A limited number of countries such as Brazil continued to suffer from strong inflationary pressures, and had to maintain a tight monetary policy stance to bring inflation under control. However, with actual production falling significantly below potential output in most parts of the world, the resulting output gaps contributed to a general climate of low inflation – and in the case of Japan, negative inflation or deflation. In this environment, monetary policy could afford to be expansionary. Real interest rates in most countries were quite low, and some short-term real interest rates even negative.

During the past two years fiscal deficits widened on a cyclical basis in most parts of the world, as subdued growth suppressed tax revenues and caused payments of unemployment benefits to rise. Apart from the automatic stabilisers at work, fiscal policies with an active counter-cyclical element were also pursued in a number of countries and led to strongly rising government deficits. The re-emergence of so-called twin deficits in the United States – sizeable deficits on both the current account of the balance of payments and on the federal government’s budgetary accounts – contributed to a significant depreciation of the US dollar against other currencies.

With its firm commitment to monetary and fiscal discipline, and having progressed a long way with a programme to improve the competitiveness and degree of inter-national integration of the domestic economy, South Africa’s sound economic performance was recognised by two international credit ratings agencies and rewarded with improved ratings. This positive sentiment also surfaced in the foreign currency market, where the South African rand remained fairly strong. Given the sound and consistent policies pursued by the authorities, relatively attractive domestic interest rates, decelerating inflation and an improvement in the terms of trade, the rand on balance appreciated by 0,9 per cent during the first five months of 2003.

However, with the sluggish world economy leaving its mark on export demand and with relatively tight monetary conditions, the South African economy could not escape a slowdown in activity. The growth rate fell back for the third successive quarter, from the brisk annualised rate of 4 per cent recorded in the second quarter of 2002 to 1½ per cent in the first quarter of 2003.

The subdued growth rate in the first quarter of 2003 arose from widespread weakness in production. Agricultural and mining output declined, while real value added in manufacturing also contracted as sluggish world markets eroded aggregate demand and foreign producers presented stiff competition to domestic producers. In the non-manufacturing secondary sectors and tertiary sectors, output continued to rise, albeit generally at lower rates.

Growth in real gross domestic expenditure slowed down slightly during the first quarter of 2003. Real household consumption expenditure remained resilient and maintained its earlier growth rate, inter alia supported by the income tax reductions announced in the Budget. Despite relatively high interest rates, the lowering of the household sector’s debt-to-income ratio since 1998 created scope for some households to incur new debt in support of both consumption and capital expenditure. In the first quarter of 2003, households’ debt-to-income ratio rose markedly.

Growth in real government consumption expenditure also continued at the same brisk pace that was recorded in the final quarter of 2002. The rate of increase in real fixed capital formation receded somewhat in the first quarter of 2003, but it still managed to record a strong growth rate of 8½ per cent. Weaker prices for agricultural products and expectations of lower production of certain crops caused a decline in fixed capital formation by the agricultural sector. In other sectors, fixed capital formation was more resilient, with general government actually accelerating its tempo of capital expenditure. The tempo of inventory accumulation decelerated somewhat in the first quarter, but kept pace with overall economic growth so that the ratio of inventories to production remained almost unchanged.

Inflation decelerated markedly in the early part of 2003 as the strengthening of the exchange rate, the sustained disciplined stance of monetary policy and the widening of the output gap moderated price pressures. Production prices declined in absolute terms during the first quarter of 2003, while the quarter-to-quarter rate of CPIX inflation decelerated from an annualised 12,1 per cent in the final quarter of 2002 to 4,8 per cent in the first quarter of 2003.

A correction in the calculation of the consumer price index was introduced by Statistics South Africa with the release of the April 2003 data, resulting in a downward revision of 1,9 percentage points in the March 2003 twelve-month rate of CPIX inflation. This brought CPIX inflation back to single-digit figures. Since recent historical inflation tends to have a strong impact on inflation expectations, the revisions could contribute to some moderation of inflationary pressures.

Productivity growth in the non-agricultural sector of the economy slowed down progressively from 3¾ per cent in the first quarter of 2002 to 1¾ per cent in the fourth quarter – the lowest rate in the past decade. With an increase of just below 10 per cent in average nominal remuneration per worker in the formal non-agricultural sectors of the economy, this resulted in nominal unit labour cost rising at a rate of 7 per cent in 2002.

