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1. INTRODUCTION.
The South African Reserve Bank was formally established in terms of the Currency and Banking Act, passed by the Senate of the South African Parliament on 1920-08-10. The Bank opened for business for the first time on 30 June 1921, and the first Ordinary General Meeting was held on 1921-07-29. It is my honour now to address this, the seventy-fifth Ordinary General Meeting of the shareholders of the South African Reserve Bank.
The recovery phase in the South African economy which started in May 1993 has now lasted more than two years. During this period an average rate of real growth, as measured by increases in gross domestic production, of 3 per cent per annum was achieved. This represents a considerable improvement when judged against the contraction of total economic activity over the prolonged recession period from early 1989 to early 1993.
The expansion in total economic activity, however, followed a roller-coaster path during the current upswing. Economic growth was particularly strong in the second half of 1993 but then contracted again during the first half of 1994, when the election took place and the accompanying political uncertainties had an adverse effect on the economy. In the second half of 1994, however, the economy rebounded, only to lose some momentum again in the first half of 1995 when adverse conditions in agriculture and in certain parts of the mining sector retarded growth.
These erratic movements were partly caused by extraneous factors, but they also reflected the difficulties experienced by the South African economy in the process of returning to normal conditions after having been internationally isolated and politically castigated for more than a decade. The macro-economic limitations on growth, ingrained in the system through many years of distortion and uncertainty, are now being exposed whenever the overall growth rate reaches for levels beyond 3 to 4 per cent. These constraints confine the sustainable growth of the economy to a level that is much too low to create sufficient jobs for the gainful employment of the growing labour force.
South Africa is now moving beyond the stage where investment interest was dependent on the return of the country to the world community. Investors, both domestic and international, are understandably becoming more assertive. They are demanding visible evidence of sound macro-economic policies, more certainty on future developments, and some assurance of reasonable returns, fair treatment and justifiable security. There is of course always risk in the future, and investments made for future returns can never be completely secure. The real question, however, is whether the South African investment environment perhaps holds more uncertainties than those of the many other countries competing for the funds of the global investor. If so, the foreign investor will remain shy of South Africa, while the South African investor will continue to exert pressure for the removal of exchange controls.
South Africa now faces the challenge of creating an investor-friendly environment that will enable the economy to break through the current limits of a growth potential that, as evidenced by the experience of the past two years, is too low to provide for the many needs and expectations of the people of this country.
A relatively stable financial situation as pursued by the monetary policies of the Reserve Bank, is an indispensable element of such an investor-friendly environment. On its own, however, financial stability is not a guarantee for more investment. To break through the existing ceiling of restricted economic growth, fiscal, labour, trade and industrial policies will have to join forces with monetary policy to pursue persistently the ultimate objective of a better economic future for all the people of this country.
2. RECENT ECONOMIC DEVELOPMENTS.
Details of economic developments over the past year are presented in the Reserve Bank's Annual Economic Report released yesterday. The following review deals only with a few of the more important developments of special significance for monetary policy.
3. ERRATIC BUT CONTINUOUS ECONOMIC UPSWING.
Aggregate real domestic production expanded at an annualised rate of 5,5 per cent in the second half of 1994, but the growth rate then subsided to a level of only about 1 per cent in the first half of 1995. The overall improvement in economic activity was broadly based, but particularly strong in the manufacturing and services sectors. During the first half of 1995, large declines in the value added by agriculture and mining partly offset the continuing good growth performance of the other sectors. Excluding the primary sector, the rest of the economy continued to expand at a seasonally adjusted annual rate of 4 per cent. Total manufacturing production indeed increased at a healthy rate of about 6 per cent per annum.
On the demand side, total real gross domestic expenditure was even more robust and increased at a seasonally adjusted annual rate of about 10 per cent in the second half of 1994, followed by a lower but still relatively high rate of about 4,5 per cent in the first half of 1995. A strong rise in real outlays on fixed investment and the accumulation of inventories were to a large extent responsible for the comparatively large increase in total real gross domestic expenditure, which outpaced the growth in domestic production throughout the recovery phase of the business cycle.
