annualised output growth in the last six months was below 1 per cent.
The slowdown in output growth in the second half of 1997 occurred over the broad spectrum of economic activities, but was more conspicuous in the manufacturing and commercial sectors. The manufacturing sector had to contend with stronger competition in an increasingly open economy. Coupled with domestic cost pressures, subdued increases in output prices and weak demand growth, this compressed operating margins to such an extent that the real value added in the manufacturing sector declined in the second and third quarters of 1997. The downward pressure on real household incomes and the weakening of consumer confidence contributed to declines in the real value added by the commercial sector. Though still positive, growth in the mining sector which was affected by falling international commodity prices and in the services sectors also slowed down towards the end of 1997.
The slowdown in private consumption expenditure, which had already become apparent in the second half of 1996, continued into 1997. Falling employment levels and heightened job insecurity have weakened consumer confidence. Although the growth in consumer spending was curtailed in 1997, households still preferred to maintain certain minimum spending levels by activating their accumulated savings. Together with a further rise in household indebtedness, this caused the household savings rate and the national savings rate to decline to a level that is inadequate for the financing of fixed investment at a pace compatible with rapid job creation.
Real government consumption expenditure grew at an exceptionally rapid rate in 1997, thereby increasing the rate of dissaving of general government and reducing the already very low national savings rate even further. Real gross domestic fixed investment still increased in the second half of 1997, but at a much lower rate than in the preceding three years. Public-sector fixed investment was mostly responsible for this slowdown in real fixed investment activity, while private-sector companies modestly increased their rate of capital formation towards the end of 1997.
As already mentioned, the measures taken in response to the apparent weakness in the overall balance of payments during 1996 had the desired effect of restoring better balance between aggregate demand and supply. The deficit on the current account of the balance of payments in 1997 as a whole, however, changed little from that of 1996. In the course of 1997, an acceleration in total domestic demand in the fourth quarter, a decline in the gold price and international commodity prices and a decline in the ratio of import prices to the prices of domestically produced goods, however, resulted in a widening of the quarterly seasonally-adjusted current-account deficit. Although the deficit also widened relative to gross domestic product, it was still within the limits of sustainability during the fourth quarter of 1997. Aggregate output responded weakly to the strengthening of domestic demand towards the end of 1997. This caused the import-penetration ratio to rise steeply.
The current account deficit in 1997 was accompanied by a strong rise in net inflows of capital which helped to rebuild international reserves. Import cover improved to about two-and-a-half months' worth of imports of goods and services. The net inflows of international capital were mostly in the form of portfolio-type investments, which nevertheless need not be of a speculative nature. A sizeable part of the inflows was related to Eurorand bond issues with a fairly long maturity and asset swap arrangements between resident and non-resident investors, thereby assuming the character of longer-term investment. Foreign direct investors, however, still seemed somewhat hesitant to commit large amounts of long-term capital, probably due to uncertainty over prospective exchange rate movements, a mismatch between productivity and remuneration levels and concerns over violent crime.
The accumulation of international reserves during 1997 helped to steady the rand after the sharp loss in value of the previous year. The rand also recovered rather quickly after the effects of the problems in Asia had spilt over into the South African securities markets in October 1997, leaving the impression that the contagion from the currency crisis in Asia had been short-lived. This stabilisation of the rand was attained without official attempts to defend the rand at any particular level.
Consumer-price inflation is now firmly on a downward trend, having risen sharply in 1996 as a result of the depreciation of the rand. Production-price inflation declined equally impressively and the most recent quarter-to-quarter inflation rates were not completely out of step with trend inflation in South Africa's major trading-partner countries. Prospects for lower inflation also appeared to have improved, given the new-found stability of the exchange rate of the rand and the easing in the growth of private-sector credit. Furthermore, the opening up of the economy increasingly discouraged producers from raising prices in order to remain competitive with foreign suppliers.
