Annual Economic Report Introduction South Africa has experienced a period of slowdown in economic activity and consolidation of the external current account from the third quarter of 1996. Economic growth has been weak and the current indicator of employment in the formal sectors of the economy has declined to its lowest level in nearly twenty years. By the middle of 1997, macroeconomic balance had been strengthened materially and earlier concerns of non-resident investors had been adequately addressed. The economies in Europe and the Americas generally appeared to be moving into a renewed growth phase, brightening the prospects for export and income growth in South Africa. In the second half of 1997, however, severe financial strains surfaced in a number of emerging market economies in Asia. Initially it seemed as if these pressures would have little effect on the growth prospects of the South African economy. In the second quarter of 1998, despite the existence of a relatively small shortfall between aggregate supply and demand, the South African economy was adversely affected by the financial turbulence in Asia. The domestic financial markets came under intense pressure in May 1998 and monetary conditions tightened considerably after they had eased somewhat in October 1997 and March 1998. These events have delayed for a while the anticipated recovery in overall real economic activity. Nonetheless, impressive gains were made in certain important respects over the past year or so: as indicated above, overall macroeconomic balance was restored to an important extent; the budget deficit of the national government was reduced much faster than most observers had anticipated; the deficit on the current account of the balance of payments was reduced in terms of absolute values and as a ratio of gross domestic product; inflation fell and inflation expectations diminished; productivity improved impressively in the formal sectors of the economy; and fixed investment in the productive business sectors of the economy has begun increasing in recent quarters. Overall, the economy was in a much healthier state at the beginning of 1998 than at the beginning of 1996. Economic growth, as measured by year-to-year changes in real gross domestic product, decelerated from 1996 to 1997, reflecting mainly the consolidation of real gross domestic expenditure and a decline in agricultural output from the exceptionally high level of 1996. In the first half of 1998, quarter-to-quarter growth in real gross domestic product continued to be sluggish. This brought the real gross domestic product to a level in the first half of 1998 that was about ½ per cent above the level in the first half of 1997. Apart from the agricultural sector, where production volumes have increased as weather conditions assumed a more "normal" pattern, all the major sectors of economic activity experienced slowdowns in output growth in the first half of 1998. The manufacturing and trade sectors were probably affected more by the slowdown in aggregate expenditure than most of the other sectors. Furthermore, increased external competition, which reduced the pricing power of domestic producers, and rising domestic cost pressures, compressed the operating margins of the manufacturing sector. Declining employment and slow growth in private households' disposable income were manifested in slow growth in the real value added by the trade sectors. Growth in real gross domestic expenditure declined from 1996 to 1997 as the rate of increase in private consumption expenditure slowed down and inventories were reduced sharply. The growth rate of real fixed investment spending was more than halved from 1996 to 1997, but was showing signs of recovery in the first half of 1998. By contrast, general government consumption expenditure increased firmly in 1997 and continued to do so in the first half of 1998, albeit at a decidedly slower pace. The slowdown in economic growth brought in its wake a further decline in total employment in the non-agricultural sectors of the economy from the middle