The diverse trends in the various sectors of the economy were reflected in a contraction of the growth in the operating surplus accruing to business concerns in agriculture and mining, whereas profits generated in manufacturing, commerce, transportation, telecommunication and finance rose sharply. Labour in general shared in the improved conditions and the rate of increase in the total nominal remuneration of employees rose from 10 per cent in 1994 to 11,5 per cent in the first half of 1995.
There was also a slight improvement in total gross domestic saving. The ratio of total saving to gross domestic product rose marginally from 17,5 per cent in 1994 to 18 per cent in the first half of 1995 - a level that remains substantially below the rate of about 24 per cent which is regarded as necessary to support economic growth of 4 per cent per annum. Because of high tax rates, most of the improved savings accrued to government and, on a statistical basis, served to reduce the rate of dissaving by government. The ratio of net saving by the private sector to gross domestic product fell back from 9 per cent in the second quarter of 1993 to 7,5 per cent in the first two quarters of 1995.
The improved economic conditions led to a reversal of the declining trend in total employment when the total number of workers in the formal non-agricultural sectors of the economy started to increase in the second quarter of 1994. Total employment, however, rose at a seasonally adjusted annualised rate of only 1,3 per cent in the last three quarters of 1994. This rate of increase is still well below the rate of growth in the total labour force and therefore not high enough to prevent a further rise in the total number of unemployed people in the country.
Despite the fact that, according to a recent household survey conducted by the Central Statistical Service, nearly one-third of the economically active population was unemployed in October 1994, the average nominal wages and salaries per worker increased by 11,9 per cent last year. Taking account of the average rate of inflation, this indicates a rise of about 3 per cent in real terms, which was more than the rate of increase in productivity per worker. The result was that the real unit labour costs in South Africa rose once again which further weakened the country's competitiveness vis-ê-vis the rest of the world.
4. LARGE CAPITAL INFLOWS PROTECT THE BALANCE OF PAYMENTS.
With gross domestic expenditure increasing at a faster rate than gross domestic production, imports of merchandise rose very sharply over the past eighteen months to open up a substantial deficit on the current account of the balance of payments for the first time since 1984. The deficit amounted to R2,5 billion in the second half of 1994, and then, in the first half of 1995, increased to R5,6 billion, equal to a seasonally adjusted and annualised amount of R10,2 billion. A sharp slowdown in the value of net gold exports, associated with a decrease in the gold production, contributed to this deterioration in the current account of the balance of payments.
The net capital inflow which had commenced after the election of the Government of National Unity in April 1994, continued in the first half of 1995 and amounted to about R18,6 billion over the twelve months from July 1994 to June 1995. More than 50 per cent of this capital inflow, however, represented short-term capital movements, mainly in the form of trade finance linked to the rising import bill and drawings under inter-bank financing arrangements entered into between South African banks and their foreign counterparts.
The surplus on the overall balance of payments, representing the combined result of the current account deficit and the net capital inflow, therefore amounted to no less than R10,6 billion over the twelve months up to June 1995. This surplus enabled the country to increase the total net foreign reserves by the same amount. At the end of June 1995 the gross gold and other foreign reserves held by the Reserve Bank and other banking institutions amounted to R15,2 billion, which was still only equivalent to the value of six weeks' imports of goods and services. As at that date, the Reserve Bank's outstanding short-term foreign borrowings amounted to only R1,6 billion, compared with R6,7 billion a year earlier.
Supported by the net inflow of capital, the exchange rate of the rand remained relatively stable over the past year. After a relatively sharp decline of about 10,7 per cent during the first half of 1994, the average weighted nominal exchange rate of the rand first appreciated slightly, and then depreciated again early in 1995 to register a relatively small depreciation of only 3,9 per cent between the end of June 1994 and June 1995. This satisfactory result was achieved despite the abolition of the financial rand in March 1995.
5. ACCELERATED INCREASE IN MONEY SUPPLY FACILITATES RISING RATE OF INFLATION.
The rates of increase in both production and consumer prices moved to higher levels over the past year. The production price index, measured over twelve months, reached a lower turning point of 5,4 per cent as early as October 1993, before moving up to 11,5 per cent in April 1995. Subsequently, it declined again to 10,9 per cent in May and 10,5 per cent in June. Both the prices of domestically produced and imported goods rose quite sharply over this period.
