A strengthening in world economic activity in the early months of 2000 was fairly broadly based, except for Japan where aggregate output declined. The outlook for Japan nevertheless remains one of a resumption of growth in the second half of 2000. The pace of activity in developing economies is also increasing, with the Asian emerging-market economies recovering rapidly from the output declines of 1998.
The latest developments in the world economy and the prospects for 2000 are more likely to help the South African economy along, rather than holding it back. The global recovery was expected to assist growth in the South African economy through international trade relations and higher commodity prices, and through increased international capital flows into the economy. Against this backdrop of rising expectations of an improvement in economic conditions, it was somewhat surprising when economic growth faltered in the first quarter of 2000 and international portfolio investors began to divest themselves of rand-denominated assets.
A sharp decline in agricultural production and a substantial slowdown in the growth of real output in manufacturing reduced aggregate output growth from an annualised rate of 3½ per cent in the fourth quarter of 1999 to just 1 per cent in the first quarter of 2000. Exceptional climatic conditions, as diverse as torrential rains and flooding in the north-eastern parts of the country and unseasonally high temperatures and widespread veld fires in the south-western parts, affected the agricultural sector adversely. Manufacturing output was also disrupted by the fall in agricultural output and by increased strike activity, but it is conceivable that some unintended inventory accumulation contributed to production cutbacks.
Aggregate spending growth in the economy slowed down too, almost exclusively owing to a sharp contraction in real consumption expenditure by general government. The growth in overall capital formation and household consumption expenditure continued to accelerate in the first quarter of 2000. General government is therefore making a contribution to the maintenance of macroeconomic stability in the country.
Unemployment remains high and the employment-creating capacity of the formal sector of the economy is still weak. But there are signs that the informal sector is absorbing increasing numbers of new entrants to the workforce: the latest available information indicates that overall employment in the economy increased between 1996 and 1998. Even so, the number of job seekers increased even faster, pushing the unemployment rate to 25 per cent in October 1998.
The growth in nominal earnings of workers slowed down appreciably in 1999. Labour productivity remained buoyant, reducing the growth in nominal unit labour costs to a rate roughly consistent with inflation in the lower end of the indicated inflation target range. This is an essential contribution to the combatting of high inflation expectations. Apart from securing a decline in price inflation, moderate wage settlements, particularly when they do not fully match productivity growth, could serve the cause of employment growth.
Despite the slowdown in nominal wage growth, the rate of inflation at the production price and consumer price levels has been accelerating. Rising oil prices, the weakness of the rand and higher food prices because of the flood damage are all adding to existing inflationary pressures. There are also indications that producers could have been widening their operating margins. Because firms can no longer count on a generally inflationary monetary policy to validate their decisions to raise their own prices, margin widening could easily endanger the continuation of the current modest recovery in economic activity.
There was a healthy surplus on the overall balance of payments in the first quarter of 2000, even though the net inflow of international capital declined from the fourth quarter of 1999 to the first quarter of 2000. The surplus on the trade account increased somewhat as total export earnings rose slightly more than the nominal value of aggregate imports. This improvement was only partially countered by a modest widening of the deficit on the services account, leading to a small improvement on the current account of the balance of payments.
Strong international capital inflows in the last two quarters of 1999 weakened abruptly in the early months of 2000. Negative sentiment towards emerging markets generally, aggravated by regional concerns, caused an outflow of portfolio capital through the Bond Exchange in the first quarter of the year. Despite this setback, the external financial position of the economy remained healthy and international reserves continued to be accumulated. The Reserve Bank's net open position in foreign currency declined to its lowest level since 1996, gradually eliminating an element of perceived vulnerability of the South African financial system.
The rand came under downward pressure because of the turn in investor sentiment towards the country, but even more so because of the strength of the United States dollar on the international currency markets. The nominal effective exchange rate of the rand accordingly declined quite sharply in the first five months of 2000. By May 2000, the earlier strengthening of the rand on an inflation-adjusted basis might have been reversed substantially. The price competitiveness of domestic producers in export markets should have benefited from this recent depreciation of the external value of the rand.
