Economic policies in the industrial countries reacted to the weakness in aggregate demand. Monetary and fiscal policies were relaxed in response to the weaker outlook for the global economy. Fairly soon, there were clearer signs that the global economy had reached a lower turning point, but so far the recovery has been somewhat tepid and not evenly distributed among the major industrial countries.
Amid these concerns about global economic developments, financial markets became more uncertain and volatile, signifying that the recovery would not be as strong as had been anticipated earlier in 2002. Still, economic activity is expected to gather momentum as the effects of the monetary easing and fiscal incentives permeate through the global economy. Even so, inflation is not likely to impede the spread of the recovery.
Apparently unperturbed by the uncertainties in the global economy, the South African economy continued to expand during 2002. The pace of overall economic growth was firm at an annualised rate of 3 per cent in the third quarter of 2002, following exceptionally strong growth of 4 per cent in the second quarter.
Growth was fairly evenly distributed over all the major production sectors of the economy. The pace-setters were the transport and communication sector, manufacturing and agriculture. Output originating in the mining sector languished somewhat, but nominal value added in this sector benefited substantially from the depreciation in the exchange value of the rand in the closing months of 2001.
In the first two quarters of 2002 economic growth was driven by rising domestic demand and growing export volumes. This benign situation of balanced growth suffered a setback in the third quarter of 2002 when the international demand for South African produced goods faltered unexpectedly. Domestic demand was still robust and aggregate gross domestic expenditure grew at a faster pace in the third quarter of 2002 than in the second quarter.
There was a large accumulation of inventories in the third quarter of 2002, but fixed capital formation also increased quite rapidly. Growth in final consumption expenditure by households, however, slowed down from the second to the third quarter of 2002. However, households’ real outlays on durable goods, such as motorcars, strengthened in the third quarter of 2002 – purchases of durable goods were apparently advanced in order to avoid paying higher prices later.
Operating surpluses of export-oriented industries were boosted by the depreciation in the exchange rate of the rand in the last quarter of 2001. This shifted the distribution of domestic income in favour of employers – the share of operating surpluses in aggregate production-factor rewards is now at its highest level since the Second World War. The strong growth in operating surpluses also helped to improve corporate saving and the national gross saving ratio.
The high level of economic activity in the second quarter of 2002 was accompanied by an increase in employment in the formal non-agricultural sectors of the economy. Of even greater significance was that this increase in the supply of jobs occurred primarily in private-sector business enterprises. This was the first time since early 1999 that measured formal-sector employment actually increased in any calendar quarter. The latest increase in employment levels may signal that the strategies aimed at containing cost and raising efficiencies in the production process have been successful and that future output expansions may perhaps be accompanied by the creation of new jobs.
The increase in employment in the second quarter of 2002 had little impact on the overall excess supply of labour in the economy. Against the background of substantial excess supply in the labour market, the rate of increase in nominal wages and salaries remained downwardly inflexible. In fact, nominal wage growth began to accelerate in the second half of 2001 and remained at a high level in the first half of 2002. At the same time, productivity growth slowed down as employers became less aggressive about paring their staff complements. This meant that the cost implications of higher nominal wage growth were not fully absorbed by higher output per worker, eventually leading to fairly strong increases in economy-wide unit labour cost in the first half of 2002.
The acceleration in growth in unit labour cost, together with the depreciation in the exchange value of the rand in 2001 and rapid increases in food and oil prices, propelled production and consumer price inflation to considerably higher levels in the first half of 2002. Measured over periods of one year, these price increases remained well above the inflation-target ranges set by government. However, there were indications that the incremental growth in prices, when measured from one quarter to the next, was actually slowing down at the production price level. But even this lower quarter-to-quarter price growth exceeded by some margin the upper limit of the inflation target range set at 6 per cent for 2002, 2003 and 2004.
Weaker global economic conditions caught up with the South African economy in the third quarter of 2002. While export volumes were still at a high level and growing in the first half of 2002, they declined quite sharply as the world demand for South African exports declined in the third quarter. Import volumes, by contrast, declined only slightly and remained at a high level, responding to fairly strong domestic demand. Interest and dividend payments to non-resident investors shrank on a net basis, but this could not prevent the current account of the balance of payments changing from surpluses in the first half of 2002 to a deficit in the third quarter. A deficit on the current account of the balance of payments usually signals that expenditure in the economy exceeds aggregate disposable income.
