After the 2001 recession, the picture emerging in the second half of 2002 is that the global downturn has come to an end and that a relatively mild but broad-based recovery may already be under way. The easing of monetary policy and a more expansionary fiscal policy stance in many advanced economies have both helped support the current upturn.
Lower oil prices early in 2002 have reduced global inflation and helped sustain real disposable income. Inflation is expected to remain low but there are risks of a rise in some countries with rigid labour markets, especially in Europe. Nevertheless, the concerns about inflation are not expected to invite policy responses which could constrain the global recovery.
Deteriorating financial market conditions could dampen the global recovery. Falling stock market prices, through various wealth channels, are fully capable of slowing down the nascent recovery. Governments are still able to finance fiscal deficits at declining bond yields, but companies’ ability to raise capital has become somewhat limited, given greater investor caution after a series of high-profile bankruptcies in the United States of America. In addition, the wider spread between corporate bond yields and government bond yields may slow down the speed of the global recovery.
Essentially because of the greater price competitiveness of exporting companies, the South African economy succeeded in outperforming the global economy in the second quarter of 2002. Whereas the growth momentum in the international economy is generally expected to have weakened in the second quarter, the seasonally adjusted annualised growth in real gross domestic product in South Africa accelerated from 2 per cent in the first quarter of 2002 to 3 per cent in the second quarter. Growth was well dispersed throughout all the productive sectors of the economy, but of special significance was the healthy performance of the increasingly export-oriented manufacturing sector.
Aggregate final demand rose robustly in the second quarter of 2002. Fixed capital formation led the way as firms added to their production capacity, apparently in anticipation of stronger future growth in demand. Final consumption spending by households and general government also contributed to the solid rise in domestic demand. However, inventory investment fell back, causing real gross domestic expenditure to decline below the level recorded in the first quarter of 2002. This decline in inventory investment dampened the demand for imported goods, thus contributing to the widening in the country’s positive trade balance with the rest of the world.
The overall saving ratio deteriorated in the second quarter of 2002. Household saving held up well in the face of consumers’ strong propensity for spending, and saving by general government improved as a ratio of gross domestic product. By contrast, corporate saving declined as a percentage of gross domestic product, mainly because of large-scale dividend distributions, a sizeable portion of which was paid to non-resident parent companies and other foreign shareholders.
The better performance of the economy during the past three years did not reverse the downward movement in formal-sector employment. Employment opportunities in the formal sectors of the economy continued to diminish in the first quarter of 2002. There were nevertheless signs that the pace of decline in employment was tapering off in both the private and public sectors. This slight improvement in labour market conditions was echoed in a rising number of vacancies in the first quarter of 2002 and an increase in the space occupied in the print media by job advertisements.
Industrial relations became far more harmonious in the early part of 2002. The number of workdays lost to strikes and other work stoppages in the first half of 2002 was much lower than in the corresponding period in 2001. Output per worker accordingly rose further, especially in the manufacturing sector where nominal unit labour cost was firmly curbed. Economy-wide productivity growth was less impressive and the year-on-year growth in unit labour cost for the entire economy exceeded the rate that could conceivably be associated with low inflation.
The acceleration in economy-wide unit labour cost, together with the depreciation in the value of the rand towards the end of 2001 and rapid increases in food prices, propelled production and consumer price inflation to considerably higher levels in the first half of 2002. These price increases started losing momentum for a while in the second quarter of 2002 but despite this, annual inflation remained at a high level, leaving little scope for complacency in the struggle against inflation.
The decline in real gross domestic expenditure in the second quarter of 2002 held back growth in merchandise import volumes. Simultaneously, export volumes benefited immensely from domestic producers’ greater competitiveness in export markets. The surplus of merchandise and gold exports over goods imports accordingly widened. There was a sharp increase in net investment income payments to the rest of the world, but the overall current account of the balance of payments remained in surplus in the second quarter of 2002.
On the financial account of the balance of payments, the net inflows of capital into the economy in the second quarter of 2002 exceeded the net outflows by the widest margin ever recorded in a single quarter. The major portion of these net inflows consisted of portfolio capital flows, essentially the national government’s borrowing in the international capital markets and non-resident investors’ increases in their holdings of domestic debt and equity securities. Portfolio investment flows, especially the purchasing of bonds and shares on traded markets, are known for being fickle and subject to sudden reversals. Something of this kind occurred towards the end of May 2002 when non-resident investors began to sell their holdings of South African equity and debt securities on a net basis.