As is usually the case shortly after a decline in bank lending rates, the growth in bank credit extension and overall monetary growth once again slowed down in the first quarter of 2000. This easing of monetary growth, of course, coincided with the slowdown in the growth of aggregate output and expenditure, but it was also assisted by a decline in the return on deposits at banks. Such a slowdown in monetary expansion, if it continues, would probably have a moderating impact on the inflation outlook and would in this way help to contain inflation. Current trends in credit growth also indicate that households are still cautious about using debt finance for current expenditure. This should help to reassure market participants that the recent increases in exogenously determined prices may not necessarily develop into a renewed acceleration of inflation.
Liquidity conditions tightened in the money market in the first five months of 2000. This was essentially the result of deliberate Reserve Bank intervention. The existence of a liquidity requirement in the money market enables the Bank to guide the actions of market participants. From 14 January 2000 the repurchase rate remained at a level of 11,75 per cent at the daily auction for central bank funding.
Bond yields fell rapidly towards the end of 1999 and in the first two weeks or so of 2000. The positive sentiment in the market was encouraged by, among other things, a relaxation of monetary policy and lower demand for funds by the public sector in the domestic capital market. From around the middle of January 2000, downward pressure on bond prices was brought to bear by the weakening of the rand, the re-emergence of inflation pressures, increased uncertainty about the future direction of monetary policy and later also by developments in other parts of sub-Saharan Africa. Bond yields have generally moved higher since then.
Foreign buying in the domestic bond market picked up in 1999 as confidence in the prospects for South Africa improved. Sentiment appeared to have changed again and since the beginning of 2000 non-residents have been selling bonds on a net basis. The changed sentiment was apparently not confined to South Africa, but was part of a heightened global aversion to risk taking in emerging-market economies and a move back to quality assets in the advanced economies of the world. The spreads of emerging-market debt instruments over advanced economy debt have widened from March to April 2000.
The share market, which rebounded strongly in the final months of 1999 and in the first two weeks of 2000, faltered in the ensuing months. Falling interest rates and the acceleration in economic activity in the last two quarters of 1999 helped to boost the outlook for corporate earnings. From mid-January 2000, the rise in inflation and growing uncertainties about the future course of short-term interest rates might have dampened confidence and share prices declined steeply. Foreign participation in the share market fell as foreign investors were scared off by the weakness of the rand and concerns about stability in other parts of sub-Saharan Africa. Nevertheless, macroeconomic policies have remained fundamentally sound and fairly modest price-earnings ratios suggest that the share market may have over-reacted.
Limited amounts of capital were raised in the primary debt market in the first quarter of 2000. To a significant extent this was related to the curtailment of the public-sector borrowing requirement, but private-sector demand for funds was also at a low ebb. There was some evidence, however, of an increase, albeit from a very depressed level, in the demand for debt financing by private-sector organisations.
The government continued to consolidate the fiscal position and improve the management of public finances during the past fiscal year. Unexpectedly strong growth in revenue and tight expenditure controls resulted in a lower-than-budgeted deficit of 2,6 per cent of gross domestic product in fiscal 1999/2000.
A primary surplus, i.e. an excess of current revenue over expenditure when interest charges are not taken into consideration, is still being realised on the national government budgetary accounts. The absolute value of total government debt rose somewhat in the first quarter of 2000, but as a percentage of gross domestic product it fell to just more than 48 per cent. The slowdown in aggregate debt growth should help reduce interest costs over time and release resources for government's reconstruction, development and redistribution policies, and provide scope for introducing further tax reforms.
The disciplined fiscal policy is not in any way adding to existing demand pressures in the economy. Furthermore with regard to inflation containment, government is encouraging overall moderation in remuneration growth through modest wage settlements in the public sector. Although a bias towards higher inflation in the economy has developed lately, the role played by government policies is likely to dampen second-round inflation effects. Government's contribution towards curbing inflation is, among other things, reinforced by the following:
In the absence of any major random shock, these forces are likely to weigh down on price increases and reduce inflation to rates consistent with the Reserve Bank's targeted objectives.