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The recovery in global economic conditions was supported by the subsiding of the turbulence in the international financial markets, owing mainly to the timely action of a number of central banks in the main financial centres of the world during 1998. With the return of stability, capital flows to many emerging markets resumed, causing share prices to rise, exchange rates to stabilise and interest rates to decline. Even when monetary conditions were tightened in the United States towards the middle of 1999, a step that was later followed by the Bank of England and the European Central Bank, the overall assessment of future global economic conditions remained positive.


On the whole, the benign international developments offer the prospect that output conditions in South Africa will improve over the next year or two. Some commodity prices have already risen in reaction to expectations of stronger world growth. Furthermore, the gold price responded positively to the allaying of uncertainties about the marketing of gold by central banks in Europe. Although there is a possibility of an economic slowdown in the United States in the course of 2000, this is widely expected to be a rather "soft" one, which is likely to be cushioned further by improved economic performances in the euro area and in Japan. South African producers are expected to benefit from this healthier global economy.


In tandem with the trend towards better global economic conditions, a gradual strengthening of domestic economic growth became apparent from the end of 1998. A relaxation of the domestic monetary policy stance, and a recovery in agricultural production, have helped the real gross domestic product to expand at progressively firmer growth rates over the past four calendar quarters, reaching an annualised rate of 3 per cent in the third quarter of 1999.


The faster growth in the third quarter was mostly concentrated in the agricultural and the services sectors of the economy, notably the communication sector and the trade sector which benefited greatly from a rise in current spending by consumers. Production conditions remained subdued in mining and in the secondary sectors — i.e. manufacturing, construction and electricity and water utilities. Manufacturing output in the first nine months of 1999, for example, was still below that of the first three quarters of 1998.


The increase in aggregate production in the third quarter of 1999 was propelled by the rise in final consumption expenditure by households for the second quarter running. In particular, spending on durable goods rose rapidly. Total consumer spending rose faster than household incomes, putting downward pressure on the saving capacity of the household sector. Wealth effects, following the demutualisation of the Old Mutual life assurance company and some recovery in the real-estate market, together with stronger cash flows because of declining debt servicing costs, were among the prominent forces behind the recovery in consumer spending, and therefore of aggregate domestic production in the third quarter of 1999.


The other main components of gross domestic expenditure fell back in the third quarter of 1999. Inventory investment was at a much lower level than in the second quarter, confirming that the large second-quarter increase was essentially unplanned or involuntary. Government affirmed its commitment to fiscal prudence at all tiers of government when the Medium Term Budget Statement was released towards the end of October 1999. Indeed, this commitment had already been put into practice as real general government consumption has been declining for four consecutive quarters.


Real fixed capital formation continued to decline, but the pace of decline in the private sector appeared to have been flattening out. Ample production capacity still exists in the manufacturing industry. New investments are therefore targeted more towards the maintenance of existing production capacity or the implementation of new technologies, rather than towards creating additional capacity.


Along with the deterioration in the household saving ratio, dissaving by the general government as a percentage of gross domestic product increased somewhat in the third quarter of 1999. The corporate saving rate broadly maintained a level similar to that of the second quarter of 1999. The weakening of the household saving ratio and the slight increase in general government dissaving therefore mean that the overall saving performance of the economy has slipped again from the higher level established in the second quarter of 1999. A meaningful and lasting improvement in the national saving rate is required for sustained economic growth at a faster rate than currently experienced by the South African economy.


As could be expected, the weak state of the economy in the second half of 1998 resulted in the redundancy of a large number of workers in the private sector of the economy. This trend persisted into the first half of 1999, despite the improvement in overall economic performance. Over the same period, government's commitment to fiscal prudence and to a smaller, more efficient public service added to the total of job losses in the economy.


Nominal salaries and wages per worker began to respond to the process of labour paring and increased by less than overall output prices in the first half of 1999. These developments, coupled with steady growth in economy-wide labour productivity, should in due course assist in a general downward movement in production and consumer price inflation.


Consumer price inflation showed a distinct downward tendency in 1999 and reached levels unprecedented during the past three decades or more. Other measures of inflation showed some acceleration during 1999. However, these measures would have indicated lower inflation, had it not been for the effects of the strongly rising prices of imported oil. On the whole, domestically generated inflationary pressures seemed to be diminishing, and the additional inflationary forces observed in the first three quarters of 1999 apparently had their origins essentially in the external sector.


With the economy currently operating in the vicinity of a lower turning point of the business cycle, surpluses on the current account of the balance of payments can be expected to grow or deficits to shrink. A positive, though relatively weak export response to the improvement in the global economy, which nevertheless exceeded the increase in the value of merchandise imports, ensured that the deficit on the external current account shrank noticeably in the third quarter of 1999.


The physical volume of non-gold merchandise exports in the first nine months of 1999 has now been restored to a level roughly commensurate with that of the first nine months of 1998. The losses in export volumes recorded during the financial crisis of 1998 have therefore largely been recovered. However, over the medium term, i.e. from the second half of 1997, there was a small decline in the volume of merchandise exports. Continued growth in export earnings is generally regarded as a prerequisite for extending the duration of the current economic recovery.