Consumer price inflation reached a lower turning point of 7,1 per cent in April 1994, and then edged upwards to 11 per cent in April 1995, before declining again to 10 per cent in June.
A number of factors contributed to the acceleration in price increases over the past year. A relatively sharp rise in food prices in the middle of 1994, which was only partly reversed during the first half of 1995, contributed to the increases in both production and consumer prices. The depreciation of the rand in the first half of 1994 had a somewhat delayed effect and prices of imported goods started rising more sharply only since July 1994. The more buoyant domestic economic conditions, and particularly the relatively sharp increases in domestic expenditure, added further to the inflationary pressures in the economy.
The South African economy still carries a deeply embedded structural inflationary bias, and little stimulation is needed to push price adjustments back into the double-digit range. The continuing rise in real unit labour costs, the relatively large deficit in the public sector budget, intermittent depreciation of the rand, lack of more aggressive competition in domestic markets, and persistent inflationary psychosis with the public in general, all contribute to the inflationary bias.
Over the past year, the rising trend in both producer and consumer price inflation found countenance in an unduly large increase in the money supply. Over the twelve months ending June 1995, the M3 money supply increased by no less than 16,8 per cent, following an increase of 15 per cent over the immediately preceding twelve months period ending June 1994. Exceptionally large increases occurred in private sector deposits with banks in the second quarter of 1995 when the total M3 money supply rose at a seasonally adjusted annualised rate of 27 per cent.
The main reason for the large increases in the money supply was a substantial expansion in the total amount of bank credit extended to the private sector which rose by no less than 19,5 per cent over the twelve months up to June 1995. The relatively large increases in domestic expenditure and in imports were therefore to an important extent made possible by the creation of additional money. In the process, the total indebtedness of the personal sector rose to a new record level of about 60 per cent of personal disposable income. Not only government, but also private individuals in South Africa, are now over-discounting future income through an excessive level of current consumption.
A growing concern about the unduly rapid expansion in the money supply, which facilitated current inflation and may easily fuel future inflation through the multiplier effect of successive rounds of further spending of the newly-created money, prompted the Reserve Bank to tighten monetary policy gradually in the course of the past nine months. The Bank rate was therefore raised on three occasions, from 12 per cent in September last year to 15 per cent as from 1995-06-30.
In the process, the Bank partly encouraged and fully endorsed the rising trend in market interest rates. The tender rate on three-month Treasury bills, for instance, increased from 10,15 per cent in February 1994 to 12,69 per cent in December 1994, and further to 14,07 per cent in June 1995. The prime lending rates of banks were raised from 15,25 per cent in September last year to 18,5 per cent in the middle of this year.
At this stage, it would appear that the more restrictive monetary policy had not succeeded in reducing the unduly high rates of increase in bank credit extension and in the money supply, although in recent months there have been some signs of a levelling out in the rate of increase in these aggregates. One of the reasons for this apparent insensitivity is the continuing abundance of liquidity available in the banking system. This is confirmed by the average daily amount of accommodation provided to banking institutions at the discount window which declined from about R5 billion in the middle of 1994 to only about R2 billion in June and July 1995.
In the circumstances, the banks paid little attention to the guidelines given to them at the beginning of the year for an acceptable rate of increase of about 10 per cent in their total credit extension to the private sector. As it turned out, nearly the full amount of R26 billion, representing 10 per cent of the total amount of bank credit outstanding on 1994-12-31, had already been absorbed during the first six months of the year in the net increase of the total claims of the banks on the private sector.
6. BOLD EFFORTS TO REDUCE BUDGET DEFICIT.
Government succeeded in reducing the budget deficit as a percentage of gross domestic product from 8,5 per cent in the 1992/93 fiscal year to 6,8 per cent in 1993/94. The Minister of Finance has budgeted for a further reduction in this ratio to 5,8 per cent during 1995/96.
It is imperative that the shortfall of total current government revenue in relation to total expenditure be reduced further in order to avoid even greater problems for the future management of fiscal policy, and for the achievement of the major macro-economic objectives of the country. Continued excessive deficits on the government budget will:
The Minister of Finance must therefore be fully supported in his efforts to make use of the present favourable cyclical conditions to reduce the deficit on the budget to a more tenable level.
