1. Introduction

The long awaited recovery in the South African economy finally materialised during the past twelve months. The country entered its longest post-war recession as far back as March 1989, while the protracted downward phase only levelled out during the first half of last year. Since the third quarter of 1993, total economic activity has clearly been on a recovery path. This new upward phase wavered in the first quarter of 1994, but then regained some momentum in the second quarter of this year. The challenge facing South Africa now is to maintain economic growth at a steady rate during the years ahead. The maintenance of overall financial stability is a prerequisite for such sustainable growth.

The recovery in the economy was partly of a cyclical nature. During the contraction of the economy over an extended period of about four years, the country's capacity to provide for the multitude of growing needs of our community was eroded to a point where it must now be expanded again. The current recovery was also fostered by favourable weather conditions which led to a sharp increase in agricultural output, and by higher growth in some industrial countries which further promoted export volumes.

Most important of all was, of course, the good progress made in South Africa over the past year in the political and social reforms which culminated in the widely supported democratic election of 1994-04-27, and in the subsequent inauguration of Mr Nelson Mandela as the new President. In the period leading up to the election, initiatives were launched for the withdrawal of international sanctions and other punitive economic actions applied against South Africa in terms of United Nations resolutions. With the progressive termination of these actions, South Africa's international economic relations were gradually normalised, and the facilities offered by such institutions as the International Monetary Fund and the World Bank became accessible once again.

In the interim, however, total economic activity continued to reflect the vicissitudes of political events in the country. During the first four months of 1994, when many uncertainties still existed about the finalisation of the new constitution and the general participation of the major political groups in the pending election, and when doubts also developed about the general acceptance of the election results, the economic upswing faltered. Fortunately, however, the final outcome of the election and the favourable reaction by most South Africans as well as the international community paved the way for a resumption of the recovery in total economic activity from May onwards.

South Africa now offers vast opportunities to realise its great economic potential in the interest of all its people. With the political reforms in place and a national commitment to a major programme of economic reconstruction and development, the attention of all participants in the economic development process, including potential international investors, is being focused more and more on the country's economic prospects. South Africa has arrived at a momentous stage in its history of development and must now display national responsibility for good economic governance and selfconfidence in its future. The country must now create and support a climate that will be conducive to sustainable economic growth in the medium to longer term. Sound economic and financial policies must be adhered to that will attract and not deter foreign investors. There must be lasting confidence within the business community to expand the country's production capacity. All South Africans must of course benefit from economic growth.

The Reserve Bank is also committed to making its contribution to the success of South Africa's process of economic reconstruction and development. As proved in many other successful countries, the most important contribution that the central bank can make is to contain the inflation pressures that will unavoidably be encountered on the long road of economic development ahead. Without financial stability South Africa's journey along the path of economic development and human betterment will not be sustainable.

2. Recent Economic Developments

The beginning of a new economic upswing

After more than four years of low and, for most of the time, even negative growth, the South African economy started to recover again during the course of 1993. In the twelve months from July 1993 to June 1994, real gross domestic product was indeed 3.5 per cent higher than in the immediately preceding twelve months. Growth was particularly strong in the second half of 1993, but then faltered in the early months of 1994, mainly as a result of renewed uncertainties leading up to the election of 27 April. In the second quarter of 1994, the expansion regained some momentum when gross domestic product increased at a seasonally adjusted annual rate of about 2 per cent.

Although a recovery of agricultural production after the drought of 1991/92 was largely responsible for initiating the new economic upswing, output of other sectors such as mining, manufacturing and services also improved slightly during the course of 1993. At the moment, however, the recovery must still be regarded as fragile. It could easily lose its momentum again, particularly if the current friction between various trade unions and employers is not resolved soon.

The present upswing was supported by firm increases in the main components of domestic expenditure, such as consumption expenditure by households, gross domestic fixed investment and the accumulation of inventories. Together with a relatively sharp rise in current consumption expenditure by general government, the increases in the various components of demand pushed total real gross domestic expenditure for the twelve months ending in June 1994 to a level 4.5 per cent above the level for the immediately preceding twelve months.

