In the third quarter of 2004 the price of crude oil reached levels previously observed 14 years earlier around the time of the Gulf War. Strong world demand for petroleum and petroleum products was complemented by fears of supply disruptions. Against the background of fairly accommodative monetary and fiscal policies in most parts of the world, this contributed to an acceleration in inflation – quite modest in most instances, but more noticeable in a number of Asian economies. In the SADC region inflationary pressures are expected to subside somewhat on account of sustained policy discipline and improved food supply conditions in most parts of the subcontinent.
While levels of short-term interest rates generally remained fairly low, a number of central banks pre-emptively started raising interest rates from late 2003 in order to contain future inflation. Having maintained the federal funds target rate at 1 per cent since 2003, the Federal Open Market Committee in the United States raised the target policy rate by 25 basis points in June 2004 and by a further 25 basis points in August.
Economic activity in South Africa picked up further in the second quarter of 2004, with the real gross domestic product expanding for the twenty-third consecutive quarter – the longest period of uninterrupted quarter-to-quarter growth since quarterly data became available in 1960. Supported by lower interest rates, a moderately higher budget deficit
and favourable international terms of trade, the annualised pace of growth accelerated to 4 per cent in the second quarter of 2004 from an upwardly revised 3.1⁄2 per cent in the first quarter. The growth trajectory has steepened noticeably since the second quarter of 2003, with each quarter’s growth rate being higher than the one preceding it.
The improvement in the economic growth rate in the second quarter of 2004 was broadly based. Growth in the primary sector accelerated on account of an improvement in agricultural output, while higher growth in production in the secondary sector was led by manufacturing. In the tertiary sector growth was maintained at a brisk pace, with real output originating in the transport and communication sub-sector rising most noticeably. As in the first quarter, all sectors and sub-sectors registered increases in real output in the second quarter of 2004.
The pace of expansion in real gross domestic expenditure was more than three times as fast as that of gross domestic production in the second quarter of 2004. A sharp acceleration in inventory accumulation in the second quarter contributed to this divergence; an important element in this build-up was the exceptionally high quantity of crude oil which was imported and added to inventories. Growth in domestic final demand, while remaining brisk, decelerated somewhat in the second quarter of 2004. Real gross fixed capital formation, while losing some momentum following the very high purchases of capital equipment by public corporations during the first quarter, still rose at a rate of more than 10 per cent in the second quarter. Growth in real final household consumption decelerated marginally as expenditure on semi-durable and durable goods lost some of its earlier momentum. Another corvette – the third in as many quarters – was acquired by the South African Navy during the second quarter of 2004, but growth in real government consumption expenditure moderated slightly.
South Africa’s export volumes rose considerably in the second quarter of 2004, following a protracted lull since mid-2001 when the world economy moved into growth recession. Growth in mining exports was led by platinum and coal, while the volume of manufacturing exports also recorded a sizeable increase as foreign demand strengthened and producers started to come to terms with the recovery in the exchange rate. Import volumes increased even more briskly than exports as a number of aircraft, the abovementioned corvette and exceptionally large quantities of crude oil were imported. Accordingly, despite the favourable terms of trade, South Africa recorded the first trade-account deficit in 22 years and a current-account deficit of nearly 4 per cent of gross domestic product during the second quarter of 2004.
The deficit was again comfortably financed by capital inflows, enabling the Reserve Bank to continue its accumulation of foreign exchange reserves. The effective exchange rate of the rand continued its upward trend, resulting in further year-on-year declines in the rand prices of imported goods at the production level. Together with prudent financial policies this resulted in CPIX inflation remaining within the target range; July 2004 was the eleventh consecutive month in which the rate of CPIX inflation fell within the 3-to-6-percent target range. The latest available data on unit labour cost also display rates of increase marginally below 6 per cent.
Inflation outcomes so far in 2004 were generally lower than expected, feeding back into lower expectations of future inflation. Having maintained an unchanged level of the repurchase rate for a period of eight months, at its August 2004 meeting the Monetary Policy Committee reviewed prospects for inflation and concluded that a further reduction of 50 basis points in the repurchase rate would be consistent with projected CPIX inflation remaining in the target range. When this reduction was announced, the exchange rate of the rand immediately depreciated; this was in contrast to the experience in 2003 when the exchange rate appeared to be oblivious to interest rate reductions. The narrower margin between interest rates in South Africa and in the rest of the world might have contributed to this greater sensitivity of exchange rate changes to interest rate movements.
There was a deceleration in growth across the spectrum of the monetary aggregates in the second quarter of 2004, after a sharp increase in the preceding quarter. This deceleration in part reflected a reversal of the exceptionally high increase in money balances at the end of February caused by coupon interest payments on government bonds and the redemption of a maturing government bond. Measured over twelve months, growth in M3 receded somewhat to levels of around 12 per cent in the period April to July 2004.
The stimulus to consumer and business sentiment induced by lower interest rates, rising house prices and rising real income was reflected in brisk expenditure growth which in turn was partly financed through rising credit extension by the banking system. Growth in asset-backed loans and advances accelerated further during the first seven months of 2004, from already high levels. The modest level of overdue loans encouraged banks to accommodate the higher demand for mortgage, instalment sale and leasing advances.
The demand for other loans and advances – often seen as a sign of corporate distress borrowing – tended downward in recent months as lower interest rates and the use of non-bank funding mechanisms made themselves felt. Higher mortgage lending by the banking sector in turn supported residential property prices whose yearly rates of increase in the first eight months of 2004 were without precedent. Nevertheless, the monthly increases in house prices have lately decelerated somewhat. Bond yields reached a peak in June 2004 and fluctuated around a declining trend in the ensuing period as the domestic inflation outlook improved. A mild softening in global bond yields reinforced the decline in domestic yields as markets apparently discounted less buoyant global economic conditions against the backdrop of high oil prices. South African share prices, which were rather lacklustre from March 2004, picked up from mid-August in response to the decline in the exchange value of the rand.
The authorities continued to pursue a cautiously expansionary fiscal policy. While the twelve-month growth in government revenue from taxes on income and profits in April – July 2004 was below the projected growth for the full 2004/05 fiscal year, the budget deficit remained well-contained and easily financed. Although the bulk of the deficit was financed through issues of conventional bonds in the domestic capital market, a foreign bond was also launched as well as a government bond series for retail investors. The latter bond series became available on 24 May 2004, and more than R600 million was raised by the end of August.