Employee remuneration remained at a relatively high level. Any increase in the current growth of nominal remuneration per worker would be difficult to reconcile with the monetary-policy objective of enhanced price stability. Employment in the non-agricultural sector continued to fall in the first three quarters of 1997. This still reflected the restructuring and rationalisation of work practices by producers facing domestic cost pressures, aggressive foreign competition and weak international commodity prices. In addition, the elimination of export subsidies also forced domestic exporters to adjust and reduce the size of their workforce.
The Reserve Bank's guidelines for M3 growth were kept unchanged at 6 to 10 per cent for 1997. The upper limit of this guideline range continued to be substantially overshot. This coincided until recently with the persistently strong growth in credit extended to the private sector by monetary institutions. By the third quarter of 1997 it had become abundantly clear that private-sector credit growth had slowed down. A "revised" or "purified" definition of private-sector credit, which excludes, among others, credit extended by banks to local governments, indicated that the slowdown in private-sector credit growth was even more impressive than that indicated by the conventional definition. This slowdown in private-sector credit growth generally reflected subdued economic activity, falling inflation and weaker household expenditure.
The decline in private-sector credit growth, the improvement in the overall balance of payments, rising gold and other foreign exchange reserves and the easing of inflationary pressures paved the way for a one percentage point reduction in Bank rate in October 1997. Bank lending rates responded with little delay to the lowering of Bank rate, but the response of money market interest rates was rather muted. This was mainly owing to two reasons: firstly, the lowering of Bank rate had already been discounted in the prevailing market-determined rates and, secondly, the decline in the net foreign assets of the Reserve Bank following the financial problems in Asia, widened the liquidity shortage in the domestic money market and put upward pressure on short-term interest rates. Money market rates nevertheless began to subside in January 1998 as the impact of the Asian problems faded and trading conditions in the money and foreign-exchange markets steadied.
The main features of financial market developments in 1997 were the bullish sentiment which prevailed in the bond market, strongly rising turnovers in the securities markets, the heightened volatility in the share market and the increased non-resident participation in the South African markets. Bond yields fell nearly 250 basis points from the end of 1996 to the beginning of 1998, reflecting growing anticipation of an easing of monetary policy, steadily declining inflation and heavy non-resident buying.
Share prices, which had risen firmly since the beginning of 1997 on the back of solid earnings growth and in anticipation of a decline in official interest rates, became highly volatile in late October 1997 when they fell back sharply as a result of the spill-over effects of the loss of international investor confidence in emerging markets. Non-residents were much more active in the South African securities markets than before. High yields, the easing of inflationary pressures, which strengthened prospects for a downward movement of the yield curve, and the perception that exchange risks had diminished lured non-resident investors back into the domestic securities markets.
Activity in the domestic primary bond market was overwhelmingly dominated by issues of entities in the public sector. As a result of the high level of liquidity in the corporate sector and the high cost of borrowed funds, private-sector companies preferred to raise capital through the issuance of shares. Private-sector companies also abstained from raising substantial amounts in international capital markets, but a number of public-sector bodies opted to issue bonds in the Eurorand market.
The overall public-sector borrowing requirement relative to gross domestic product in the first three quarters of fiscal 1997/1998 increased in comparison with its counterpart of the previous fiscal year. In contrast, the deficit before borrowing and debt repayment on the Exchequer account as a ratio of gross domestic product, was reduced from the first three quarters of fiscal 1996/1997 to the first three quarters of 1997/1998. The portion of the budgeted deficit absorbed in the first ten months of the current fiscal year was nevertheless significantly higher than during any of the previous five fiscal years. This was mainly the result of some provincial governments exceeding their budget allocations which also caused substantial increases in their indebtedness to the banking sector.
The first "Medium Term Budget Policy Statement" was released on 2 December 1997 and set out broad-based expenditure and revenue plans for the next three fiscal years. A key element of this Statement is the "Medium Term Expenditure Framework" which initiated a process of three-year rolling budgets. Government departments will in future be expected to frame their policy proposals within their three-year budgetary allocations. The Statement retained the budget deficit reduction targets indicated by the Macroeconomic Strategy for Growth, Employment and Redistribution. The Statement also pledged to restrain the growth in nominal government expenditure. If future economic growth does not meet current expectations, then spending growth will be contained below the projected expenditure levels.