This will not only contribute to a more stable financial environment, but will also make it easier for monetary policy to reduce inflation further, and to bring down interest rates that will boost investment in the private sector, and create more jobs for the many unemployed people in the country.
7. MONETARY POLICY AND NET CAPITAL INFLOWS.
For many years, foreign capital flows into and out of South Africa were dominated by non-economic considerations. In the turmoil preceding the South African political and social reforms the country had to contend over a prolonged period with a continuous large net outflow of capital. Indeed, over the nine-year period from 1985 to 1993 the accumulated net outflow amounted to more than R50 billion.
As pointed out earlier, this situation was dramatically reversed immediately after the election of the Government of National Unity in April 1994. The major part of the total net capital inflow of R18,6 billion from July 1994 to June 1995, however, was accounted for by an inflow of short-term capital. This included additional foreign borrowings of short-term funds by South African banking institutions and the use of foreign facilities to finance the growing volume of South Africa's international trade.
Although these short-term foreign liabilities have a formal maturity of less than twelve months, the facilities are normally available for longer periods, as they are utilised on a continuous basis. The existence of an unduly large amount of such short-term foreign liabilities does, however, make a country vulnerable to major changes in its perceived creditworthiness as judged by foreign lenders, and to the shocks of political or social upheavals.
The inflow of long-term capital, that is, investment in assets with a formal maturity of more than twelve months, on the other hand, also includes potentially volatile funds such as portfolio investments by non-residents in securities listed on The Johannesburg Stock Exchange. During the twelve months up to June 1995, the total net investment by non- residents made through The Johannesburg Stock Exchange amounted to R3,5 billion. Since the abolition of the financial rand in March 1995, these inflows, amounting to about R3 billion, were added to the net official foreign reserves, but any net outflows in future will, of course, have to be funded from the country's foreign exchange reserves.
The experience of Mexico during the past year provides a stark warning to other developing countries of the risks involved in the high degree of capital mobility in the present growing flexible international financial system. The kind and therefore durability and sustainability of capital inflows into any country will, to a very important extent, depend on the internal political, social and economic policies pursued by the country itself. The Mexican debacle, which was partly caused by excessive reliance on volatile investment inflows, and partly by adverse internal political events, underscores the critical need at times to take timely and often unpopular monetary measures to contain a country's foreign financial credibility, and to counter adverse political developments. The Mexican experience also serves as a warning that the international capital markets can severely punish developing countries when they are perceived to follow non-sustainable domestic policies.
Easier access to international financial markets has undeniable advantages for a developing economy. Scarce domestic saving can be supplemented by attracting more non-resident investment capital; the capital importing country's net foreign reserves can be augmented by the inflows, thereby increasing its capacity to import more goods and services; domestic interest rates can be maintained at lower levels to lend more support to fixed investment; and the financing of the government's budget can be facilitated by raising funds abroad.
Capital inflows may, however, also have many undesirable effects on the economy, particularly if the inflows are predominantly of a short-term nature or can easily be reversed again. These undesirable effects will be exacerbated by a relatively large concentration of capital inflows in a relatively short period of time.
Firstly, in the environment of a floating exchange rate regime, as applies in South Africa, a net capital inflow in excess of the deficit on the current account of the balance of payments exerts upward pressure on the exchange rate, with a consequent reduction in the international competitiveness of the domestic economy. If the challenge cannot be met by appropriate internal adjustments such as increases in multi-factor productivity, and/or a decline in real wages and the gross operating surplus accruing to investors, the current account of the balance of payments will eventually deteriorate beyond sustainable levels. Any sudden discontinuation or reversal of the capital inflows will then demand even greater adjustments in less time, which can cause major disruptions.
Secondly, the capital inflows tend to increase liquidity in the banking system which could eventually stimulate an undesirable and excessive expansion in domestic credit extension. This problem may even be exaggerated by central bank intervention in the foreign exchange market with the objective of stabilising the exchange rate. Over the past year, the net foreign assets of the Reserve Bank increased by more than R10 billion with, as a counterpart, an addition to the reserve money base of the banking system. This explains at least partly the continuing liquid situation of the money market that underpinned the excessive increases in total bank credit extension over the past year, and also the unduly large increases in the money supply.