The deficit on the current account of the balance of payments in the middle quarters of 1999 was comfortably financed by relatively strong inflows of international capital. In fact, the surplus on the overall balance of payments enabled the Reserve Bank to accumulate international reserves steadily and reduce its net open position in foreign currency.


The net inflow of international capital during the first three quarters of 1999 was more than fully accounted for by inflows of portfolio capital. Such flows, and more specifically those that enter the economy through the fixed-interest securities markets, are known for their capricious behaviour: they are volatile and their direction of flow is often reversed abruptly.


The relative stability of the financial markets and positive assessments of the economic outlook created circumstances for the rand to appreciate from the beginning of the year. The appreciation in the weighted effective value of the rand could have gone further, with negative consequences for import-competing industries and exporters trying to gain an increased share of foreign markets, had it not been for the Reserve Bank's steady purchases of foreign currency. By strengthening its international reserves, the Bank also contributed to an overall reduction in the economy's vulnerability to exogenous shocks.


The growth rates of the monetary and credit aggregates measured over twelve months decreased during the first nine months of 1999, reflecting the mildly subdued real economic conditions, combined with the legacy of the highly restrictive monetary policy stance of 1998. This seems to indicate the possibility of a slowdown in future inflation, especially as the growth in narrow money holdings have slowed down more than broad money growth.


Credit growth, although considerably below the growth of 1998, began to show some tentative signs of renewed buoyancy as the real-estate market picked up, and companies and households became more inclined to take on debt at the prevailing interest rate levels. The growth in M3 also appeared to have been accelerating from the second to the third quarter of 1999, but much of this should be attributed, for the present, to the influence of the technical procedures followed in accounting for changes in partially processed items appearing on the balance sheets of banks.


The shrinking borrowing requirement of public-sector bodies and the low level of fixed capital formation in the private sector have substantially reduced the demand for loanable funds in the primary capital markets. Simultaneously, financial stress among private households, which led to a sharp increase in surrenders of pension fund and life assurance business, reduced the current revenue surpluses of institutional investors. This decline in the supply of funds prevented capital market interest rates from responding more positively to the decline in the demand for loanable funds. Continued reductions in the public sector's demand for funds, coupled with the restoration of growth in the current revenue surpluses of institutional investors are likely to lead to a greater demand for non-government paper in the period ahead.


The real-estate market, as reflected in the average nominal value per real-estate transaction, rebounded from the depressed levels of the last months of 1998 and the early months of 1999. Share prices also recovered from September 1998 to July 1999 and recouped most of the losses sustained during the financial market turmoil of 1998. There was little growth in share prices from July to October 1999. Turnover nevertheless remained lively and non-residents maintained a prominent presence as net buyers of South African equities.


An important feature of the economy over the past year was the recovery of the fixed-interest market from the disruptions of 1998. Money market interest rates declined throughout the first ten months of 1999, overtly guided lower along their descending path by the Reserve Bank's signalling at the daily auction of repurchase transactions. The private banks followed the lead given by the rate on repurchase transactions and lowered their retail lending rates on four occasions from June to October 1999.


In contrast to the general behaviour of short-term interest rates, the market-determined yields on long-term government bonds generally moved along a gentle upward trend from the beginning of the second quarter of 1999. An undertone of uncertainty about the situation in emerging markets, the rise in capital market rates in the United States and concerns about the accumulation of inflationary pressures imparted an upward bias to long-term interest rates over the first ten months of the year. News of an imminent implementation of an inflation-targeting monetary policy framework and expectations of an upward re-rating of South Africa's creditworthiness by a prominent international rating agency caused long-term bond yields to move downwards quite strongly from the end of October and in November 1999.


As a consequence of the divergent movements in short-term and long-term interest rates, the yield curve assumed an increasingly steeper positive slope over maturities of less than five years. Over maturities of longer than five years, the yield curve retained its generally flat shape. This might have been indicative of pervasive uncertainties in the financial markets about future movements in the general price level and possibly also of fears that the downward trend in inflation might be reversed.


In the area of public finance, the public-sector borrowing requirement improved in the first half of fiscal 1999/2000 because of, among other things, a reduction in the financing needs of non-financial public-sector enterprises. There was also a noticeable reduction in the national government budget deficit relative to gross domestic product. Exchequer revenue exceeded the budgeted revenue growth by more than the excess of actual expenditure growth over budgeted expenditure growth. The budget deficit for the full fiscal year as a percentage of gross domestic product is likely to be lower than the budgeted projections.


Fiscal consolidation in South Africa has now been continuing for more than five years. Since 1994, fiscal policy has focused consistently on enhancing national saving by reducing budget deficits. This, along with a monetary policy committed to price stability over the medium to long run, is a central element in creating an environment that will foster capital investment, rising productivity, more job opportunities and higher living standards for all the people of the country. When the Minister of Finance released the Medium Term Budget Policy Statement on 29 October 1999 he reaffirmed that these policies would be extended into the future for at least the next three fiscal years.