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The September attacks are expected to depress world economic growth and reduce projected growth in international trade, arguably the most important conduit for spreading economic weakness, or strength, around the world. Some estimates of world economic growth for 2001 were scaled down by as much as a full percentage point as a consequence of the attacks. Growth in global trade looks set to decline to 2 per cent in 2001 from a 12 per cent high in 2000.
Initially, the economic effect of this unnatural disaster was predominantly a loss of productive assets. The loss of income came later and will probably endure much longer. The erosion of consumer and business confidence may conceivably lead to further reductions in aggregate spending. Airlines, insurance companies, travel agents and the financial services sector were affected almost immediately by the attacks, but disruption is now spilling over into other areas such as manufacturing, retailing and information and telecommunication technology.
The damage to economic activity could be deeper and more protracted if consumers and producers perceive an ongoing threat of more terrorism and an escalation of the allies' military response. Paradoxically, however, the negative effects on growth could be shortened and turn positive by mid-2002 if the monetary and fiscal policy stimuli in the United States have the desired results. The expansionary effects of easier macroeconomic policies in the United States and other developed economies will probably be reinforced by the onset of rebuilding and damage repair. By encouraging a stimulatory policy response, the attacks have, therefore, increased the likelihood of an early recovery in economic growth over the next year or so, particularly in the United States.
Economic growth in South Africa up to the second quarter of 2001 had apparently been unscathed by the gathering global recession. Domestic economic growth held firm and even accelerated in the second quarter of 2001. But by the third quarter of 2001 the domestic economic situation became more closely aligned with the world economy, and annualised growth in real gross domestic production fell from 2 per cent in the second quarter to about 1 per cent in the third. Output growth slowed down throughout all the main production sectors of the economy, but was particularly severe in agriculture, mining and manufacturing where output volumes actually declined.
The slowdown in domestic output growth coincided with a relatively strong pickup in aggregate gross domestic expenditure in the third quarter of 2001, establishing an excess of domestic expenditure over domestic production and a deficit on the current account of the balance of payments. All the major components of aggregate final demand continued to grow robustly during the third quarter of 2001, and there were even indications of some counter-cyclical acceleration in final consumption expenditure by general government. Capital formation in the private sector and by general government continued to rise strongly but public corporations cut back on their capital programmes. Inventories were accumulated, giving a fillip to domestic expenditure in the third quarter.
Although growth in the real disposable income of households slowed down in the third quarter of 2001, households maintained quite a brisk rate of spending growth, partly by financing expenditures through increased recourse to bank credit. This reduced the household saving ratio. At the same time, high levels of dividend payments by companies in the face of weaker growth in operating surpluses also whittled off part of corporate savings. Overall, the national saving ratio declined in the second and third quarters of 2001, threatening to reverse the steady progress made in improving the economy's saving performance over the past five years.
Broadly reflecting the slowing pace of economic activity, labour demand in the formal economy weakened in the first half of 2001. Employment in the formal sectors of the economy continued along a declining trend, but survey results point to an unchanged overall level of employment from the beginning of 2000 to the beginning of 2001, leaving the unemployment rate virtually unaffected but at a still uncomfortably high level.
Increases in worker compensation trended down in the second quarter of 2001, but growth in measured labour productivity was compressed by heightened industrial action and by slower growth in output. Growth in unit labour cost nevertheless remained flat, adding minimal upward pressure to the overall price level.
Slow growth in nominal unit labour cost undeniably helped to contain inflation, but other counter-inflationary forces also made noticeable contributions. These were
Although inflation moved lower in the third quarter of 2001, there are signs of potentially faster future increases in the aggregate price level. In particular, there are concerns about the potential second-round price effects of the depreciation in the exchange value of the rand. So far, many producers and merchants have succeeded in absorbing upward cost pressures by reducing profit margins, but the reduction in the exchange rate could easily result in a stronger pass-through effect of the higher prices paid for imported goods. Nor can the squeeze on retail profit margins continue indefinitely. Higher wage settlements during the third quarter also point to the likelihood of a stronger wage-push effect in the near term. The recent stronger growth in the money supply also signals a potential threat of future increases in aggregate gross domestic demand. Furthermore, high food prices may contribute to a temporary acceleration of the inflationary momentum of the economy.
Economic slowdowns are usually associated with improvements in the balance on the external current account – either as growing surpluses or as shrinking deficits. However, despite the general slowdown in economic activity, the current account of South Africa with the rest of the world fell into deficit in the third quarter of 2001.
Until the second quarter of 2001 exports had held up well in the face of slowing world economic growth, underpinned by the competitiveness of the exchange rate as well as positive developments in some commodity markets. But during the third quarter of 2001 the potentially positive effects of the depreciation of the rand were negated by the adverse effects of slowing growth and declining income levels in trading-partner countries. The low level of the rand and weaker domestic economic conditions also dampened import growth, but not enough to prevent the current account from falling into deficit.
In the external financial account, recorded inflows exceeded net outflows as had been the case in the second quarter of 2001. Within the components of the financial account the imbalances remained very volatile and to some extent offset one another, leaving the overall positive balance almost unchanged from the second quarter of 2001 to the third quarter.