The excess of the net inflow of capital over the net outflow, together with a surplus on the current account of the balance of payments, led to a significant improvement in the country’s net holdings of international reserves in the second quarter of 2002. Under circumstances such as these, a strengthening in the exchange value of the rand can normally be expected, and the rand appreciated accordingly in the first five months of 2002. Since the beginning of June 2002 the rand has again come under some downward pressure because of problems in other emerging markets and fears that problems in neighbouring countries may spill over into South Africa. The contents of a draft mining charter for South Africa also failed to instil confidence in the rand among participants in the foreign-exchange markets.
The rates of growth in the monetary aggregates have slowed somewhat from the beginning of the year, but they remained relatively strong. To the extent that the balances encapsulated by these aggregates are used to purchase goods and services, they are an indication of potential inflationary pressures. This assumption is strengthened by the greater concentration of deposits in the hands of non-financial companies whose spending plans are more likely to be directly related to aggregate nominal spending on goods and services than those of financial companies.
Part of the reason that growth in the monetary aggregates remained relatively strong in the second quarter of 2002 was the greater demand for money for precautionary purposes. In the face of heightened uncertainty about asset price movements and future income growth, companies and individuals chose to hold a higher level of deposits for precautionary purposes. This choice, and a shift towards more investment-oriented long-term deposits, partly countered the potential impact on inflation of the very high level of aggregate money holdings.
Credit extension to the private sector was flat in the second quarter of 2002. One of the principal reasons for this was the unwinding and eventual turnaround of leads and lags in payments for and receipts from foreign transactions. The appreciation of the rand in the first and second quarters of 2002 provided an incentive to exporters to repatriate their export proceeds as soon as possible. This generally dampened the demand for credit, especially the demand by companies for borrowing from the banking sector. By contrast, households’ demand for mortgage bond lending remained firm.
On 14 June 2002 the Monetary Policy Committee of the Reserve Bank increased the rate on repurchase transactions by 100 basis points. This meant that the repurchase rate was increased by a total of 300 basis points in the first half of 2002. In reaching this decision, the Monetary Policy Committee indicated that the sharp decline in the exchange value of the rand in the last quarter of 2001 and higher international petroleum prices had fuelled inflationary expectations, prompting a tightening of the monetary policy stance in the quest to attain the inflation targets.
Short-term money market interest rates moved higher, following the Bank’s cumulative increase in the repurchase rate. By contrast, the mood in the bond market turned positive by the end of March 2002 and the average monthly yield on long-term government bonds declined quite substantially as market participants held to the view that the acceleration in inflation would only be temporary.
The steady fall in bond yields was assisted by the limited supply of investable securities in the market, due to the national government’s preference for offshore bond financing. At the same time, the outlook for the economy and corporate profits became slightly less certain, strengthening the demand for fixed-interest securities at the expense of the demand for equities. The divergent movements of short and long-term interest rates caused a flattening and eventually an inversion of the slope of the yield curve.
Share prices staged a strong comeback in the aftermath of the September 11 attacks on America. Most of the incoming information during the first five months of 2002 suggested that the economy had proven remarkably resilient and economic prospects were improving. The upward momentum in share prices was checked when many market participants in the United States became worried about the credibility of corporate financial statements and lowered their outlook for the economy. The JSE Securities Exchange SA followed the global trend downwards and the daily closing level of the all-share price index fell by 24 per cent from 22 May 2002 to 5 August.
Non-resident investor sentiment towards bonds improved noticeably in the second quarter of 2002 but then deteriorated abruptly in July. Since May 2002, non-residents have also been net sellers of shares listed on the stock exchange. Heightened aversion to risk taking in emerging markets and problems in some countries in the Southern African region led to a reduction in the exposure of international investors to South African shares and other financial assets.
The improving economic conditions and efficient tax administration have led to a smaller national government budget deficit than had been anticipated earlier. The national government budget deficit was reduced from 2,0 per cent of gross domestic product in fiscal 2000/01 to 1,5 per cent in fiscal 2001/02 – well below the original budgeted target of 2,5 per cent.
The budget for 2002/03 indicates an increase in the national government deficit to 2,1 per cent of gross domestic product, partly due to some tax relief for lower and middle-income taxpayers and higher spending in priority areas such as poverty reduction, social and economic infrastructure, HIV/Aids and crime. Despite these concessions, tax revenue growth continued to exceed expectations in the first four months of fiscal 2002/03, and the steps taken to improve expenditure monitoring and control ensured that growth in spending stayed broadly on target.
The funding of the relatively small national government budget deficit was mainly obtained in the international capital markets, releasing resources in the domestic fixed-interest market and assisting the bull market in bonds. The national government also used financial surpluses over the past year to pay down its outstanding domestic marketable debt. Overall, the public debt to gross domestic product ratio remained fairly modest, as did foreign debt as a portion of total public debt.