Total consumption and other current expenditure by both households and general government increased at a higher rate than domestic production, with the result that total domestic saving declined further to only about 16 per cent of gross domestic product in the first half of 1994. It is estimated, however, that saving, that is the difference between total current income and total current expenditure, will have to be raised to a level of about 24 per cent of gross domestic product before South Africa will be able to maintain an economic growth rate of 3.5 per cent per annum. Only persistent net foreign capital inflows can lessen the reliance on the total body of South African consumers - that is households and all levels of government - to improve our savings ratio by as much as 50 per cent.

Despite the revival in total economic activity, total formal-sector employment continued to decline in 1993. In fact, the rate of decrease in employment accelerated from 0,6 per cent in 1990 and 2,1 per cent in both 1991 and 1992 to 2,5 per cent in 1993. More recent statistics on employment are not available at this stage and it will be some time before it can be determined whether the recent further improvement in total economic activity has led to any improvement in overall employment. It is an unequivocal fact, however, that massive unemployment will remain a feature for some time to come as a legacy of the dismal performance of the South African economy over the past decade. It follows that, in order to create more jobs, sound and sustainable economic growth must be promoted and maintained as a matter of the utmost national importance in the years ahead.

Persistent capital outflows deplete available savings and foreign reserves

As could have been expected against the background of rising domestic expenditure, increases in imports, particularly in the first half of 1994, led to a smaller surplus on the current account of the balance of payments. Following upon a surplus of R5,9 billion in 1993, the actual current account surplus declined to only about R0,5 billion in the first half of 1994.

This rapid deterioration in the current account during the early phase of an economic recovery makes the need for an improvement in the capital account of the balance of payments all the more important. Thus far, the net capital outflow has receded from no less than R9,8 billion in the last six months of 1993 to R3,7 billion in the first six months of 1994. This improvement occurred mainly in the form of a substantial reduction in the outflow of short-term capital, partly reflecting the easier access which South African borrowers now have to international banks and other financial institutions.

The balance of payments remains a major constraint on the economic development process in South Africa, particularly if account is taken of the relatively low level of the official foreign reserves. Years of protracted capital outflows from the country not only depleted the gross foreign reserve holdings of the Reserve Bank, but also forced the Bank from time to time to make extensive use of short-term foreign credit.

These net capital outflows, which averaged R5,5 billion per year over the nine-year period from 1985 to 1993, also absorbed a substantial part of the country's domestic saving. An improvement in the capital account of the balance of payments, if only to a position of a zero net outflow, can therefore make an important contribution towards increasing the amount of saving available for the financing of the national economic development programme.

In order to ameliorate the effect of the large capital outflows of the past year on the exchange rate of the rand and to create some scope for a less restrictive domestic monetary policy, the Reserve Bank increased its outstanding short-term foreign borrowings from R1,6 billion at the end of June 1993 to R5,3 billion by the end of December 1993. On 1994-05-10, the total outstanding foreign loans of the Reserve Bank amounted to no less than R8,5 billion. In addition, the Government also borrowed R2,8 billion from the International Monetary Fund in December 1993 to provide the country with additional foreign exchange for meeting its balance of payments commitments. A reversal of the large outflows of short-term capital after the election in April enabled the Bank to reduce its foreign liabilities again to R5,7 billion by end July 1994.

Despite all these borrowings, the gross gold and foreign exchange reserves, including the foreign exchange holdings of the private banks, in nominal terms showed a slight decline from R10,2 billion at the end of June 1993 to R9,7 billion by the end of June 1994. The last-mentioned figure represented the equivalent of only five weeks of imports, against a normal comfortable level of about twelve weeks.

It should be emphasised, however, that short-term borrowing by the Reserve Bank is of a bridging nature only. The Bank cannot embark on a programme of longer-term balance of payments or economic development financing. Every possible effort must therefore be made to encourage the inflow of more permanent short and long-term capital to finance the country's longer-term requirements.

