In response to the weakness in economic activity, monetary authorities in the United States and the other major industrial countries eased policy throughout the year. In some countries, fiscal measures were also taken to add to the stimulatory impact of an easier monetary policy.

Evidence of an improvement in global economic conditions began to surface in the fourth quarter of 2001. Since then the signs that a worldwide recovery was under way have steadily increased. Confidence in the United States economy, the traditional locomotive of the world economy, is returning more rapidly than expected and growth of close to 6 per cent was measured in the first quarter of 2002.

The synchronisation of the recovery in various parts of the world will probably strengthen the global expansion, in the same way as the downturn of 2001 was aggravated by its wide dispersion. Through various linkages, the South African economy stands to benefit from the world economic recovery, provided no major setbacks occur later in the year.

The South African economy could not escape the slowing down of the global economy but still succeeded in maintaining growth at a year-to-year rate of just more than 2 per cent in 2001. Growth at this level was broadly sustained in the first quarter of 2002, making this the fourteenth consecutive quarter of economic growth, starting in the fourth quarter of 1998.

A slight slowdown in economic growth from the fourth quarter of 2001 to the first quarter of 2002 was mainly concentrated in the manufacturing sector where growth merely returned to more normal levels after a period of frenetic growth in the final months of 2001. Overall, production structures are apparently still adjusting to a new set of relative prices so that the full impact on manufacturing output growth of the vastly more competitive exchange rate is yet to be seen.

Domestic spending was high in the first quarter of 2002. Final consumption expenditure by private households and general government contributed to the pick-up in spending, but the strongest contribution came from investment, especially the accumulation of inventories. Inventory investment contributed as much as 1½ percentage points to overall economic growth in the first quarter of 2002. In this respect the South African economy resembled the United States economy where growth also originated largely from a strong build-up of inventories in the first quarter of 2002.

A higher rate of gross fixed capital formation throughout all the main sectors of the economy also added to the strength of gross domestic expenditure in the first quarter of 2002. Fixed capital formation is widely acknowledged as the fountainhead of economic growth. However, in so far as it is of the efficiency-enhancing and labour-saving kind, it may not necessarily contribute to the creation of new employment opportunities.

Aggregate domestic expenditure rose considerably faster than domestic production in the first quarter of 2002 but this did not worsen the imbalance between spending and disposable income in the domestic economy. In fact, this imbalance improved appreciably because there was a sharp decline in dividend payments to the rest of the world, leaving a much higher portion of domestically generated income for spending in the South African economy.

Although there has been a persistent increase in the nominal compensation per worker in the formal sectors of the economy over the past five years, the share of employee compensation in the overall value of output kept on shrinking. This had much to do with the continuous reduction in employment opportunities in the formal sector of the economy, but rapid increases in operating surpluses, especially in mining and other export-oriented sectors of the economy, have also played a prominent role over the past year or so. The high level of operating surpluses led to higher corporate saving, providing some of the wherewithal for more investment in the economy.

The weakening in economic activity during 2001 took its toll on the labour market. Employment in the formal non-agricultural sectors of the economy edged down and there were signs that the pace of labour attrition might have accelerated in the fourth quarter of 2001. Job cuts accelerated in the construction sector as well as in the financial intermediation and insurance industry towards the end of last year. The officially measured unemployment rate moved up in the second half of 2001.

Given the prevailing economic conditions, growth in labour productivity was impressive in 2001, but it was nevertheless slower than in 2000. It should be remembered that productivity growth typically declines when the economy slows down, partly because employers tend not to shed workers in proportion to reduced demand.

Economy-wide nominal labour remuneration per worker during 2001 increased more or less at the same rate as in 2000. However, with productivity growth somewhat more sedate than in the previous year, growth in nominal unit labour cost picked up by almost 2 percentage points in 2001. This, of course, could impact negatively on overall price inflation but need not spill over into expectations of higher future inflation. Just as the increase in unit labour cost in 2001 was supported by the smaller productivity gains that accompanied weak economic activity, future increases in unit labour cost would be held down if output per worker began to increase more rapidly when the economy strengthens.

Higher unit labour cost growth contributed to a pick-up in domestically generated inflation in the second half of 2001, but the main factor responsible for the steep rise in inflation was the decline in the exchange value of the rand. This, alongside higher international crude oil prices, was responsible for an abrupt upward adjustment in the level of the production price index in the first four months of 2002. These price increases spilled over into higher consumer prices where the inflation situation was further aggravated by sharp increases in food prices, also partly related to the depreciation in the value of the rand. More recently there have been indications that the pace of food price growth is slowing down. Together with the price effects of the recent appreciation of the rand, the slowdown in food prices may in due course contribute to a better outlook for inflation than suggested by some current projections of inflation.

Export earnings rose strongly in the first quarter of 2002 as export prices improved, the global economy recovered and domestic producers expanded their sales into export markets. Gold exports, benefiting from the depreciation of the rand and the rising US dollar price of gold, bolstered export earnings even further. At the same time, imports remained lively in order to satisfy the fairly robust aggregate demand in the economy. More capital goods were imported, reflecting the high level of investment activity in the economy.

These developments led to the positive balance on the trade account with the rest of the world remaining broadly unchanged from the fourth quarter of 2001 to the first quarter of 2002. But there was a sharp decline in the deficit on the "services account", causing the overall balance on the current account of the balance of payments to turn from a deficit in the fourth quarter of 2001 to a fairly sizeable surplus in the first quarter of 2002. A steep decline in dividend payments by the domestic subsidiaries of former South African companies that now have head offices in London, was primarily responsible for the quick turnaround in the balance on the current account.

