In South Africa the composite leading indicator of economic activity of the Reserve Bank, having trended downward over the 11 months to April 2003, picked up strongly in May and June as rising share prices, a higher rand price of gold, increases in the net gold and other foreign exchange reserves, lower short-term interest rates and favourable developments in other leading variables suggested an imminent turnaround for the better.

Promising as these developments may be, domestic economic growth was still decelerating up to the second quarter of 2003 as weakness in the world economy was reflected in sluggish demand for South African exports. Growth in South Africa’s real gross domestic product receded from its recent peak rate of 4 per cent, reached in the second quarter of 2002, to only 1½ per cent in the first quarter and 1 per cent in the second quarter of 2003. Agricultural output contracted sharply in the second quarter on account of lower production of field crops. The real value added by manufacturing also fell back in the second quarter, while output growth in most other sectors of the economy remained positive but slowed down. There were clear signs of surplus capacity in the economy, with capacity utilisation in manufacturing for instance receding to 79 per cent in the second quarter of 2003, against a post-1994 average level of 80½ per cent.

While growth in real production slowed down, the already brisk growth in gross domestic expenditure picked up further in the second quarter of 2003 to reach an annualised rate of 5½ per cent. Inventory accumulation accelerated noticeably, offsetting a slower rate of increase in real fixed capital formation. In mining and manufacturing it seems likely that the inventory investment was partly involuntary and resulted from a quicker than anticipated reduction in sales, including export sales. Growth in real fixed capital formation by public corporations decelerated markedly during the second quarter of 2003, while that by general government and by the private sector gained further momentum. In the private sector the platinum mines recorded impressive fixed capital formation growth, with the agricultural sector at the other extreme reducing its fixed capital formation against the background of lower real output and prices of agricultural products.

Real consumption by households maintained its earlier growth momentum in the second quarter of 2003, supported by slightly stronger increases in households’ real disposable income and consumers’ willingness to raise their debt levels somewhat. Real consumption expenditure by government also continued to increase briskly. With all the main components of real domestic expenditure rising healthily, weak net exports to the rest of the world stood central in the explanation of the slowdown in domestic economic growth.

Reflecting the fragile world economy, South African export volumes remained subdued during the second half of 2002 and first half of 2003. By contrast, import volumes rose somewhat against the background of firm real domestic expenditure, and rising capital formation in particular. The current account of the balance of payments moved into deficit in the first quarter of 2003. Furthermore, the deficit rose from 0,6 per cent of gross domestic product in the first quarter to 1,4 per cent in the second quarter.

At this well-contained level, the current-account deficit in the second quarter was more than fully financed by inflows of foreign capital. The inflows were concentrated in portfolio investment. The National Treasury issued a new bond to the amount of €1,25 billion in the international market, while non-residents became net buyers of both domestic shares and bonds during the quarter.

Under these circumstances South Africa’s international reserves rose significantly in the first half of 2003. The level of the country’s gross reserves increased from 17½ weeks’ worth of imports at the end of March 2003 to 20 weeks’ worth at the end of June. The net open foreign-currency position of the Reserve Bank has also been maintained in overbought territory since mid-May 2003.

The nominal effective exchange rate of the rand recovered by 7½ per cent during the first quarter of 2003 and by a further 7½ per cent during the ensuing five months to the end of August. While curbing the international price competitiveness of South African exporters and import-competing industries, it helped to rein in inflation.

Led by reductions in the rand prices of imported goods, overall production price inflation receded from twelve-month rates in excess of 10 per cent in 2002 to rates as low as 1,2 per cent in May and 1,5 per cent in July 2003. Consumer price inflation also declined markedly; for instance, twelve-month CPIX inflation receded, on balance, from 11,3 per cent in November 2002 to 6,6 per cent in July 2003, while seasonally adjusted and annualised CPIX inflation in the second quarter of 2003 amounted to only 2,4 per cent.

The rate of increase in the monetary aggregates slowed down notably on account of the reduction in inflation and real domestic production growth from around the second half of 2002. The narrow M1A and M1 aggregates contracted in the first seven months of 2003 as depositors were attracted to somewhat longer-term deposits, probably attempting to protect their interest income at a time of strong expectations of imminent interest-rate reductions. While M3 continued to grow, its twelve-month rate of increase stayed below 10 per cent in the first seven months of 2003, contrasted to double-digit rates of increase throughout 2002.

Growth in the monetary sector’s loans and advances to the domestic private sector decelerated markedly during the course of 2002 and reached twelve-month rates of increase of less than 10 per cent in late 2002 and early 2003. However, it picked up again from April 2003 and by July stood at 13,0 per cent, underpinned by firm demand for credit by businesses engaged in capital formation and by households contemplating buying real estate or consumer items.

The Reserve Bank continued to decrease its use of foreign currency swaps with deposits in its management of the domestic money market. Private-sector banks’ liquidity requirement fluctuated around R11 billion during the first eight months of 2003.

Significantly improved prospects for inflation motivated the Reserve Bank’s Monetary Policy Committee (MPC) to lower the repurchase rate by 150 basis points at its June 2003 meeting. At the same time it was announced that the frequency of scheduled meetings of the committee would be increased from quarterly to once every two months. In August the MPC decided to reduce the repurchase rate by a further 100 basis points to 11 per cent per annum, again prompted by encouraging prospects for lower inflation. Other money-market interest rates moved broadly in step with the repurchase rate, although the fact that some market participants may have looked for a somewhat larger cut in August might have contributed to limited increases in rates on some forward-looking money-market instruments. At a special meeting of the MPC held on 10 September it was decided to lower the repurchase rate by a further 100 basis points. This was informed by an assessment of the most recently available data and forecasts.

In the key international markets, long-term bond yields started decisively moving upward from June 2003, discounting prospects for stronger growth. In South Africa a slight increase in yields on long-term bonds was recorded, while simultaneously the June and August reductions in the Reserve Bank’s repurchase rate were reflected in downward movements of yields on short-dated bonds. Accordingly, the yield curve flattened somewhat. The shape and level of the yield curve, as well as the trend in breakeven inflation (the difference between nominal and index-linked bond yields), indicate some success in the reduction of the public’s inflation expectations.

Whereas non-residents were net sellers of South African bonds and shares during the first three months of 2003, favourable ratings by international ratings agencies contributed to a reversal in the second quarter when they turned into net purchasers. However, foreign investors subsequently again reduced their holdings of both bonds and shares in July and August 2003. Nevertheless, share prices on the JSE Securities Exchange SA have trended upward since April 2003 despite the further recovery in the exchange rate of the rand, supported by demand from value-seeking investors.

Residential property prices rose fairly steadily during 2002 and gained further momentum from early in 2003. Purchases, first in anticipation of and then in response to lower interest rates, supported the buoyancy in the property market.

Sluggish tax revenue in the period April to July 2003 was consistent with the lower real economic growth rate and reduced inflation. Together with budgeted higher real government expenditure, it was set to contribute to a smoother performance of the economy. With both fiscal and monetary policy operating within sound medium-term frameworks, the prospects for achieving more vibrant, sustainable growth and development have been enhanced – a valuable contribution to the goal of halving unemployment by 2014 which was adopted by government, the business sector, labour and organised community at the Growth and Development Summit in June 2003.