The support given by the Reserve Bank to the foreign exchange market was not sufficient to prevent the exchange rate of the rand from depreciating quite substantially over the past nineteen months. The weighted average value of the rand against a basket of the currencies of South Africa's major trading partners depreciated by no less than 18,7 per cent from the end of December 1992 to the end of July 1994. This depreciation in the nominal value of the rand exceeded the inflation differential between South Africa and the relevant countries, with the result that the real effective exchange rate of the rand depreciated by about 10 per cent over the same period.

In the short term, the depreciation of the currency may provide some stimulus to those domestic producers that rely on the export market, and also to those competing against imports in the domestic market. In due course, however, the competitive advantages gained through a currency depreciation will be absorbed in rising costs of production if the inflationary effects of the depreciation cannot be contained by more restrictive monetary and fiscal policies, and by constraints on rising labour costs. It is very unlikely, in the present environment of relatively unfavourable expectations of future inflation and aggressive demands for high wage increases, that a depreciation of the rand will achieve any durable benefits for economic growth. On the contrary, there is a substantial risk that a continuous fall in the external value of the rand could easily plunge the country into a destructive depreciation- inflation-depreciation spiral. The eventual cost of breaking such a vicious circle will almost certainly exceed any short-term advantages that might be gained from a continuous depreciation of the rand.

In July 1994, when the Reserve Bank's net foreign reserves increased by R1,5 billion, the Bank made use of the opportunity to deliberately intervene in the foreign exchange market in an effort to stabilise the exchange rate. From 26 July 1994, when the rand reached a record low of R3,70 against the US dollar, up to 16 August, the rand appreciated again to R3,59 per one US dollar. The Bank also continued to support the market by providing forward cover to banking institutions and their clients in respect of determinable future commitments in foreign currencies.

Current financial developments reflect an economic recovery combined with growing balance of payments pressures

In 1993, the Reserve Bank not only provided the foreign exchange market with substantial amounts of foreign exchange in order to lean against the wind in respect of a declining exchange rate, but also supported the money market to avoid an excessive tightening in liquidity and a possible rise in interest rates at a very early stage of the economic upswing. The assistance provided by the Bank to the money market was, however, not excessive and could be justified by a relatively low rate of increase in the money supply at that stage.

The situation, however, changed during the course of 1993. The rate of growth in the M3 money supply measured over twelve-month periods increased from 1,9 per cent in July 1993 to 7,0 per cent in December 1993, and to 15,0 per cent in June 1994. Although these trends were affected by a large accumulation of cash funds in the government accounts with the banking sector in the first half of 1993, and a subsequent reduction in these balances in the first half of 1994, the underlying changing trend in the rate of increase in the money supply could not be ignored.

The rate of expansion in the amount of bank credit extended to the private sector, also measured over twelve- month periods, contracted from 8,7 per cent in December 1992 to 5,7 per cent in May 1993, before rising again to 9,7 per cent in December 1993 and to 13,2 per cent in June 1994. It is understandable that the demand for bank credit will expand during an economic recovery, but long-term economic growth can, of course, not be financed on a durable basis by the creation of money through the lending activities of banking institutions.

Against the background of the persistent outflows of capital and the depreciation in the exchange rate of the rand, the Reserve Bank switched to a more neutral policy stance during the early part of 1994 and refrained from any further special assistance to the money market. This new policy approach was almost immediately reflected in growing money market shortages as the continued decline in the net foreign reserves drained liquidity from the system. The total accommodation of which banking institutions availed themselves at the discount window of the Reserve Bank accordingly rose from R3,9 billion at the end of February 1994 to R7,1 billion at the end of April. Money market conditions then remained relatively tight and only showed some easing in July when the net foreign reserves of the country rose sharply.

