Annual Economic Report Introduction The most significant development during the past twelve months was the sudden downward change in the outlook for the world economy towards the end of 2000. This was mainly a consequence of developments in the United States, but it became sufficiently widespread to cause estimates of future global economic growth to be marked down quite substantially. Sharp falls in share prices also occurred in most of the prominent international financial markets. The United States Federal Reserve System has moved quickly to ease monetary policy by lowering interest rates on six occasions since the beginning of 2001. These steps could not be expected to prevent a slowing in the economy, but were regarded as necessary for reducing the possibility of a recession. Easings of monetary policy soon followed in other countries and regions, such as the United Kingdom and the euro area, albeit in the latter case far less aggressively than in the United States. The slowing United States' economy, and particularly the cutback of investment in computing and electronics equipment, affected exports from Asia, and then rippled out to commodity-producing economies. Despite the easing of monetary policies in the advanced economies, there has been little sign so far of greater confidence emerging in the financial markets that would point to a strengthening of global economic activity in the second half of 2001. The South African economy had been recovering quite robustly from the setbacks suffered at the time of the international financial crises of 1997 and 1998 when world economic conditions began to deteriorate towards the end of 2000. Real gross domestic product was growing at an average annualised rate of some 3½ per cent in the second half of 2000, but when weaker international demand conditions began to spill over into South Africa, economic growth fell back to an annualised rate of about 2½ per cent in the first half of 2001. The depreciation in the value of the rand during the past year and a half cushioned the full impact of the weakening in the world economy on the domestic economy. The slowdown in the domestic economy in the first half of 2001 was mainly confined to the supply side of the economy. Fixed capital formation, predominantly by private business enterprises in most of the production sectors, boosted domestic spending in real terms in the first half of 2001. Final consumption expenditure by households also grew further in the first half of 2001, albeit at a slightly slower pace than in the second half of 2000. Although real gross domestic expenditure expanded in the first half of 2001, it has increased at a lower rate than real gross domestic product since the second half of 1999. During the two previous periods of economic recovery in 1986-89 and1993-96 domestic expenditure increased faster than domestic production, creating imbalances in the economy and fuelling increases in the overall price level. The reversal in the relative growth rates of aggregate spending and production during the current recovery in economic activity undoubtedly contributed to the waning of inflationary pressures, and helped to improve the saving ratio of South African society. The gross saving ratio has increased further in the past year and a half, mainly due to an improvement in general government finances and the saving performance of the corporate sector. Household saving was still constrained as households' consumption expenditure has remained relatively strong. In total, gross saving, which is meant to provide the wherewithal for capital formation, remained too low for economic growth to meet its full potential. Despite the pick-up in overall economic activity since the second half of 1998, employment creation has remained sluggish. In fact, consistently constructed indicators of formal-sector employment point to further declines in 2000 and the opening months of 2001. More structurally, there was a serious deterioration in the relationship between economic growth and employment creation in the first half of the 19