Aggregate employment in the formal sectors of the economy recorded uninterrupted increases in each of the final three quarters of 2002, resulting in a cumulative employment gain of about 70 000 workers. This welcome change from the longer-term downward trend in employment came equally to the fore in the numbers of private-sector and public-sector employees.

Despite an improvement in the terms of trade in the first quarter of 2003, the weakness of world demand and reduced competitiveness of South African exporters on account of the recovery in the exchange rate of the rand resulted in a small deficit being recorded on the current account of the balance of payments, following a small surplus in the fourth quarter of 2002. Exporters of manufactured goods suffered most from the contraction in the international demand for South African produced goods. The volume of imports also fell back, but not by as much as the reduction in exports.

A small net outflow of funds was recorded on the financial account of the balance of payments as non-residents reduced their portfolio and other investments in South Africa. The deficits on both the current and financial accounts of the balance of payments resulted in a decline of R5,4 billion in South Africa’s holdings of inter-national reserves. However, this decline did not significantly change the level of import cover of the international reserves, which remained broadly unchanged at around 17½ weeks’ worth of imports from the end of December 2002 to the end of March 2003.

A milestone was reached when the Reserve Bank’s oversold net open foreign-currency position (NOFP) was closed out in May 2003. Following declines in the NOFP earlier in 2003 as the Bank purchased modest amounts of foreign exchange in the foreign-currency market, government sold the proceeds of its €1,25 billion global bond issue to the Bank in May 2003. The Bank delivered these proceeds to private-sector parties in terms of existing forward contracts, thereby reducing the Bank’s forward foreign exchange book and eliminating the NOFP. In this way, a perceived element of risk and vulnerability which had attracted much attention, especially in the late 1990s, was laid to rest.

Growth in money supply responded in the usual way to the tightening of monetary policy, decelerating progressively from high rates in the early part of 2002 to very slow growth in early 2003. From the fourth quarter of 2002 to the first quarter of 2003, annualised growth in M3 amounted to a mere 2 per cent. Apart from the marked slowdown in inflation and weaker growth in real income and expenditure, the slow growth in the monetary aggregates probably also reflected negative wealth effects arising from the downward revaluation of the financial asset holdings of South African households and firms. The growth in the underlying demand for bank credit also slowed down significantly, although the headline measures of credit extension rose briskly in early 2003 on account of changes in the reporting of derivatives instruments on the banks’ balance sheets.

Against the background of an unchanged Reserve Bank repurchase rate, short-term interest rates were fairly stable during the first five months of 2003. However, from April 2003 they increasingly started to reflect expectations of decreases in the Bank’s repurchase rate. Long-term bond yields declined further during the first five months of 2003, indicating expectations of lower inflation and the continued pursuit of sound policies. The yield curve therefore continued to display a strongly inverted shape.

Weakness in share prices in other parts of the world, combined with the expected impact of a stronger rand exchange rate on corporate profitability, led to further declines in domestic share prices. From a high point reached on 22 May 2002, the all-share price index declined by 37 per cent to a recent low point on 25 April 2003. Subsequently, share prices recovered by 16 per cent to the end of May, mainly due to a moderate weakening of the exchange rate of the rand.

The South African government remains fully committed to pursuing sound fiscal policies. This is demonstrated by the non-financial public-sector borrowing requirement, which amounted to only 1,0 per cent of gross domestic product in fiscal 2002/03. The widening of the deficit ratio from 0,8 per cent of gross domestic product in fiscal 2001/02 was furthermore due to a healthy reason – a much-needed increase in capital expenditure by the public sector in order to improve the country’s infra-structure. Firm control over government expenditure growth continued and tax collection improved further. By containing the budget deficit, and helped by the downward revaluation of its foreign-currency denominated debt, government succeeded in reducing the ratio of its loan debt to gross domestic product from 42,9 per cent at the end of March 2002 to 37,9 per cent at the end of March 2003. This helps to contain the interest cost of servicing the government debt, freeing up resources for improved service delivery.