Interest rates in general reached a lower turning point in February 1994. From then onwards the yield curve over its full maturity spectrum shifted to a higher level. With long-term rates increasing even faster than short-term rates, the yield curve adopted a rather steep upward slope as the gap between long and short-term interest rates widened.

These developments ruled out the possibility for any further reduction in the Bank rate after six consecutive reductions had been made from 18 per cent in March 1991 to 12 per cent in October 1993. In the environment of relatively large capital outflows from the country, a depreciating exchange rate, rising demand for credit, an escalation in the rate of increase in the money supply, a relatively large deficit on the budget of general government and apparently rising expectations of higher inflation, there was surely no justification for what would merely have been regarded as an artificial further reduction in the Bank rate. On the contrary, it was only because of a belief held by the monetary authorities that at least some of these adverse developments, such as the outflow of capital and the depreciation of the currency, were directly linked to the transitory political events of the period and would be reversed again in the second half of 1994, that deterred the Reserve Bank from switching to a more restrictive monetary policy thus far in 1994.

Conflicting developments between rising demand for funds from private sector and large borrowing requirements of government

Over the past three fiscal years that ended on 1992-03-31, 1993 and 1994, the deficit before borrowing on the budget of the central government amounted to 4,3, 8,3 and 6,9 per cent of gross domestic product, respectively. For the fiscal year 1994/95 this deficit has been projected at a level of R29,3 billion, or 6,6 per cent of the estimated gross domestic product.

Deficits of the government of this magnitude inevitably reduce total saving available for investment and development in the private sector, and represent dissaving by government - to the extent that the deficits exceed the relatively small amount of capital expenditure by government. Furthermore, the total deficit also represents an addition to total government debt and to the already heavy cost for the taxpayer of servicing the large public debt. Interest payments on the government debt at this stage already absorb 17,2 per cent of the total budget expenditure, equal to 5,6 per cent of gross domestic product.

In the rather depressed economic environment of the past few years, it was not difficult for government to raise the required funds in the domestic financial markets. Very little recourse was had to bank credit during this period and interest rates in general continued to fall in line with a declining rate of inflation. It can indeed be argued that, in the circumstances, the larger than normal deficits on the budget of the government provided some temporary stimulus to the economy and prevented the recession from deepening even further.

However, circumstances have changed significantly over the past year. The economy is now on a new course of expansion, private sector fixed investment is increasing and there is a rising demand for funds, as evidenced by the recent, admittedly only moderate, increase in the amount of bank credit extended to the private sector. In this situation, excessive borrowing by government can easily lead to an upward pressure on interest rates and a "crowding-out" of the private sector, and/or to the temptation of financing part of the deficit with bank credit. Both these courses will sooner or later dampen the economic upswing and so reduce the country's ability to maintain the current welcome expansionary phase for any length of time, not unlike the old stop-go experiences of the seventies.

The Reserve Bank's efforts to maintain overall financial stability in support of sustainable economic growth in the medium and longer term therefore now require effective co-ordination between monetary and fiscal policy, more so than at any other time in the past five years. Attempts to stimulate the economy through excessive increases in government expenditure can at this stage yield a perverse result, and again lead to an early abortion of the economic recovery. As so often happens with macro- economic decisions, the authorities must in the present situation do less to achieve more in due course. The Reserve Bank can therefore only lend its full support to the Minister of Finance's attempts in his budget for 1994/95 to provide more funds for the Reconstruction and Development Programme of the government, not by increasing total government expenditure, but rather through a re-prioritisation of existing expenditures.

3. Three problem areas in the ecomony

Inflation declines but inflationary pressures persist

One of the most gratifying developments in the past year has been the decline in the rate of inflation. Both the producer and consumer price indices over the past year increased at their lowest rates for more than two decades. The overall producer price index in 1993 increased by only 6,6 per cent and the consumer price index by 9,7 per cent. Measured over twelve-month periods, the rate of change in the producer price index reached its lowest level of the past eighteen months equal to 5,4 per cent in October 1993, before rising again to 7,9 per cent in June 1994. On the same basis, consumer price inflation turned around from a low of 7,1 per cent in April 1994, before increasing to 7,5 per cent in June 1994.

