Notwithstanding the turmoil related to the sub-prime market, global economic growth remained brisk in the first three quarters of 2007. Emerging-market economies including China, India and virtually all the oil-exporting countries continued to bolster global production volumes, offsetting the hesitation in some of the developed economies. In Africa it seemed likely that the real growth rate for 2007 would exceed 5.1⁄2 per cent for the fourth successive year, aided by the strong momentum of the world economy, high commodity prices and improved economic policies.
In South Africa the real economic growth rate for 2006 was revised upward to 5,4 per cent – a rate previously encountered in 1981. Growth in the first three quarters of 2007 fell marginally below that rate, displaying a slight reacceleration in the third quarter. The services sectors, and in particular the finance, real-estate and business services sector, made the strongest contribution to growth in the third quarter of 2007 as banks’ balance sheets and revenues continued to expand apace. Trade and construction also recorded robust increases. By contrast, the real value added in manufacturing contracted in the third quarter as production was hampered by strike activity in the motor industry and slowing demand alongside a relatively strong exchange value of the rand. Capacity utilisation in manufacturing also receded significantly in the third quarter from earlier exceptionally high levels. At the same time mining output recovered as platinum and diamond production responded to favourable international prices, whereas growth in agriculture decelerated in the third quarter as field crop production declined.
From very strong rates of increase in the first quarter of 2007, growth in both real final consumption expenditure by households and real fixed capital formation decelerated in the subsequent two quarters. Tighter monetary conditions probably contributed to the slower pace of increase in household consumption and in some of the components of capital spending. Household debt nevertheless edged higher to a record level. Real inventory investment slowed in the third quarter of 2007, as the pace of inventory accumulation lost momentum in most sectors of the economy. By contrast, the government’s real final consumption expenditure reverted to strong growth in the third quarter, reflecting the acquisition of military items and the normalisation of real compensation of employees which had previously been dragged down by the strike in the public service during the second quarter of 2007.
Despite the moderation in the pace of increase in real fixed capital expenditure, this component of aggregate final demand still rose at a double-digit annualised rate in the third quarter of 2007. Accordingly, some further rebalancing from household consumption to capital expenditure was recorded. Under these circumstances real imports edged higher, whereas export volumes recorded a marginal decline. Furthermore, import prices were bolstered by the further surge in international crude oil prices, while considerably higher dividend payments to non-resident investors contributed to a widening of the deficit on the services and income account of the balance of payments. The net result of these forces was that the deficit on the current account of the balance of payments widened to 8,1 per cent of gross domestic product in the third quarter of 2007 – the highest ratio since the 9,2 per cent registered in the first quarter of 1982.
However, this deficit was again readily financed by non-resident capital inflows. In fact, such inflows were enough to enable the South African Reserve Bank (the Bank) to purchase an amount of more than US$2 billion in the foreign-currency market during the third quarter alone. Further additions to the Bank’s reserves in October and November 2007 brought the level of the gross gold and foreign-exchange reserves to more than US$32 billion at the end of November 2007 – four times as much as at the end of 2003. Recently the official gross reserves have covered the country’s foreign-currency denominated external debt maturing within one year almost twofold. The net inward movement of capital was recorded in all investment categories, although more prominent in the category for inward portfolio investment.
The nominal effective exchange rate of the rand depreciated significantly from late July to mid-August 2007 following the eruption of turmoil in international credit markets, but subsequently recovered as it became clear that emerging markets were not directly affected. The US dollar, by contrast, reached successive record lows against the euro in recent months. News in late October 2007 of the acquisition of a 20-per-cent stake in a South African bank by a Chinese bank provided further support to the exchange value of the rand. In the second half of November, however, the rand’s earlier gains were largely reversed.
The short-term momentum of inflation was fuelled by record-high international oil prices and a substantial acceleration in food prices in the course of 2007. Twelve-month CPIX inflation rose above the target range in April 2007 and subsequently remained above
6 per cent, reaching 7,3 per cent in October. Measures of underlying inflation such as CPIX excluding food and fuel also accelerated, suggesting that more widespread inflationary pressures were at work. Wage settlements also edged higher in the course of 2007.
In order to prevent the temporary acceleration in inflation from becoming entrenched, the Monetary Policy Committee of the Bank raised the repurchase rate by 50 basis points on each occasion at its meetings in June, August and October 2007. This came in addition to four increases of a similar magnitude which were implemented during the final seven months of 2006. Other money-market interest rates rose broadly in line with the repurchase rate. Despite significant increases in both nominal and real interest rates, banks’ loans and advances to the domestic private sector continued to rise briskly. Loans extended to the corporate sector continued to rise strongly, consistent with the strength of fixed capital formation. Mortgage advances to the household sector also maintained brisk momentum during the first ten months of 2007, although tentative signs of moderation started to emerge recently. On the other side of the banks’ balance sheet the money supply continued to grow rapidly, reflecting positive wealth effects, rising income and expenditure levels, as well as buoyant financial market turnover. Some investors also decided to keep more of their assets in the form of cash, probably for precautionary and speculative reasons.
Anchored by the repurchase rate, short-term interest rates rose considerably more than long-term rates over the past 18 months and the yield curve became inverted. Bond yields moved higher on account of worsening inflation risks, but nevertheless continued to reflect a conviction in the market that over the longer run inflation would remain firmly under control, even if partly influenced by limited supply.
South African share prices broadly emulated share prices in the major centres of the world, declining significantly in the wake of the credit market turbulence in the third quarter of 2007. South African share prices subsequently recovered as it was realised that emerging markets had limited, if any, exposure to the structured products in question. In November share prices again receded somewhat as confidence waned and some commodity prices moderated.
Higher mortgage interest rates probably contributed to a slowdown in the pace of fixed property price increases during the first ten months of 2007. The South African consumer’s net worth nevertheless continued to benefit from the appreciation in house prices which softened some of the impact of rising household debt.
The Minister of Finance projected a disciplined fiscal stance in the October 2007 Medium Term Budget Policy Statement, with expected fiscal surpluses in each of the fiscal years up to 2010/11. Government introduced the concept of a structural budget balance which reflects the conventional balance adjusted for cyclical factors, mainly as they affect revenue collection. Recognising that the budget position was strengthened by the robust upswing in the business cycle and favourable prices of export commodities, it was estimated that the structural budget balance of the national government was in deficit and would continue to reflect a deficit of around 0,6 per cent of gross domestic product over the three-year forecast period. Government’s approach would be to use the windfall revenues from favourable economic conditions to invest in physical infrastructure and human capital formation and to raise the level of savings. Should these windfall revenues abate, resources would be available to continue spending on key priorities without placing an unpalatable financing burden on the economy.