Foreign direct investment capital continued to move into the economy, but at such a modest pace that it was more than fully offset by the outward movement of portfolio capital. The surplus on the financial account was therefore the net result of inward movements of other mostly short-term foreign capital, such as unsecuritised loans, trade finance and bank deposits.
The surplus on the financial account precisely matched the deficit on the current account, leaving no room for a build-up of the country's net international reserves during the third quarter of 2001. This exerted some downward pressure on the exchange rate, aggravated by a heightened awareness of the risks associated with investing in emerging markets, disquieting developments in neighbouring states, and the typical leads and lags phenomena in foreign payments and receipts during periods of currency weakness. The exchange value of the rand declined sharply, also because of some position-taking by market operators. In the end, the decline in the value of the rand during the third quarter has been more severe than during any single quarter since the international financial crisis in 1998.
Growth from quarter to quarter in the broadly defined money supply remained solidly high throughout the first three quarters of 2001 and even accelerated somewhat from the second to the third quarter. Depositors were probably influenced by fears of potential losses from equity investments and the lack of opportunities for diversifying investment assets into offshore markets, so they preferred to make longer-term deposits of a more saving-related nature. There had also been signs of a faster accumulation of short-term transaction-related deposits in the third quarter of 2001, increasing the potential of the money supply to fuel aggregate spending pressures in the economy. The growth in aggregate money supply exceeded by a substantial margin the growth capacity of the South African economy.
Growth in the money supply in the third quarter of 2001 was influenced strongly by the expansion of bank credit. The demand for bank credit grew at a relatively modest pace in the first two quarters of 2001, but credit growth picked up quite significantly during the third quarter of the year. In particular, credit extension to the private sector rose firmly in the third quarter. Asset-backed lending (i.e. mortgage financing, instalment sale and leasing finance) increased robustly, reflecting the buoyancy of the real-estate market and ongoing fixed capital formation by private-sector companies, as well as private households' strong demand for financing durable consumer goods.
The bull run in the secondary bond market continued throughout the first ten months of 2001. Bond yields were driven lower by the steadily declining supply of public-sector debt, coupled with the strong demand for fixed-interest assets by domestic institutional investors and the growing realisation in market circles that monetary policy was firmly committed to enduringly low inflation. Furthermore, price formation in the domestic bond market was largely unaffected by the terrorist attacks on America.
An assessment of a benign outlook for inflation allowed the Monetary Policy Committee of the Reserve Bank to announce reductions in the rate on repurchase transactions on two occasions during the June–September period. Together with a technical adjustment in September, the repurchase rate was reduced by a full 250 basis points from the middle of June 2001 to the end of September, taking the level of this rate down to 9,5 per cent. The predominant lending rates of the private banks and the short-term interest rates determined in the money market, broadly traced the movements of the repurchase rate, but when the technical adjustment was introduced, market rates remained essentially unchanged.
In the primary debt market the availability of excess funds, following the shrinking of the public sector's borrowing requirement, created opportunities for the further development of the corporate bond market. This is evident from the growth in the nominal value of listed private-sector fixed-interest securities from about R4 billion two years ago to R20 billion currently. Mirroring to some extent the growth in the primary corporate debt market, the demand for new equity financing waned noticeably in the first three quarters of 2001.
Unlike bond prices, share prices were at first drastically influenced by the events of 11 September. The all-share price index tumbled by 15 per cent from 10 to 21 September, but subsequently recovered quite impressively and by the middle of November was again higher than on the eve of the first attacks. Over the past fourteen months, starting in August 2000, the South African share market has also outperformed the Wall Street market by a fair margin. Global investors recognised this and added some R26 billion in South African equities to their asset holdings over the first ten months of 2001. Real-estate values grew impressively as well, but the robust pace of increase in 1999 and 2000 has been tempered somewhat in recent months.
The fiscal situation in South Africa remained healthy in the first half of fiscal 2001/02 and the prospects are that this situation will continue in the second half of the year. The finances of the provincial governments in particular have been placed on a sound footing. Overall expenditure increased faster than the usual growth in the months from April to September, but this was off a relatively low base in the first half of fiscal 2000/01. Simultaneously, growth in national government revenue by far exceeded the budget projections of revenue growth for the full fiscal year. As a consequence, and allowing for the usual seasonal pattern of revenue and expenditure flows, the budget deficit of the national government is on target to meet the projected deficit for the full fiscal year – in terms of absolute size and also as a percentage of gross domestic product.
The steady reduction in the borrowing requirement of the public sector in recent years has not only released resources for absorption by private-sector borrowers but also contributed to the substantial decline in the long-term cost of capital. Growth in the interest burden of national government accordingly slowed down to a low rate in the first half of fiscal 2001/02. At the same time, the primary surplus (i.e. when interest payments are not seen as part of expenditure) rose to a level equal to about 1½ per cent of gross domestic product.
When presenting the Medium Term Budget Policy Statement to the Budget Committee of Parliament, the Minister of Finance announced that after consultation between the National Treasury and the Reserve Bank, agreement had been reached on medium-term inflation targets. The inflation target would remain at 3 to 6 per cent for the annual average of CPIX inflation for the year 2003, but for 2004 and 2005 the target was set at 3 to 5 per cent.