Thirdly, the inflows of easily reversible capital also tend to conceal underlying structural deficiencies of the domestic economy and, as long as such capital inflows continue, they may even lull economic policy makers into believing that there is more time than they really have for essential structural adjustment. If, or rather when, the capital inflows subside or, even worse, the capital starts flowing out of the country one day, the structural deficiencies will re-emerge, but often then with an even greater vengeance. This is particularly true of deficiencies such as excessive deficits on the budget and on the current account of the balance of payments, both manifestations of insufficient domestic saving and of uncompetitive domestic production processes.
Fourthly, the capital inflows destabilise the domestic financial system and reduce the reliability of conventional indicators such as the money supply aggregates, money market shortages, short-term interest rates and the yield curve as a basis for monetary policy decisions. Even domestic financial asset prices can be badly distorted by such inflows.
These disadvantages are, of course, all reduced if the capital inflows should be less volatile and of a more permanent nature. Against the background of the Mexican experience, however, authorities in many countries, particularly in those countries with emerging economies such as Argentina, Chile, Colombia, Malaysia and Thailand, have over the past year introduced deliberate administrative and macro-economic disincentives to the excessive inflow of short-term capital.
South Africa also has to contend increasingly with conflicting objectives within the context of a large inflow of mainly short-term capital. There is an urgent need to increase the official foreign reserves held by the Reserve Bank, but also a commitment to restrict excessive increases in the money supply. Foreign capital is needed to supplement the scarce savings in the domestic economy, and to provide foreign exchange needed to cover the rising bill for imports, but prudence and past experiences warn against the imminent danger of a rising tide of short-term international indebtedness. An appreciation of the exchange rate of the rand can make a contribution to the important price stabilisation objective, but it will at the same time harm the international competitiveness of the economy.
The approach of the Reserve Bank therefore has been one of caution. The main task of the Bank, namely to fight inflation, must remain a first priority. If the value of the rand is threatened by excessive capital inflows, which may necessitate Reserve Bank intervention in the foreign exchange market, the Bank must also act to neutralise the undesirable effect of the inflows on money market liquidity, on domestic interest rates, on bank credit extension and on the money supply. Central bank intervention in these circumstances becomes essential to sterilise at least part of the domestic monetary counterpart of the capital inflows.
Against this background the Bank over the past year:
The Bank also advised the Minister of Finance to relax exchange controls further. The financial rand system was abolished in March 1995 and the Government extended the exchange control mandate to the Reserve Bank to gradually relax the restrictions on foreign portfolio investments by South African institutional investors. The Reserve Bank remains of the opinion that the exchange controls should be eased gradually in the light of the reintegration of South Africa into the global financial system, but at the same time the programme should be implemented with caution, particularly as long as the capital inflows remain predominantly of a short-term nature, and while the improvement in the foreign reserves is based primarily on rising short-term foreign liabilities.
A further important step was also taken in the liberalisation of the foreign exchange market when the Reserve Bank announced its intention of reducing its role in providing forward foreign exchange to cover future external commitments. Private banking institutions will hopefully take up the challenge of developing an active and efficient forward foreign exchange market without undue participation by the Reserve Bank. In the transition phase, the Reserve Bank will continue to lend its support to the development of the forward foreign exchange market as an essential supplement to the spot foreign exchange market.
8. INTERNAL ADMINISTRATION OF THE BANK.
The staff of the Bank is fully committed to serving the mission of the Bank - that is, to protect the value of the rand. All staff members are continuously reminded of this overriding objective in all the activities of the Bank.
Over the past few years, the Bank has gone through a difficult rationalisation programme and the total staff of the Bank has been reduced from just over 2,400 people in March 1990 to approximately 1,800 presently. This was mainly necessitated by a reduction in the banking services provided to clients of the Bank, and the centralisation of the bank accounts of the central government in head office. The rationalisation programme primarily affected the branch network of the Bank.
The Bank also adjusted itself to the changing environment within which it operates and introduced three new functions in recent years.