The many disadvantages of inflation have been spelled out in previous Governor's Addresses at these meetings, in almost all the Annual Economic Reports issued by the Bank in recent times, and in many public speeches and publications by Reserve Bank officials. These disadvantages can be summarised in terms of the following quote from the last pages of the Reconstruction and Development Programme itself: "Excessive inflation or serious balance of payments problems ... would worsen the position of the poor, curtail growth and cause the RDP to fail".

One aspect of the inflationary process that needs further attention in South Africa is the role of expectations. Although nominal rates of inflation declined quite remarkably over the past year, we have not yet succeeded in breaking the inflation psychosis. This requires a long and persistent battle that should not be allowed to be derailed by short-term fluctuations in prices. As long as inflation and the expectations concerning inflation, continue to have a material effect on current decisions to save, invest, produce or consume, the battle is still on. As long as the South African rate of inflation remains at a level well above that of our major international trading partners and competitors, the country will have to fight rising costs to be competitive in world markets. As long as there is inflation, whatever the level may be, the Reserve Bank has an obligation to counter it.

This is no easy task, particularly not in the present economic climate. Many of us have a desire to force-feed the economy beyond its actual potential and to exert pressure on the monetary system to accommodate these desires by simply creating more money. And yet, we also agree that the creation of more money has never been a panacea for poverty. Indeed, high inflation financed by excessive increases in the money supply not only depresses economic growth in the longer term - it also discriminates unfairly against the poor through an inequitable erosion of living standards.

We are therefore obliged to remain on guard in the fight against inflation. Recently, ominous signals have come from the changes in the rate of growth in financial aggregates such as the money supply and bank credit extension, from changes in the exchange rate of the rand as well as interest rates, particularly long-term rates and in the shape of the yield curve. Both the producer and consumer price indices recently also started to move up again. Unless there is now, in the post-election period, a determined return to a more stable overall financial climate in the country, the Reserve Bank will have little option other than to yield to the signals of the market forces and shift to a more restrictive monetary policy.

There are normally long time-lags involved in the reaction of prices to inflationary impulses from financial changes. Macro-economic analysts estimate these time-lags to be as long as eighteen months to two years. If the Reserve Bank therefore waits until measured inflation reaches an unacceptably high level before it tightens monetary policy measures, it would turn out to have waited far too long. Early and decisive action will be needed if we do not want to sacrifice the progress already made over the past few years to restore financial stability to the South African economy.

Multi-factor productivity must improve to support sustainable economic growth

In the almost forgotten Normative Economic Model issued by the Minister of Finance as a discussion document in March 1993, an analysis was provided of the poor performance over time in South Africa's total multi-factor productivity, and also compared to the more successful economies in South-East Asia. Inputs of both capital and labour yielded relatively low returns in terms of output, and contributed significantly to the erosion of South Africa's competitiveness in world markets. Now that South Africa is being reintegrated into the world economy and our producers are increasingly being exposed to international competition, it is of the utmost importance that we shall as a nation become much more competitive.

More recent statistics are unfortunately not available, but there were encouraging developments during 1993 as far as labour productivity and the unit cost of labour were concerned. The rate of increase in the average nominal wage per worker in the non-agricultural sectors contracted from 15,4 per cent in 1992 to 10,6 per cent in 1993. After adjustment for inflation, the increase in the average real wage per worker was less than one per cent in 1993.

Mainly because of technical reasons, for example the retrenchment of workers, average labour productivity increased last year in the sense that less labour was used to produce a unit of production. The combination of the relatively low wage increases on the one hand, and the increased output per worker, on the other, resulted in a decrease of no less than 3,0 per cent in the real labour cost per unit of physical output in 1993. This development, if maintained, augurs well for the country's prospects for economic development.

