Some improvement in economic conditions began to emerge in the United States of America in the fourth quarter of 2001. Recovery in other parts of the world economy also set in and global economic activity strengthened considerably in the first half of 2002. However, the rapid growth experienced in the early part of that year wavered in the second half as consumer and business confidence was negatively affected by revelations of corporate accounting malpractices, declining equity values and the threat of war against Iraq. By the end of 2002 the recovery in the world economy was still fragile and not evenly distributed across all regions.
The South African economy weathered the turbulent global economic conditions of the past two years well. Until the end of 2002 domestic economic growth outpaced the rate of expansion in many parts of the world, despite losing some momentum from the first to the second half of last year. The exchange value of the rand recovered appreciably from the setbacks suffered in 2001. In a drastic reversal of events in 2001 when the weighted external value of the rand fell by 24 per cent from the end of September to the end of December, the nominal effective exchange rate of the rand jumped by 18 per cent from the end of September 2002 to the end of December 2002.
The appreciation of the exchange value of the rand in 2002 has undoubtedly helped to reduce the cost of imported intermediate and final goods, thereby helping to improve the prospects for the successful attainment of the inflation target ranges set for 2004 and 2005.
The fairly impressive performance of the South African economy is also reflected in the duration of the current upward movement of the business cycle. In December 2002 the cyclical upward movement, which had started in September 1999, has been in progress for 40 months, making this expansion the fourth longest on record in the Post World War II period. Unfortunately, the economy lost some of its lustre when growth slowed down from annualised rates of 4 per cent and 3 per cent in the second quarter and third quarter to 2½ per cent in the fourth quarter – still a fairly healthy rate compared with growth in the past.
The slowdown in growth in the second half of 2002 was mainly due to slower growth in the real value added by the secondary sectors of the economy. Activity in the tertiary sectors remained lively, while virtually no growth was registered in the primary sectors of the economy. Despite the slowdown in quarter-to-quarter growth in the last two quarters of 2002, year-to-year economic growth was 3 per cent in 2002 as a whole – still slightly higher than the growth rate recorded in 2001.
Growth in aggregate real gross domestic expenditure slowed down considerably in the fourth quarter of 2002. Despite rising real income levels of the household sector, the growth in final consumption expenditure by households decelerated. Because of the more prudent spending habits of households, their debt-to-income ratio improved further in 2002. Inventory investment was scaled down as firms aligned their inventory levels to lower expected sales volumes, thereby contributing to the slowdown in aggregate domestic spending. The growth in fixed capital formation picked up in the fourth quarter of 2002, boosted by a strong increase in capital spending by public corporations, and growth in government consumption expenditure also proceeded at a lively pace. However, the stronger growth in capital formation and government consumption spending could not prevent a general slowdown in aggregate domestic expenditure from occurring in the fourth quarter of 2002.
Overall rates of inflation were noticeably higher during 2002, largely as a result of the depreciation of the exchange value of the rand towards the end of 2001 and steep increases in food and fuel prices. These price increases fully offset the counter-inflationary effects of greater efficiency in the South African economy. Nevertheless, the expansion and modernisation of production structures in recent years and the associated improvement in efficiency have continued to boost aggregate supply and productivity, thus helping to keep in check the gathering inflationary forces. During the final quarter of 2002 and in January 2003 there were signs – especially at the level of production prices – that inflation might be abating.
The productivity growth of the first three quarters of 2002 helped to expand aggregate supply while tighter monetary conditions contributed to slower growth in aggregate demand. For 2002 as a whole, the increase in nominal aggregate supply exceeded the increase in nominal aggregate demand. The counterpart to this was that a surplus developed on the current account of the balance of payments for the first time since 1994. The overall improvement of the current-account balance also had some help from a smaller deficit on the services and income account in 2002, among other things due to lower dividend and interest payments to non-resident investors.
An expansion of aggregate supply in excess of the growth in aggregate demand is likely to ease upward pressure on the aggregate level of prices and lower overall inflation. However, productivity growth slowed down in the second half of 2002, raising concerns that faster growth in unit labour cost may spill over with some time delay into higher final-product prices in 2003.
The current-account surplus in the fourth quarter of 2002, as well as in the calendar year 2002 as a whole, was accompanied by an inflow of capital from the rest of the world. The capital inflow in the fourth quarter of 2002 consisted mainly of a net accumulation of “other” foreign investment liabilities such as loans and advances by non-resident creditors, trade finance and bank deposits. Foreign direct investment capital – which is widely regarded as a vehicle for promoting sustainable growth and rising standards of living – was still leaving the economy in the fourth quarter of 2002, while non-residents were net sellers of portfolio capital. In fact, these outflows offset in large measure the net inflow of capital classified in the “other foreign investment” category in the fourth quarter of 2002.
With surpluses on both the current and the financial accounts of the balance of payments in the fourth quarter of 2002, an increase was recorded in the country’s net gold and other foreign reserves owing to balance-of-payments transactions. In such a situation, there is a strong likelihood for an appreciation of the exchange value of the rand. The positive change in net international reserves certainly contributed to the relative strength of the rand in the fourth quarter of 2002, but a host of other factors co-determined the extent and speed of this appreciation. Among these were great confidence in economic developments arising from the sound underlying macroeconomic fundamentals of the country and relatively high gross domestic product growth. Rising international commodity prices and the wide interest rate differential between South Africa and other economies also contributed to the strengthening of the rand.
Although the amount of the country’s gross international reserves valued in US dollars increased in the fourth quarter of 2002, there was a sizeable decrease in these reserves when measured in rand, virtually entirely due to revaluation losses arising from the stronger exchange value of the rand against the US dollar. Import cover accordingly fell from 20½ weeks’ worth of imports of goods and services at the end of September 2002 to 17½ weeks’ worth at the end of December.