There was a sudden reversal of portfolio capital movements from strong net inflows in the second quarter of 2002 to net outflows of almost equal size in the third quarter. Market participants linked this sudden flow-reversal to the leaking of a draft empowerment charter for the mining industry which raised concerns about the riskiness of investment throughout the South African economy. The overall positive imbalance on the financial account of the country with the rest of the world declined to a level in the third quarter which fell far short of the financing requirements of the current account. By necessity, the country’s holdings of net gold and other international reserves subsequently declined in the third quarter of 2002.
The deficit on the current account in the third quarter of 2002 and the small inflow of capital into the economy weighed on the exchange rate of the rand, pushing the weighted exchange value lower by some 1,3 per cent from the end of June 2002 to the end of September. The exchange rate strengthened in the early part of the fourth quarter, creating the impression that the overall balance-of-payments position was improving.
As regularly happens shortly after an increase in bank lending rates, overall monetary growth and the growth in bank credit extension accelerated in the first quarter of 2002. This coincided with the expansion of aggregate income and expenditure and also provided the monetary accommodation for rapidly rising prices, inevitably following in the wake of the depreciation in the exchange value of the rand in the second half of 2001. In the long run, and in the absence of velocity changes, an increase in the overall money supply in excess of real output must be associated with inflation.
Later, in the second and third quarters of 2002, growth in M3 and in bank credit extension were reined in by, among other things, the progressive tightening of the Reserve Bank’s monetary policy stance. From January to September 2002 the Reserve Bank increased its interest rate on short-term repurchase transactions on four occasions by 100 basis points at a time. Quarter-to-quarter growth in M3 and bank credit extension slowed down to relatively low rates in the third quarter of 2002, signalling a reduction in the inflationary pressures in the economy.
Short-term money-market interest rates generally moved higher in the first ten months of 2002, either following increases in the Reserve Bank’s repurchase rate or in anticipation of future increases in this rate. By contrast, the yield on long-term government bonds generally declined from about the end of March 2002, reflecting falling inflation expectations and a limited supply of investable paper in the market.
The downward movement in bond yields was interrupted by a fairly short interlude of rising yields from about the end of July 2002 to the beginning of October. This temporary reversal of the downward drift in bond yields was caused, alongside other factors such as higher inflation expectations, by the leaking of the draft empowerment charter for the mining industry.
The divergent movements of short- and long-term interest rates caused a flattening of the yield curve and later inverted the slope of the curve over the entire maturity spectrum. Some analysts interpret such a downward sloping yield curve as a reflection of a tight monetary policy stance, leading eventually to enduringly lower inflation.
Following the lead given by the major international markets, share prices on the JSE Securities Exchange SA fell by almost a quarter from the end of May 2002 to the beginning of August. In the ensuing months some of these losses in capital value were recovered, mostly in the resources sector of the market. The real-estate market also revealed a softer undertone in the middle quarters of 2002.
The financial position of the national government remained sound in the first half of fiscal 2002/03. Judging by information released through the Medium Term Budget Policy Statement the prospects are that this situation will continue in the second half of the year. Overall national government expenditure increased slightly faster than the usual growth in the months from April to September, but the small excess over budgeted expenditure is unlikely to widen in the second half of the fiscal year. Incoming information indicates that growth in spending is broadly on target for the fiscal year as a whole.
Simultaneously, improving economic conditions, higher inflation and efficient tax administration assured that growth in national government revenue by far exceeded the budget projections 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 as a ratio of gross domestic product is expected to fall to 1,6 per cent – well below the originally projected deficit ratio of 2,1 per cent for fiscal 2002/03.
A capital transfer of R7 billion was made by the national government to the Reserve Bank during the third quarter to compensate the Bank for losses incurred on forward foreign-exchange transactions. Also, the financial position of the provincial governments deteriorated and the surpluses of the non-financial public-sector businesses narrowed. All these contributed to an increase in the borrowing requirement of the overall non-financial public sector from 0,8 per cent of gross domestic product in the first half of fiscal 2001/02 to 3,0 per cent in the first half of the current fiscal year, still well within the limits of sustainable public-debt growth.
When presenting the Medium Term Budget Policy Statement to Parliament, the Minister of Finance announced that an agreement had been reached between the National Treasury and the Reserve Bank to raise the upper limit of the inflation target range for 2004 from 5 per cent to 6 per cent.