There is an undeniable potential to increase productivity further in South Africa, for example through better education and training, improvement of services such as housing, health care, transportation and electrification, the introduction of more advanced technology and the promotion of effective competition. In other words, the achievement of many of the objectives of the Reconstruction and Development Programme is of great importance, not only for socio-political reasons, but also for future economic development.

Although these actions may seem to fall outside the ambit of the monetary policy responsibilities of the Reserve Bank, they are of vital importance to realise the common and ultimate objective shared by consistent macro-economic policies, and that is to improve the standard of living for all the people of South Africa. The most important contribution monetary policy can make to the achievement of this objective is to protect the value of the rand, for it is only in an environment of financial stability and corresponding expectations that the benefits of improved productivity will accrue visibly and on an equitable basis to the real producers of wealth.

The encouraging developments of last year in labour productivity and in the average labour cost per unit of production occurred in a climate of serious recession. It will be a sad experience if these developments were to flounder again during the current phase of economic recovery under the pressure of a new wave of wage disputes between employers and employees.

The constraint of exchange controls

Over a period of more than thirty years, the South African balance of payments was subjected to many non- economic actions introduced from time to time by other countries to affect the course of socio-political developments in the country. During this period a very extensive exchange control system was introduced to regulate capital movements out of the country. These controls, which affect both non-residents and residents, were also used to protect the domestic economy from the adverse effects of balance of payments developments inspired by non-economic factors. Because of the nature of their origin, such developments could not always be managed with conventional macro-economic policy instruments.

The exchange controls may have had some success in achieving the original objectives, but like all direct controls of market activities applied over an extended period of time, they have also created many distortions in the South African economy, affecting the exchange rate, the general level of interest rates, the prices of real estate and financial assets, and even wages and salaries. Adjustments in these important economic variables which should normally have taken place over the years were either postponed or depressed under the system of exchange controls, and backlogs which accumulated will have to be accommodated once the controls are ultimately removed.

There should be no room for any major dispute on this issue. In the long run, and in the interest of future economic growth, South Africa must liberalise its foreign exchange market and revert to a system of unitary floating exchange rates, influenced only by necessary Reserve Bank intervention aimed at smoothing out reversible short-term fluctuations.

An important step in this direction was taken when agreement was reached in September 1993 with South Africa's foreign creditor banks for a final rescheduling of the remaining amount of US $4,5 billion of the original amount of $13,6 billion blocked in South Africa since August 1985 in terms of a series of interim debt arrangements. This balance will be fully repaid to creditors in regular six- monthly instalments up to 2001.

As far as the remaining exchange controls are concerned there are, however, many different views on how and when South Africa should move from the present system to the desired system, and what supplementary and supporting actions may be necessary to facilitate this transition. In many other countries, exchange controls were successfully abolished only as part of a comprehensive and well-planned macro-economic restructuring programme, often with the co- operation and support of the International Monetary Fund and the World Bank. Such programmes normally provided for appropriate interest rate and exchange rate policies, and also committed the central bank and the government to clearly defined restrictive monetary and fiscal disciplines. The programmes as prescribed for some countries also included constraints on future wage increases, and established external financing facilities to support the balance of payments in the transition period, if necessary.

The abolition of exchange controls in isolation without any supportive auxiliary measures may cause serious disruptions in the initial phase of the transition, and force the re-introduction of the old controls, or even the application of other new direct controls over markets, all of which may be more damaging to the economy. South Africa must for obvious reasons avoid this route.

The timing of the abolition of exchange controls, particularly if it were to be done without the support of a comprehensive package of other macro-economic measures, is of vital importance. It will be advisable, for example, to take the plunge only after South Africa has finalised arrangements for re-entering the international capital markets. The Reserve Bank has also warned before that the adjustment process could be rather painful if the abolition of exchange controls were to take place in a situation where the discount between the two exchange rates is still substantial, large amounts of readily available financial rand balances are still held on deposit with banking institutions in South Africa, and the Reserve Bank has but a small amount of foreign reserves at its disposal to support the foreign exchange market in the initial transition period.