Firstly, in order to provide for the training needs of the Bank's own staff and to make a contribution to the training of bankers in general, a Central Bank College was created with a full-time lecturing and administrative staff. The Institute has now been firmly established in the old Reserve Bank building on Church Square and, during the past year, ran a number of courses in central banking functions and techniques, mostly for the Bank's own staff. It also presented a number of specialised courses in the field of central banking, covering areas such as general monetary policies, management of the foreign reserves, exchange rate and exchange control policies, and banking supervision.
The course in central banking was presented to selected personnel at the Bank of Namibia in Windhoek earlier this year, and the Institute will hopefully find it possible to assist other central banks in the Southern African Development Community with their training needs. It is indeed the intention to invite other central banks in the region to send participants to some of the Institute's courses next year. The Bank also introduced a Cadet Training Scheme with a view to developing new recruits in the banking world with a keen interest in following a banking career. The first intake of eight cadets was done in July 1994 and a second intake is planned for January 1996, when the management of the scheme will be taken over by the SARB Training Institute.
At the same time, the Bank has stepped up its various internal training schemes for the advancement of its own staff. Of special importance is the Accelerated Management Development Programme which concentrates on a condensed training programme for younger staff with proven management skills.
The Bank Supervision Department presented a course in banking supervision to 25 participants from the East and Southern Africa Banking Supervisors Group (ESAF) in Pretoria from 5 to 16 September 1994. Bank supervisors from 13 different African countries participated in this course. The Bank has undertaken to repeat the course for the ESAF countries in September this year.
In expanding its assistance to central banks in other African countries, the Reserve Bank over the past year received 22 officials from 10 different African central banks on specialised training missions. The Bank is indeed enthusiastic about the role it can play in developing the skills of central bankers to promote more effective monetary policy mechanisms in the region.
Secondly, to accommodate the Bank's growing responsibilities for the extension of economic and financial co-operation with other African countries, an International Relations Division was established within the Economics Department. This unit now has six staff members and comes under tremendous pressure, not only because of the Bank's own extended Africa relations, but also from various government departments for specialised assistance.
During the past year, the International Relations Division was involved in the negotiations for South Africa's membership of the Southern African Development Community, the review of the Southern African Customs Union, meetings of the Common Monetary Area, discussions on closer economic co-operation amongst Indian Ocean Rim countries, the United Nations Economic Commission for Africa, and the Zone of Peace and Co-operation in the South Atlantic.
A member of the Bank's staff also serves as a special representative of the Bank in the South African Diplomatic Mission to the European Union in Brussels and keeps the Bank informed about the monetary integration process in Europe.
The Reserve Bank is enthusiastic about the recent decision to establish a Committee of Governors of Central Banks within the framework of the Southern African Development Community, and intends to use this communication channel for the promotion of greater co-operation amongst the central banks of the Southern African region.
Thirdly, in response to the explosive development of electronic financial services and of the volumes in the financial markets, the Reserve Bank in 1994 took the initiative to create, in consultation with banks and other stakeholders, a strategic framework for the reform of the national payment system. The framework provides for extended access to the national payment system and for different payment instruments, in order to cater for the diverse payment needs of the heterogeneous South African society, and also to encourage efficiency through competition. A new Payment System Division has been established within the Information Technology Department and extensive research work is being undertaken, also on the development of national payment systems in other countries.
The initial focus has been on the domestic payment system. The intended new national payment system will provide facilities for banks to settle their obligations in real-time on a gross basis, or to opt for a delayed settlement arrangement in which settlement is guaranteed. The main purpose is to reduce systemic risks in the payment system.
At a later stage, the logical next step will be to address regional and cross-border payment issues. Thereafter, it will be necessary to work towards the integration of the national system into international payment system networks. South Africa must be ready to participate in the world-wide trend towards the globalisation of financial markets, or be excluded from the advantages of greater international financial co-operation and integration.
Lastly, the Bank is also continuing with its internal affirmative action programme, which was difficult to apply previously against the background of the rationalisation programme and the reduction of 25 per cent in the total staff of the Bank over the past few years. Good progress has nevertheless been made with the development of a multi-cultural climate and with the active restructuring of the staff complement. Over the past eighteen months, the total white complement of the staff has indeed been reduced by 193 persons, whereas the black complement has been increased by 67.
