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At the international level, the attacks on America that destroyed the World Trade Center in New York and damaged the Pentagon building in Washington, D.C. pushed the United States economy into a recession. The attacks also triggered a chain reaction of economic events that spread the recession to other parts of the world and will probably affect the behaviour of communities for a long time.

As the United States economy faltered, it dragged other economies into its slump. This meant weaker demand from companies and households in most parts of the world, suppressing corporate earnings and prompting some governments to provide assistance to struggling industries. Fiscal policy became quite expansionary in the United States and monetary conditions have been eased on eleven occasions since the beginning of 2001. Still, the combined output of the members of the Organisation for Economic Cooperation and Development might have declined towards the end of 2001 for the first time since the beginning of the 1990s.

The key development in the world economy during the fourth quarter of 2001 was the weak growth in output and the relatively strong growth in demand, spurred in many countries by the easing of macroeconomic policy. The result has been substantial reductions in inventory levels, but this low level of inventories could now be laying the foundation for an output recovery in the remaining months of 2002. In the advanced economies a reversal from inventory run-downs to stockpiling should return the global economy to positive growth early in 2002, resulting in a fairly mild and relatively short recession.

The South African economy reacted in varying ways to the changing global economic scene. Until the middle of 2001 domestic economic growth had held up well in the face of the global slowdown and growth actually accelerated from the first to the second quarter. In the third quarter, export volumes bore the full brunt of the weakening international economic conditions and declined sharply, causing overall output growth to slow down to an annualised rate of just 1 per cent.

In the fourth quarter, and again contradicting the slower pace of global economic activity, export earnings recovered strongly, and along with continuing solid growth in domestic final demand, pulled output growth higher to an annualised rate of 2½ per cent. The resilience of domestic economic growth against the backdrop of the weakest international economy in more than a decade, was probably influenced significantly by the greater competitiveness of South African producers in recent years, brought about by cost-cutting programmes since the beginning of the 1990s and competitive gains due to the depreciation in the real exchange value of the rand since 1996.

Domestic final demand conditions were highly conducive to an output expansion in the fourth quarter of 2001. Households increased their real spending levels at a faster pace than earlier in the year without incurring excessive debt. Government consumption started showing signs of renewed vigour and capital formation programmes got under way throughout the private business sector more resolutely than before. By contrast, inventory investment was curbed somewhat in the fourth quarter of 2001, but this was essentially because inventories had to help satisfy the strong expansion in domestic demand.

The national saving ratio remained disappointingly low. Corporate saving, which still represents the mainstay of the national saving effort, weakened in the fourth quarter of 2001 as companies stepped up distribution instead of retaining income in the business. This could have been motivated by the decline in capital cost which tilted the optimal debt-equity ratio in favour of debt financing, in the form of increased borrowing from banks or the issuance of interest-bearing securities.

Despite a narrowing in the discrepancy between growth in domestic expenditure and output in the fourth quarter of 2001, aggregate domestic expenditure still exceeded national disposable income by a sizeable margin. This left a gap between aggregate spending and disposable income which required the transfer of financial resources from the rest of the world in order to limit downward pressures on the exchange value of the rand, and general upward pressures on prices. These resource flows were, however, not forthcoming in the fourth quarter of 2001 and the exchange rate of the rand consequently suffered downward pressure.

Reflecting the relative strength of aggregate domestic demand, payments for imports — particularly of durable consumer goods and capital equipment — grew quite strongly in the fourth quarter of 2001. Export earnings, in turn, expanded even more than the payments for imports, improving somewhat the positive balance on the trade account of the country with the rest of the world. The overall imbalance on the current account of the balance of payments also had some help from a smaller deficit on the services account in the fourth quarter of 2001, among other things due to smaller dividend payments to the rest of the world. Still, the current account remained in deficit in the fourth quarter of 2001 to the tune of 0,3 per cent of nominal gross domestic product.

The balance on the financial account of the balance of payments switched from a healthy surplus in the third quarter of 2001 to a deficit in the fourth quarter, i.e. capital was exported from the economy in the last quarter of 2001. Outflows of capital on a net basis were recorded in all the major identified categories of capital transactions, namely foreign direct investment, portfolio investment and other investments such as short-term bank loans, trade financing and cross-border bank deposits. Exporters apparently accumulated offshore assets, i.e. they allowed capital to leave the economy by delaying the repatriation of export proceeds in order to profit from the depreciation in the exchange value of the rand.

With deficits on both the current account and the financial account of the balance of payments during the fourth quarter of 2001, a decline was recorded in the country’s net gold and other foreign reserves owing to balance of payments transactions. In such circumstances, there is a strong likelihood of a depreciation in the exchange value of the rand, but the extent and the speed of the depreciation are obviously not easy to explain.

Although the country’s net international reserves declined as a result of balance of payments transactions, there was a sizeable increase in these reserves when measured in rands, virtually entirely due to revaluation gains from the stronger exchange value of the US dollar against the rand in the fourth quarter of 2001. Import cover accordingly improved from about 20 weeks’ worth of imports of goods and services at the end of September 2001 to 24 weeks’ worth at the end of December.

Despite continuing economic growth, overall employment in the modern sectors of the economy kept falling in the first three quarters of 2001. The pace of labour attrition nevertheless slowed down quite noticeably, giving the impression that the processes directed towards improving the international competitive ability of private businesses and the quality of public-service delivery may have achieved the desired results.