South Africa is now involved in the intricate process of acquiring an international credit rating from reputable international rating agencies that will facilitate future borrowings from the global capital markets. This exercise will hopefully be completed before the end of this year and will remove one more obstacle in the way of South Africa's reintegration in the world economy.

Once South Africa has re-entered the world capital markets it will be possible to syndicate the country's off- shore borrowing amongst a wider spectrum of investors. This will alleviate the heavy dependence the country has had on the international banking community which has patiently and consistently supported the capital account of the balance of payments for almost a decade.

The Reserve Bank furthermore remains confident that the capital account of the balance of payments will continue to improve, and that more international liquidity will become available to support a responsible programme for the abolition of the exchange controls. In the meantime, the financial rand exchange rate will hopefully also move closer to the commercial rand rate, although this may require further adjustments in the prices of underlying assets held by non-residents in South Africa. More favourable conditions may nevertheless develop in the future for the abolition of the exchange controls - if not in total then at least in part.

It is naive to believe that huge amounts of capital will flow into South Africa on a net basis once the restrictions on the outflow of capital from the country are removed. Exchange control is but one obstacle for the foreign investor who is looking around the world for countries where he can invest his savings. Other considerations, such as social and political stability, economic viability, sound fiscal and monetary policies and improvements in multi-factor productivity, are of even greater importance for most potential foreign investors.

4. The Financial Structure

A number of South African banking institutions are now involved in programmes for the establishment of a presence in major international financial centres and are also opening branches or subsidiaries in other African countries. This "internationalisation" of South African banks increases the responsibility of our regulatory and supervisory authorities to promote sound and well-managed banking institutions in the country. The South African banks are not only the custodians of the money supply and short-term savings of the South African public, but must now also carry the image of a well-disciplined South African financial system into the rest of the world.

Opportunities are therefore opening up for the South African financial markets to serve not only the South African public, but also interested participants from the rest of the world. However, it has to be recognised that this integration into international financial markets, which is likely to escalate over time as South Africa's foreign exchange market is liberalised, brings with it greater responsibility to adhere to international norms and standards. Global market participants are reluctant to operate in less than well-organised markets and in lax regulatory jurisdictions.

For these reasons, the South African regulatory authorities have actively encouraged the development of appropriate clearing, settlement, ownership-transfer and market information systems and are now insisting on proper intra-market and cross-market risk management systems, including capital adequacy requirements for market participants. Extended risk management arrangements have become necessary because of the rapid growth of the South African financial markets during recent years - in terms of the number of instruments and participants as well as turnovers - and the concomitant higher potential for systemic risks, including cross-market contagion.

Mainly because of the rapid growth in financial market transactions, the daily amounts to be settled have increased substantially. The daily value transferred through cheques, the main payment instrument, has reached R60 billion at times. This has focused the attention of the Reserve Bank on the payment system itself and the Bank's own exposure to risk. In the existing circumstances it will be difficult for the Bank to avoid standing behind the banking system in the event of a settlement default by a clearing bank. Settlement periods in the financial markets may be as long as 14 days and give rise to long and intricate chains of transactions which, in case of default, cannot be unwound within a reasonable time frame. Because of the disruptive effects on markets of a delayed settlement, the Reserve Bank is in the present situation almost forced to assume this unacceptable settlement risk.

The Bank, therefore, has a great interest in the efficient and safe functioning of the payments system and has taken the position that financial intermediaries and market participants preferably have to control their own credit and market risks, and that they have to work together with the Bank to reduce risks in the payment system. The Clearing Bankers' Association during the past year took the initiative by producing a report on payment system risks. Following upon that, the Reserve Bank is now leading another initiative to create a strategic framework for the further development of the national payment system, aimed at achieving greater efficiency and risk reduction.

