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IntroductionThe Annual Economic Report provides the broader economic context to the address by the Governor of the South African Reserve Bank (the Bank) at the annual meeting of shareholders. The focus in this review of economic events is on the calendar year 2012 and the first half of 2013, going beyond the Bank’s financial year. Apart from tracing the evolution of a wide range of economic indicators, attention is also given to institutional, legislative and regulatory changes introduced during the period under review that have a bearing on the economy and its functioning.During 2012 and the first half of 2013 the global economy continued to function under the cloud of a global financial crisis that had its origin more than five years earlier and yet had not been adequately resolved, with the focus widening from the stability of the financial system to fiscal sustainability and sovereign debt issues. Global output growth continued to disappoint, particularly in the developed economies, despite the continuation of extraordinarily expansionary monetary policies. Part of the reason for the lack of momentum in economic activity was the fact that fiscal policy settings were generally tightened over the period, although in a number of instances tax revenue remained suppressed on account of subdued economic activity to such an extent that not much progress could be made in reducing the fiscal deficit and turning around the unsustainable pace of increase in government debt.A number of events were prominent in shaping the course of the global economy in the past 18 months:· In July 2012 the President of the European Central Bank (ECB) reassured the market that the ECB would do “whatever it takes” to preserve the euro, leading to a narrowing of risk premiums on non-core European government bonds and reduced strain on the public finances of the countries involved. · In December 2012 the Federal Reserve in the United States (US) redirected its assurances regarding the maintenance of an expansionary monetary policy, linking the consideration of monetary policy tightening not to a likely timeframe as had been the case previously, but to the state of the economy: Consideration of tightening would not commence before the US unemployment rate had fallen below 6,5 per cent or inflation had risen above 2,5 per cent. Quantitative easing was also clarified by the announcement of a monthly flow rate of purchases of bonds by the Federal Reserve. · Towards the end of 2012 Japan introduced a suite of measures aimed at far more aggressive stimulation of the economy than before, thereby providing further support to the global recovery. · Confidence in Europe was undermined when the Cypriot financial crisis intensified in March 2013 with a bailout being announced, which initially would have involved a levy on all bank deposits as part of the package; this was subsequently softened. · A further significant development was the deceleration in the growth rate of the Chinese economy which came to the fore in the early part of 2013, contributing to a softening in the international prices of a range of commodities. · In May 2013 the initial “tapering” comments by the Chairman of the Board of Governors of the Federal Reserve System brought about a significant decline in financial asset prices.Closer to home, the announcement that South African government bonds would be included in Citi’s World Government Bond Index (WGBI) from October 2012 led to pre-emptive buying by investors in the months preceding the inclusion, contributing to lower yields. This was later on partly negated when South Africa’s sovereign credit ratings were downgraded, not least due to the labour turmoil and loss of life at Marikana in August 2012, and the subsequent deterioration in labour relations in general.South Africa experienced a pedestrian rate of economic growth in 2012 and the first quarter of 2013, reflecting both supply-side constraints and weaknesses in aggregate demand. The tertiary sector continued to record the strongest and most consist