In view of the technical nature of central bank operations, the essential need to maintain high standards and the unceasing quest for excellence in the South African Reserve Bank, a cautious policy, traditional to central banking in general, must also be followed with staff management. Hence the great priority given at this stage to the training of good central bankers, and the development of the management skills of the employees of the Bank. As with the implementation of monetary policy, the Bank is determined also with its internal administration to serve the national interest with a well-planned programme of sound and disciplined adjustment.
9. CONCLUDING REMARKS.
Economic developments during the past year were encouraging but also exposed the major constraints on sustaining high economic growth in South Africa. With real domestic production expanding by nearly 6 per cent in the second half of 1994 and real domestic expenditure growing at more than 10 per cent on an annualised rate basis, several bottlenecks developed.
Firstly, the value of imports rose by no less than 22,3 per cent from the first to the second half of last year, to bring about a substantial deficit in the current account of the balance of payments.
Secondly, the demand for funds to support the growth in real economic activity led to an untenable increase in money creation through the extension of more bank credit, filling the vacuum of an insufficient amount of domestic saving.
Thirdly, underlying inflationary pressures stimulated by escalating wages and salaries, facile price increases, an excessive rise in the money supply, and a depreciating exchange rate, pushed the rate of inflation back into the double-digit range.
In the circumstances, a more restrictive monetary policy was clearly dictated in order to maintain overall financial stability. The monetary authorities became particularly concerned about the rising trend in the amount of bank credit extended to the private sector, and in the money supply. In the longer run, no economic expansion founded on the continuous creation of more money can be sustained. Sooner or later, rising inflation will force a painful abortion of the upswing.
A substantial net inflow of capital during the past year served to underpin economic growth at a level of approximately 3 per cent per annum. The large inflow of capital, however, created new challenges for monetary policy and for the management of the exchange rate of the rand. In particular, the creation of domestic liquidity caused by large inflows of short-term funds complicated the efforts of the Reserve Bank to preserve overall financial stability.
The cyclical upswing of the past two years provided convincing evidence of a new vitality in the economy, instigated mainly by the successful political reforms and the new spirit of co-operation and determination of the people of South Africa. The upswing, however, also exposed structural deficiencies such as balance of payments vulnerability, insufficient domestic savings in both the private and public sectors and uncompetitive production processes. Together with the many remaining real and imagined uncertainties linked to the major reforms, and the continuing high level of violence and crime in the country, these structural deficiencies frustrated efforts to thrust economic growth in South Africa on a more durable basis to a higher level. More attention will have to be given to the removal of these impediments. The South African economy has the potential to provide better living conditions for all of its people, provided we are prepared to accept and tolerate the disciplines of tested and sound macro-economic policies.
Internally, the Reserve Bank positioned itself better to meet the challenges of the changing environment in which it operates. New functions and facilities to provide for better training of central banking staff, active participation in the extension of economic relations with other African countries, the development of a new national payment and settlement system, and a positive affirmative action programme, all form part of this strategy of adaptation.
The Bank was indeed sorry to lose a number of its staff through retirement, retrenchment and resignations during the past year. Dr Pierre Groenewald, Senior Deputy Governor, retired from the Bank's service at the end of July 1995 after more than 41 years service. Two general managers, namely Mr James Cross and Dr Hennie van Greuning, resigned from the Bank to take up assignments outside of the country. We thank them, and all the other staff members who left the Bank during the past year, for the outstanding contributions they made to establishing a central bank for South Africa that is highly respected world-wide.
In thanking the members of the Board of the Bank for their loyalty and support during the past year, I must point out that, including the position of a deputy governor, there are now three vacancies on the Board for Government representatives, two being for part-time directors, that must be filled by Government in terms of the requirements of the South African Reserve Bank Act.
Finally, I wish to thank all the staff of the Reserve Bank for their loyalty and support during the past year. We, as the central bankers of South Africa, will continue to strive for lower inflation and an overall stable financial environment. This is the contribution expected from us in the reconstruction and development programme of our country.
Thank you to those shareholders of the Bank who honoured us today with their presence at this, the seventy-fifth Ordinary General Meeting of the South African Reserve Bank.