The growth rates of the monetary aggregates – measured over twelve months as well as from one quarter to the next – decreased appreciably from the beginning to the end of 2002. This was in part a repetition of the monetary and credit growth cycle usually encountered after monetary policy had been tightened in the past. When bank lending rates were increased in January 2002, overall monetary growth and bank credit extension temporarily accelerated in the first quarter. This provided the monetary accommodation for a rapid increase in the general price level.
In the last three quarters of 2002, growth in M3 was reined in by the Reserve Bank’s progressive tightening of its monetary policy stance. From January to September 2002 the Reserve Bank increased its interest rate on short-term repurchase transactions on four occasions by 100 basis points at a time. The growth in the broad money supply slowed down to relatively low rates in the second half of 2002, signalling a possible reduction in inflation during 2003. In the long run, and with a stable velocity of circulation of money, an increase in the money supply which is broadly consistent with the growth in real aggregate output must be associated with a relatively stable price level.
Another positive development from a counter-inflationary viewpoint was that narrow money holdings (M1A) – usually accumulated to finance spending – actually declined in the fourth quarter of 2002.
Aggregate credit growth decelerated in the first three quarters of 2002 but bounced back in the fourth quarter when the banking regulatory authority reiterated that all banks must fully report on their balance sheets those assets and liabilities arising from their involvement in repurchase and other similar transactions. Because a sizeable portion of repurchase transactions involves government securities, the implementation of these accounting procedures by delinquent banks led to a sharp increase in banks’ claims on the government sector. Credit demand by private-sector businesses and households continued to grow at a modest rate in the fourth quarter of 2002.
Short-term money-market interest rates generally moved higher during 2002, either following increases in the Reserve Bank’s repurchase rate or in anticipation of future increases of this rate. By contrast, a bull market in bonds took shape from about the end of March 2002, lasting well into 2003 and taking long-term bond yields to their lowest level since 1980.
Because of these divergent movements of short-term interest rates and long-term bond yields, the yield curve had assumed an inverse shape towards the end of April 2002. Since then, short-term interest rates have been consistently higher than long-term rates, causing the yield curve to slope downwards as maturities lengthen. Market participants interpret this as indicating a fairly tight monetary policy stance that will ultimately succeed in lowering price inflation.
Emulating the movement of share prices in the international financial markets, the South African all-share price index fell by 29 per cent from May 2002 to February 2003. The share prices of companies listed in the resources sector of the market were particularly hard hit by the appreciation of the exchange value of the rand. Since about the middle of 2002 this weakness in share prices probably influenced non-resident investors to reduce their equity holdings in the domestic market on a net basis.
Trading conditions in the real-estate market maintained a lively pace throughout 2002 and in the early part of 2003, apparently oblivious of the steep increase in the cost of mortgage financing over this period. Increases in house prices nevertheless tapered off in the second half of 2002 and the early part of 2003.
The management of the country’s fiscal affairs continues to be sound. The national government’s budget imbalance was a surplus equal to 0,2 per cent of gross domestic product in the first three quarters of fiscal 2002/03, compared with a deficit ratio of 0,6 per cent in the corresponding period of the previous fiscal year. This outturn can be attributed to strong revenue growth and steps taken to strengthen expenditure monitoring and control. Improving economic conditions, higher inflation and efficient tax administration assured that the growth in national government revenue exceeded by a sizeable margin the original budget projections for the full fiscal year, whereas the growth in expenditure was considerably closer to the budget targets. This further consolidation of the public finances during the current fiscal year helped to maintain an approximate macroeconomic balance in the South African economy, thereby making an indispensable contribution to the eventual realisation of the national policy objective of general price stability and low inflation.
Unlike the finances of the national government, the accounts of the non-financial public sector (i.e. the entire public sector, including national government, provincial governments, local governments and non-financial public-sector businesses) turned from a surplus in the first nine months of fiscal 2001/02 to a deficit in the first nine months of fiscal 2002/03. There was a deterioration in the financial imbalances of provincial governments, local governments and non-financial public-sector business enterprises. As a percentage of gross domestic product the overall non-financial public-sector deficit was still quite small: merely 0,8 per cent in the first nine months of fiscal 2002/03.
The fiscal rectitude of the past eight years or so afforded the Minister of Finance the opportunity to introduce a growth supportive budget to Parliament for fiscal 2003/04 on 26 February 2003. The Budget for fiscal 2003/04 indicates an increase in the national government deficit from 1,4 per cent of gross domestic product in fiscal 2002/03 to 2,4 per cent in fiscal 2003/04, partly due to some tax relief for lower and middle-income taxpayers and higher spending in priority areas such as health, welfare, education, economic infrastructure, HIV/Aids, and combatting and prevention of crime. The government stated further that it remains committed to a gradual approach to exchange control relaxation and demonstrated confidence by announcing further changes in exchange control in the Budget speech.
The paucity of employment growth remains an intractable problem facing policy makers in South Africa. Employment opportunities in the major formal sectors of the economy have been declining since 1989, relegating growing numbers of workers to low-quality jobs in the informal economy or into unemployment and poverty. Some improvement set in during 2002 when employment totals in the formal sectors of the economy increased for two consecutive quarters.
As part of a broad strategy to add impetus to the improvement in employment prospects, government has announced a Growth and Development Summit to be held in May 2003, involving the government, the organised business sector and the labour movement. The summit will seek to establish binding commitments between the three entities in order to boost growth and employment creation in a sustainable way without compromising macroeconomic stability.