Global inflationary pressures increased during the past year due to rising food and energy prices. Consumer price inflation in many emerging-market countries exceeded those in developed countries, not least due to the larger weight of food in the consumer price basket of the former group of countries.
In the first half of 2008 policy-makers in many countries faced the challenge of weaker growth and intensifying inflationary pressures. Monetary policy reactions were not uniform, ranging from the aggressive lowering of interest rates in countries such as the United States, to the tightening of policy in several other countries.
After approximately four years of above-trend economic expansion in South Africa, growth in real gross domestic product (GDP) slowed abruptly to an annualised rate of only 2,1 per cent in the first quarter of 2008. This slowdown was widespread and reflected both frictions from the supply side and a moderation in some elements of aggregate demand. Real output in the primary sector contracted as the mining sector had to cope with electricity rationing. At the same time, the secondary sector expanded at a slower pace, with the real value added by the manufacturing subsector contracting due to the adverse impact of power shedding, weaker global demand, slower growth in real incomes, relatively high interest rates and high input costs. The strong growth in the real value added by the tertiary sector, which underpinned much of the growth momentum in the domestic economy over the past eight years, also slackened somewhat as retailers’ confidence levels fell to a five-year low in the first quarter of 2008. This signalled a tougher business environment with subdued consumer confidence originating from higher indebtedness of the household sector, partly due to higher interest rates.
In contrast to the slowdown in real GDP, annualised growth in aggregate real gross domestic expenditure accelerated considerably in the first quarter of 2008 from virtually no growth in the preceding quarter. This increase could be attributed to a rebound in inventory accumulation and stronger growth in final consumption expenditure by the government and in fixed capital formation.
Among the main expenditure components, only real final consumption expenditure by households exhibited slower growth in the first quarter of 2008, reflecting higher debt financing cost and a slowdown in households’ real disposable income due to higher inflation. Real final consumption expenditure by general government accelerated in the first quarter of 2008 as a result of increased spending on final goods and services as the South African Navy took delivery of the third and last submarine under the Strategic Defence Procurement Programme.
Real gross fixed capital formation accelerated moderately, led mainly by an increase in capital spending by general government. Real capital outlays by public corporations and the private sector moderated somewhat in the first quarter of 2008 on account of subdued capital spending in the manufacturing, transport and communication as well as finance sectors.
From depletion in the fourth quarter of 2007, real inventory investment made a sudden reversal to a rebuilding of stocks in the first quarter of 2008. Steps were taken to replenish inventories in areas, such as coal, where stocks had fallen too low. Slower consumption expenditure, high import volumes and a decline in export volumes probably contributed to some involuntary accumulation of inventories.
The volume of merchandise exports shrank in the first quarter of 2008 alongside the general slowdown in global growth, although the demand for mining products remained strong. Mining output and exports were adversely affected by sporadic power shedding and electricity quotas, and the sector could not fully exploit the continued brisk demand for mining products. Simultaneously, the volume of imported goods rose, supported by lively domestic demand and the above-mentioned acquisition of a submarine.
The terms of trade improved considerably in the first quarter of 2008. The depreciation in the value of the rand and further increases in international crude oil prices pushed up the rand price of merchandise imports, but the renewed increase in international commodity prices – partly due to fears that South Africa’s production of mining commodities would decline – caused export prices to accelerate at a much faster pace. Nevertheless, the movements in import and export volumes and J-curve effects of the depreciation of the rand more than offset the improvement in the terms of trade, resulting in a widening of the trade deficit. Net service and income payments to the rest of the world also rose further. Consequently, the deficit on the current account of the balance of payments widened to 9,0 per cent of GDP in the first quarter of 2008 – a level previously observed in the first quarter of 1982.
On the financial account a net outflow of capital was noted in the category for portfolio investment in the first quarter of 2008, partly in view of increased risk aversion by international investors in the wake of the financial market turbulence. In the categories for direct and other investment, net inflows of capital were registered, partly as a result of the acquisition of a 20-per-cent shareholding in a domestic bank by a non-resident bank.
Net capital inflows on the financial account of the balance of payments exceeded the absolute value of the external current-account deficit and, therefore, resulted in a further surplus on South Africa’s overall balance of payments in the first quarter of 2008, although the surplus was smaller than in the preceding quarter. During the first quarter of 2008 the nominal effective exchange rate of the rand declined by approximately 20 per cent, partly due to increased risk aversion by international investors towards emerging markets and negative investor perceptions regarding South Africa’s growth prospects following electricity supply outages. During April and May 2008 the exchange rate of the rand strengthened, supported by the increase in domestic interest rates, which was effected against the background of low short-term interest rates in the United States.
Growth in employment did not match the robust growth in economic activity in recent years and decelerated notably during the second half of 2007. The slower pace of employment gains was mainly caused by a slowdown in employment growth in the private sector, where job losses were recorded in a number of sectors. By contrast, robust employment growth was maintained in the public sector. Wage settlements continued to edge higher in 2007 and early 2008, but sustained increases in productivity helped to moderate the rate of increase in nominal unit labour cost.
Inflationary pressures continued to rise throughout 2007 and the first four months of 2008. Soaring food prices, increasing petrol prices on account of further surges in the price of crude oil, and domestic supply constraints in certain sectors kept inflationary pressures high. Both producer and consumer prices maintained double-digit rates of inflation in April 2008.
Growth in the broad money supply, M3, remained robust, buoyed by medium to longer-term deposits as uncertainty in the financial markets and relatively attractive domestic interest rates supported the precautionary demand for such deposits. A moderation in the growth in total loans and advances extended to the private sector by the banking sector was recorded as the impact of rising interest rates became evident. A main contributor to the growth in loans and advances was the corporate sector, reflecting robust fixed investment and infrastructural spending.
Having left the repurchase rate unchanged at its January 2008 meeting, the Monetary Policy Committee (MPC) increased the repurchase rate to 12,0 per cent by raising the rate by 50 basis points on each occasion at its April and June 2008 meetings. This emanated from the deteriorating inflation outlook partly due to a series of supply-side shocks of extended duration which started to evolve into generalised domestic inflation pressures. Since the beginning of the monetary policy tightening cycle in June 2006, the repurchase rate had been raised by a cumulative 450 basis points, with other money-market interest rates broadly mirroring these increases.
The rate of increase in residential real-estate prices decelerated further in 2008, in response to reduced affordability due to higher financing costs and lower personal disposable income.
Companies listed on the JSE Limited (JSE) raised equity capital in the domestic and international primary share markets amounting to R29,3 billion in the first four months of 2008. This was 37 per cent less than the amount raised during the same period in 2007, possibly due to higher volatility in global share markets and the subsequent repricing of risk. Non-resident investors’ interest in the South African share market waned substantially in the first two months of 2008, as equity markets declined in response to continued fears of a slowdown in global growth. From March 2008 sentiment improved and, coupled with high commodity prices and the depreciation of the rand, record-high domestic share prices were recorded.
Fiscal policy remained supportive of monetary policy. The activities of the non-financial public sector resulted in a cash surplus in fiscal 2007/08, as significant increases in expenditure were more than fully matched by increases in revenue. National government tax revenue was buoyed by the considerable increase in both company and personal income tax collections.