A substantial surplus on the financial account of the balance of payments was recorded in the first quarter of 2002, following an outflow of capital from the economy in the fourth quarter of 2001. Central to this improvement was the conversion of part of the reserve-related external liabilities of the Reserve Bank into a long-term foreign liability of the National Treasury. The financial account also benefited from the reversal of the leads and lags in foreign-trade payments and receipts experienced in the fourth quarter of 2001.

Together, the surpluses on the current and financial accounts of the balance of payments occasioned a strong increase in the country’s holdings of gold and foreign-exchange reserves. This reduced the net open position in foreign currency of the Reserve Bank. Valued in rands, the stronger exchange rate of the rand, however, reduced the value of gross international reserves in the first quarter of 2002, contributing to a decline in import cover from 24 weeks' worth of imports of goods and services to 20 weeks' worth.

The excess supply of foreign currency in the domestic foreign-exchange market changed the fortunes of the rand quite drastically in the first quarter of 2002. Notwithstanding a decline in turnover in the market for foreign exchange – claimed by some analysts as a potential cause for rand weakness – the greater supply of foreign currency in the market caused the rand to strengthen. From a low point on
20 December 2001 to 31 May 2002 the nominal effective exchange rate of the rand strengthened by as much as 30,1 per cent.

The broad monetary aggregates grew rapidly towards the end of 2001 and in the first quarter of 2002. Measured from quarter to quarter, M3 increased at an annualised rate of over 30 per cent in the first quarter of 2002 – significantly above the rate of the past several years and well above the growth in nominal gross domestic product.

Part of the rapid growth in the broad money supply might have been a consequence of investors' portfolio restructuring. Because the rates of return provided by many components of M3 change sluggishly, the decline in market interest rates lowered the opportunity cost of money holdings up to the end of 2001, specifically of the narrow asset classes M1 and M2. Moreover, uncertain returns and heightened volatility in the equity market raised the demand for money assets as a safe investment haven throughout the second half of 2001 and into the first quarter of 2002.

In so far as the rapid accumulation of money was a consequence of investors' portfolio adjustments, there is no need to fear an increase in the inflationary potential of the economy. But part of the money accumulation could have been for transaction purposes with a view to increasing future spending, potentially to a level exceeding current disposable income. If such a situation is sustained over the medium to longer term, higher inflation would be the almost inevitable result. All prolonged periods of rapid monetary expansion in history have been accompanied by high price inflation.

The expansion of the banks' deposit liabilities at a faster rate than domestic credit extension facilitated the accumulation of foreign assets on a net basis by the consolidated banking sector in the first quarter of 2002. But assets in the form of claims on the domestic private sector also continued to rise steadily. The greater part of this was extended to the corporate sector where fixed capital formation, an important driver of future economic growth, has been growing solidly over the past year. The smaller part of credit extension to the private sector reflected a still reasonably buoyant demand for consumer goods and services.

Money-market conditions eased considerably during the first five months of 2002. Strong liquidity injections emanated from the deficits incurred by the Reserve Bank on transactions in the forward foreign-exchange market, and from an increase in the Bank’s net foreign assets. At times the money market became awash with funds when the Bank had to provide liquidity assistance to smaller banks confronted by large-scale deposit withdrawals. To ensure the efficiency of the Bank’s interest-rate policy, these liquidity injections had to be mopped up. The Bank employed various liquidity mopping-up techniques, including foreign- exchange swap transactions linked to foreign-currency deposits with the Bank and the issuing of Reserve Bank debentures.

Money-market interest rates generally moved higher during the first five months of 2002, reacting to the changes, or in anticipation of likely changes, in the Reserve Bank’s repurchase rate. Bond yields, which changed inversely to the price of bonds, moved in tandem with the rise in money-market interest rates from the end of November 2001, also following the widely-held expectation of an acceleration in inflation. From the end of March 2002 bond yields began to decline, partly because of the relatively small supply of long-term fixed-interest bearing securities in the market.

Non-resident investors returned to the domestic bond market as net buyers in the first five months of the year, following a two-year period when they had consistently reduced their exposure to South African fixed-interest securities. The presence of non-resident investors as buyers in the bond market has also helped to lift the prices of bonds since the beginning of April 2002.

Share prices strengthened remarkably after the tragic events of 11 September 2001, driven higher by particularly strong interest in gold-mining stock and the resources sector of the JSE Securities Exchange SA. Prices of companies listed in the industrial and financial sections of the Exchange also showed some improvement, but this was far less impressive than in the gold and resources sectors. Non-resident holders of equity in South African companies added to these holdings over the first five months of 2002.

A strong improvement in overall tax administration and firm control over outlays led to a smaller national government deficit than had been anticipated earlier. The fiscal 2001/02 deficit was R15,1 billion, or about 1½ per cent of gross domestic product – well below the record deficit of R31,5 billion recorded in fiscal 1996/97 and the deficit of 2½ per cent of gross domestic product projected by the Minister of Finance when he presented his budget proposals to Parliament in February 2001. Given the overall healthy state of public finances, the Minister could announce sizeable tax concessions for the current fiscal year – a measure that is expected to assist the economic recovery and help to put the economy on a faster growth path in the years ahead.