A relatively benign international economic environment contributed to the improved prospects facing the South African economy in 2005. Global output growth continued at a firm pace, rendering support to international trade volumes and commodity prices. At the same time world inflation remained low, with little evidence that the increases in the prices of crude oil and other commodities would trigger a more generalised inflationary spiral.
In recent years the rate of real output growth in the South African economy has exceeded the pace of expansion in the real fixed capital stock by a considerable margin, resulting in a declining capital-output ratio. As the use of capital stock is increasingly stretched to its limits, it is likely to prompt higher fixed capital formation in order to boost the capital stock and accommodate a sustained acceleration in output growth. This outcome was observed as capital expenditure again rose briskly in 2005, but not sufficiently to prevent a further reduction in the capital-output ratio. Further substantial strides in fixed capital formation are required – including the increases to which the public sector is committed, congruent with the Accelerated and Shared Growth Initiative of South Africa (Asgisa).
In 2005 all three of the main components of domestic final demand – final consumption expenditure by households, final consumption expenditure by government, and gross fixed capital formation – rose at strong real growth rates ranging from 5.1⁄2 to 8 per cent. Household expenditure on durable and semi-durable goods recorded further buoyant increases in 2005, supported by high consumer confidence, rising income and the lowest nominal interest rate levels in 25 years. Real final consumption expenditure by general government was driven by actions to improve service delivery as well as defence procurement. The private sector – particularly the manufacturing, commerce and construction sectors – was responsible for most of the growth in real fixed capital formation in 2005, although public corporations also increased their expenditure on the upgrading of the electricity distribution network and on harbour facilities.
Real value added by the primary sector picked up in 2005 on account of a significantly higher level of agricultural production. The secondary and tertiary sectors broadly retained their earlier growth momentum in 2005. However, quarterly growth rates were erratic, with the mining sector for instance experiencing strongly positive growth rates in the first half of 2005 but reductions in real production in the second half of the year, partly on account of scheduled maintenance of a smelter. Erratic behaviour was observed in the real value added by manufacturing which registered a contraction in the first quarter of 2005, strong increases in the middle quarters, and again a marginal contraction in the final quarter when petroleum refinery output was temporarily held back by plant conversions to replace leaded fuel. Summing across all sectors, quarter-to-quarter growth in real gross domestic production reached its peak in the second quarter of 2005 and decelerated somewhat in the subsequent two quarters.
Strong domestic production and expenditure in 2005 were accompanied by buoyant demand for imports. For the year as a whole, the volume of merchandise imports rose by 11.1⁄2 per cent. Over the same period merchandise export volumes expanded by 8.1⁄2 per cent, consistent with the solid performance of the world economy. Both the trade deficit and the deficit on the service, income and current transfer account widened in 2005, resulting in a deficit on the current account of the balance of payments amounting to 4,2 per cent of gross domestic product. The deficit in the fourth quarter also widened despite the meaningful narrowing of the trade deficit.
The financial account of the balance of payments registered a larger surplus in 2005 than in 2004. A large foreign direct investment transaction in the banking sector contributed significantly towards this outcome and also helped to stimulate interest in investment in South Africa generally. Portfolio investment into South Africa also continued in 2005 and mainly involved investment in shares. The continued surplus on the financial account in respect of the final quarter of 2005 reflected, among other things, further direct investment activity as well as flows related to the domestic private-banking sector.
During each of the quarters of 2005 the overall balance of payments registered a surplus. This was reflected in further increases in the gross holdings of gold and foreign exchange of the South African Reserve Bank (the Bank), which doubled in less than two years, reaching US$20,6 billion at the end of December 2005. The gross reserves came to US$22,5 billion at the end of February 2006. Given the overall balance-of-payments surplus, alongside sustained high prices of commodity exports and widespread interest in South Africa as an investment destination, the nominal effective exchange rate of the rand, on balance, declined very little in 2005 – a 9-per-cent depreciation of the exchange value of the rand in the first half of the year was largely reversed in the second half. Some further appreciation of the rand followed in early 2006.
Overall employment in South Africa increased by a welcome 658 000 jobs, or by 5,7 per cent, over the year to September 2005. Wage settlements and increases in nominal remuneration per worker moderated somewhat in 2005, and increases in unit labour cost were fully aligned with the inflation target. However, at the same time the number of man-days lost due to strikes and other work stoppages more than doubled to 2,3 million.
CPIX inflation continued along its disciplined path, recording its 29th successive month within the target area of 3 to 6 per cent in January 2006. Both the goods and the services components were within the target area. If the price of petrol is excluded from the inflation calculation, administered price inflation fell close to the midpoint of the target range. Similarly, production price inflation remained well contained.
The M3 money supply rose at brisk rates in 2005 and January 2006, consistent with the strength of domestic production and expenditure. Positive wealth effects on account of rising prices of real-estate and financial assets also supported the demand for money. Monetary institutions’ loans and advances to the domestic private sector maintained strong momentum over the past year, with mortgage and credit card advances recording exceptionally high rates of increase – symptomatic of the buoyancy of the real-estate and household goods and services markets, respectively. As a counterpart to these developments, the household debt ratio rose from 58 per cent of disposable income in the fourth quarter of 2004 to a new record level of 65.1⁄2 per cent in the fourth quarter of 2005.
Interest rates in the money market remained aligned with the Bank’s repurchase rate. This policy rate was adjusted only once in 2005, when a reduction from 7.1⁄2 per cent to 7 per cent was announced in mid-April. Other money-market rates generally declined by a similar margin. Yields on long-term rand-denominated bonds of the South African government trended down during 2005 and reached 35-year lows in February 2006, reflecting the modest Budget deficit and confidence that inflation would remain under control.
With mortgage interest rates at relatively low levels and displaying a high degree of stability, while real income and employment continued to expand, house prices again recorded double-digit rates of increase in 2005 and the first few months of 2006. Sentiment in the real-estate market was also supported by the reduction in transfer duty announced in February 2006.
Reflecting the sound performance of the economy, high international commodity prices, strong profit growth and upbeat expectations, South African share prices rose by 43 per cent from the end of 2004 to the end of 2005 – the seventh highest local-currency price performance in the world according to the World Federation of Exchanges. While share prices reached successive record highs in 2005 and early 2006, on each of these occasions the historical price-earnings ratio of JSE Limited (JSE) shares still fell short of its upper turning points in a number of previous instances. Non-residents’ net purchases of shares on the JSE reached a record high level in 2005 and continued apace in the first two months of 2006.
National government revenue was exceptionally buoyant in fiscal 2005/06, exceeding the initially budgeted amount by a significant margin as a reflection of the strength of domestic production and expenditure, as well as further improvements in tax administration. Government expenditure progressed in broad conformity with the initial Budget. As a result, the latest estimates provide for a 2005/06 national government deficit before borrowing and debt repayment of only 0,5 per cent of gross domestic product, compared with an originally budgeted ratio of 3,1 per cent. The strong fiscal position made it possible for government to provide for significant tax relief and increases in real non-interest expenditure in 2006/07, while still restricting the deficit ratio to 1,5 per cent of gross domestic product and allowing the ratio of government debt to gross domestic product to somewhat decline further.