In the context of the South African economy, nominal wage growth was still fairly moderate during the first three quarters of 2001, even though the growth in nominal remuneration accelerated slightly from the rates of 2000. Simultaneously, the slower decline in employment levels, combined with weaker output growth, held back the solid advances in productivity growth seen in recent years. Economy-wide growth in unit labour cost accordingly picked up somewhat during the first three quarters of 2001.

As yet, little of the product price effects of higher growth in nominal unit labour cost have become evident in domestic price increases during the fourth quarter of 2001, but latent inflationary pressures were activated by steep increases in food prices and the first-round effects of the depreciation of the rand. Although these price shocks are not inflation in the strict sense of the word, they do help to perpetuate an inflation psychosis through their influence on price expectations.

What is usually found in the aftermath of one-off price shocks such as the rise in food prices and the depreciation of the rand, is that the overall price level is raised and that during the adjustment process, actual inflation is higher than it would otherwise have been. All other things remaining equal, consumers will experience a decline in their real income. If they are compensated for such a loss in real purchasing power, an inflationary process may get under way, or an already persistent increase in the general price level may be aggravated.

The immediate effect of a random price shock cannot be controlled by monetary policy measures. For instance, no level of interest rates would be sufficient if the prices of imported goods were to rise as a consequence of a depreciation of the rand, i.e. the first-round price adjustments following the depreciation. However, such a one-off price increase could be perpetuated as a process of continual increases in the prices of all goods and services if monetary policy is not vigilant enough.

Growth in the broadly defined money supply expanded in the second half of 2001, at first quite vigorously in the third quarter but later somewhat more moderately in the fourth quarter. Although this was partly a positive development reflecting the inherent strength of the economy, the high growth in money supply is unlikely to be consistent with low and stable inflation. Money was accumulated particularly in corporate bank balances with short maturities. This probably reflected concern about the sustainability of asset price increases generally, inducing a preference for money balances as a temporary safe haven for investment. However, part of the money accumulation could also have been for transaction purposes with a view to increasing future spending. In this sense, rapid money growth might be indicative of a problem as it is known that growth rates of money supply and the general price level are highly correlated in the long run, with a correlation coefficient of close to one.

On the asset side of banks’ balance sheets, credit extension to the private sector, especially to companies, was the main accounting counterpart of the expansion of the broad money supply in the second half of 2001. "Other loans and advances", which includes overdrafts to companies, contributed substantially to the overall growth in private-sector credit as, among other things, exporters accessed domestic bank facilities while delaying the repatriation of their export proceeds. Mortgage borrowing by households increased at a lively pace in the second half of the year alongside the buoyancy of the real-estate market. Instalment sale financing and leasing contracts also expanded appreciably in response to the strong demand for durable consumer goods, especially new motorcars.

The long bull market in bonds since May 2000, firmly based on declining inflation expectations and a dwindling supply of public-sector fixed-interest securities, was brought to a sudden end by the depreciation in the value of the rand in December 2001. Bond yields rose sharply as the decline in the value of the rand fuelled expectations of higher inflation. This rise in bond yields received further support from an upward adjustment in the Reserve Bank’s repurchase rate in January 2002 — a step taken to prevent the depreciation of the rand from developing into a succession of rapid rises in the general price level.

Share prices increased strongly from September 2001 to early February 2002. It was mainly the prices of counters listed in the resources sector of the JSE Securities Exchange SA and other companies also benefiting from the depreciation of the rand that were pushed to new heights. Non-residents were eager buyers of listed South African equities throughout 2001, but simultaneously they were offloading their holdings of fixed-interest securities.

In the primary capital markets, companies shied away from the share market for raising new investment capital — capital raised in the primary equity market in 2001 was almost 70 per cent below the total amount of funds raised in 2000. However, in the primary fixed-interest market, the shrinking demand for funds by public-sector borrowers made room for private-sector borrowers to satisfy their funding needs outside the banking sector. The primary corporate bond market blossomed and the value of private-sector loan stock listed on the Bond Exchange of South Africa almost doubled from the end of 2000 to the end of 2001.

Sustainable and efficient fiscal policies are seen as a prerequisite for steady long-term economic growth. They usually stimulate private-sector investment while limiting the negative consequences for saving and investment that may arise from high and varying tax rates. Sound fiscal policy also supports the task of monetary policy makers to maintain price stability. There is likely to emerge over time a virtuous cycle of fiscal efficiency and price stability on the one hand, and sustained growth and rising employment on the other.

The fiscal authorities in South Africa have taken major steps during recent years in securing fiscal sustainability. The budget deficit of the national government relative to gross domestic product in the first three quarters of the current fiscal year has been reduced to levels not seen in the past twenty years, the rise in the public debt relative to gross domestic product has been stopped and the interest burden of the national government has been eased considerably. All these initiatives contributed to the emergence of a healthy financial surplus in the accounts of the non-financial public sector in the first three quarters of fiscal 2001/02. These improvements in the efficiency of fiscal policy are helping to lay the foundation for sustained long-term economic growth and employment creation which are likely to promote further the government’s empowerment and redistribution objectives.

The principles of sound fiscal management were again firmly embedded in the Budget proposals of the Minister of Finance for the 2002/03 to 2004/05 medium-term planning period. Fiscal consolidation over the past five years has afforded government the opportunity to deepen its commitment to redistribution, allowing consumers significant tax relief, encouraging investment by the private sector and placing a renewed focus on physical infrastructural development.