This greater pre-occupation of the Reserve Bank with the risks of the financial system and with overall clearing and settlement arrangements does not mean that the Bank regards the management of the business risks of the individual financial institution now to be of less importance. The Office of the Registrar of Banks continues to work very closely with the directors, the management and the auditors of each individual institution to enhance risk management at the corporate level.

The arms-length relationship that has developed over the past few years between the Office of the Registrar with an interest primarily in risk exposures within the individual institution, and the Reserve Bank in its capacity as lender of last resort and with a greater interest in the avoidance of systemic risks, is hopefully now better understood. Neither the Office of the Registrar nor the Reserve Bank can, however, in all circumstances guarantee full security for shareholders in, or depositors with, any particular banking institution. Despite all the precautions taken by the Office of the Registrar, cases of default by banking institutions still occur and conditions develop beyond the point where normal Reserve Bank assistance at the discount window can salvage the situation. The authorities cannot always prevent the traumatic and painful process of liquidation, not even of a registered banking institution. Neither can the authorities be held responsible for failures caused by internal misjudgments, bad management or unfortunate external developments that may sometimes force liquidation on a bank. Depositors with financial institutions must therefore always be reminded that they themselves ultimately carry the full responsibility for decisions on where they want to invest their funds.

Many demands are now being made on South African banking institutions to extend their activities in South Africa to accommodate also the banking needs of the less privileged parts of the population, and to provide more funds for purposes such as housing, export financing, agriculture and small business development. The banks surely have responsibilities in this regard and can in the normal course of their business make an important contribution to the implementation of the Reconstruction and Development Programme. However, it must be taken into consideration at all times that a bank's credibility and survival in the longer run will be determined by the quality of its assets book. Banks must not be forced into excessive risk exposures, for then they may also one day become dependent on subsidies from government.

It must also be borne in mind that banks are special institutions, entrusted with a special mandate to create money. By making loans, banks create deposits, and deposits with banks form part of the money supply. Situations arise from time to time when it becomes necessary in the national interest to curtail the money creation capacity of banking institutions, for example by restricting the amount of basic liquidity made available to banks through the open-market operations of the Reserve Bank, or through a tightening of the conditions on which accommodation can be obtained at the discount window of the Bank. If banking institutions in this situation are committed to the provision of certain dedicated loans, another form of "crowding-out" of the rest of the private sector will become inevitable.

5. Concluding Remarks

South Africa earned the admiration of the world with the way in which it introduced a new and fully democratic political dispensation. The people of the country tackled almost insurmountable problems of socio-political reform with determination, and with the will to succeed.

South Africans must now face the next task, that is of economic reconstruction and development, in the same spirit - we must play the game with the will to win. On the one hand, the country is faced with massive but not unreasonable expectations of its people for better living conditions and a better standard of life. On the other, we have limited resources to meet the needs of our people, for example, limited savings from which the necessary funding for the many urgent development programmes and expansion of the physical production capacity must be provided.

This challenge gives no reason for despair - it is a normal situation for any country in a similar stage of economic development. This is indeed what economics is ultimately about: how to provide maximum satisfaction of the ever growing needs of the people with the limited resources at our disposal. The art of successful economic management is after all how to maximise the total output from our limited resources, and how to ensure that maximum satisfaction will accrue to all the people of South Africa.

There is no instant solution to this macro-economic challenge. South Africans must rid themselves of the illusion that a solution can be found simply through artificial changes to prices: we cannot make South Africa rich just by depreciating the exchange rate, by lowering interest rates, by increasing wages, or by creating more inflation. Real wealth comes through hard work, greater efficiency, improved productivity and by being more competitive than other nations. Real wealth can only be created over decades rather than years, and any durable process of economic development can only be maintained in an environment of overall social, political, financial and economic stability.

Against this background, the Reserve Bank has no other option but to continue to pursue its objectives of maintaining a stable overall financial environment, backed by sound and well-managed financial institutions, operating in efficient and reliable financial markets. This must remain the cornerstone of monetary policy in South Africa in the years ahead.