With global output growth probably at its highest since 1976, international commodity prices recorded buoyant levels in 2004. This benefited most commodity-exporting countries, including South Africa – not only by directly raising export revenue, but also through its secondary effects on expenditure and income and through increasing the attractiveness of investment to residents and non-residents alike.

While the relatively high international prices of commodity exports supported South Africa’s terms of trade and balance of payments position, it was the buoyancy of real domestic expenditure in particular that propelled growth in 2004. Within an environment characterised by rising income and the lowest inflation and nominal interest rate levels encountered in more than twenty years, all the major components of real domestic final demand rose strongly in 2004. Households’ real final consumption expenditure increased by 6 per cent in 2004 as real household disposable income registered a broadly similar rate of increase, supported by increases in employment and wage settlements which remained above the contemporaneous inflation rate. Consumer confidence was also lifted by wealth effects stemming from rising real-estate and financial asset prices and by more affordable interest rates. Real final consumption expenditure by government rose by 7 per cent in 2004 as the focus on public service delivery sharpened and the South African Navy took delivery of three maritime vessels. Real fixed capital formation increased by 9.1⁄2 per cent during 2004, as firm growth in real capital outlays by private-sector enterprises offset slower growth in investment expenditure by public corporations and general government.

As may be expected with consistently rising economic activity and sales volumes, real inventory levels rose further throughout 2004. Together with the increase in final demand, this brought the rate of increase in real gross domestic expenditure to 6.1⁄2 per cent in 2004. Real domestic production responded positively to the growth in real expenditure and registered a growth rate of 3,7 per cent in 2004. This compares favourably with the growth in real gross domestic production of 2,8 per cent which was recorded in 2003. For 2004 as a whole the tertiary sector experienced the strongest growth among the major production sectors. Within the tertiary sector, the commerce sector registered the highest rate of increase in real value added, consistent with the brisk pace of expenditure in the economy. In the primary sector agricultural output recovered somewhat in 2004 following a contraction in 2003, while real value added in mining rose significantly in 2004 in the wake of strong world demand for commodities. Real value added by the secondary sector recorded the slowest rate of increase among the major output sectors in 2004, but still expanded by roughly 3 per cent during the year. Manufacturing output increased significantly, partly in response to the strong domestic expenditure growth and the strong international demand for certain types of manufactured goods in the current global upswing.

On a quarter-to-quarter basis the annualised rate of growth in real gross domestic product accelerated for five consecutive quarters to a recent maximum of 5.1⁄2 per cent in the third quarter of 2004. Growth decelerated somewhat to 4 per cent in the final quarter of 2004, primarily on account of the weaker performance of the mining and manufacturing sectors. The firm increases in economic activity were accompanied by significant gains in employment. Enterprise-surveyed employment numbers rose by approximately 215 000 over the five quarters to September 2004, with 58 000 employment opportunities created in the third quarter of 2004 alone. The major part of the increase in employment was recorded in the private sector. Wage increases moderated further in 2004, with the average level of wage settlements in collective bargaining agreements receding from 8,9 per cent in 2003 to 6,8 per cent in 2004.

Lower historical inflation contributed to the moderation in wage settlements. Year-on-year CPIX inflation slowed down to 4,3 per cent in 2004 as a whole, and amounted to 3,6 per cent in January 2005 – its lowest level since the first calculations of CPIX in 1997. By January 2005 CPIX inflation had been in the target range of 3 to 6 per cent for seventeen consecutive months, thereby contributing to the moderation of inflation expectations. Inflation at the production level also remained low, with the strengthening in the exchange rate of the rand contributing to the containment of the prices of both imported and domestically produced goods.

South Africa’s sound economic performance was recognised by two international credit ratings agencies and rewarded with improved ratings which were announced in October 2004 and January 2005. These announcements, together with the acceleration in economic growth, decelerating inflation, a generalised depreciation of the US dollar and favourable international prices of South African export commodities, contributed to an increase of 11,7 per cent in the trade-weighted exchange rate of the rand during the course of 2004. This increase in the trade-weighted exchange rate was followed by a small decline in the first 2.1⁄2 months of 2005.

The high level of domestic expenditure and the appreciation in the exchange rate of the rand resulted in buoyant imports, raising the deficit on the current account of the balance of payments in 2004 to 3,2 per cent of gross domestic product. This was the

highest annual deficit ratio since 1982, when the current-account deficit amounted to 4,5 per cent of gross domestic product. However, net financial inflows more than neutralised the deficit on the current account in 2004 and enabled the Reserve Bank to accumulate international reserves. Net inflows of portfolio capital–especially into the share market, which was made attractive by relatively favourable yields and expectations of further strong growth in economic activity and profits – constituted the most significant component of the financial inflows in 2004.

Growth in the broadly defined money supply, M3, maintained a robust pace in 2004, consistent with firm increases in nominal income, expenditure and wealth. The accumulation of government deposits in late 2004 and early 2005, in preparation for sizeable coupon interest and capital redemption payments on government bonds at the end of February 2005, contributed to a slowdown in M3 growth as government deposits with the banking system are not included in M3.

Banks’ loans and advances to the domestic private sector recorded brisk growth in 2004 and early 2005. Rising property prices gave support to both the demand for and supply of mortgage advances, while the expansion of mortgage finance, in turn, helped to underpin the increases in property prices. However, some moderation in the pace of increase in house prices was observed in recent months. Strong sales of vehicles and other durable items underpinned the brisk increases in instalment sale and leasing finance in 2004 and early 2005. Against the background of an unchanged Reserve Bank repurchase rate, short-term interest rates were fairly stable from mid-August 2004 to mid-March 2005. On occasion, usually prompted by episodes of rand exchange rate appreciation or the release of favourable inflation data, some money-market rates tended to reflect expectations of an imminent decrease in the Bank’s repurchase rate. Long-term bond yields declined further during 2004 and the early part of 2005, signalling expectations of lower inflation and the continued pursuit of sound policies. In the second half of 2004 and early months of 2005 both nominal long-term and short-term interest rates receded to levels last observed more than a quarter of a century ago.

Higher economic growth, rising corporate profitability, lower interest rates and improving business confidence led to further increases in domestic share prices in 2004 and early 2005. From a recent low point reached on 18 May 2004, the all-share price index, on balance, rose by 41 per cent to an all-time high on 17 March 2005.

More generally, shares and bonds as well as residential real-estate all displayed vigorous price increases during the past year, creating significant positive wealth effects. There was a significant acceleration in tax collections during the second half of the 2004/05 fiscal year. Strong domestic expenditure was reflected in high rates of increase in import duty, company tax and value-added tax collections, while the buoyant conditions in the real-estate market continued to boost revenue from transfer duty. Given the high tax collections, the Minister of Finance in the 2005 Budget revised the estimated 2004/05 deficit downward by R9,8 billion to R32,2 billion or 2,3 per cent of gross domestic product. For fiscal 2005/06 the Budget provided for a deficit of 3,1 per cent of gross domestic product and an increase of 12,9 per cent in expenditure as public service delivery, infrastructure provision and access to social services are improved. The rate of taxation on corporate profits was lowered from 30 to 29 per cent as part of a fiscal policy that supports economic growth, but within limits of sustainability.