1. INTRODUCTION

In last year's Chairman's Address, the attention was focused on monetary policy and net foreign capital movements. The following warning notes were then sounded about the large capital inflows experienced at that time.

• The net capital inflow in excess of the current account deficit exerted upward pressure on the exchange rate of the rand and reduced the international competitiveness of the domestic economy. A sudden reduction in the capital inflow would demand painful adjustments and cause major disruptions.
• The overall balance of payments surplus created surplus liquidity in the banking system and stimulated an undesirable and excessive expansion in domestic credit extension.
• The inflows concealed underlying structural weaknesses of the economy.
• The large net capital inflow destabilised the domestic financial system and reduced the reliability of 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.

In retrospect, these warnings proved to be very timely. The most important change in the macroeconomic scene over the past year was the substantial decline since February 1996 in the total net capital inflow from abroad. This sudden deceleration changed the overall balance of payments position, the foreign exchange market, the domestic financial situation, the local business mood as well as foreign investors' assessment of South Africa as an emerging market economy where sound high-yielding investments could be made.

The smaller net capital inflow from February 1996 onwards led to an overreaction in the foreign exchange market, and triggered a downward adjustment in the exchange rate of the rand which continued with intermittent pauses during the subsequent six months. From the middle of February 1996 to the middle of August 1996 the average weighted value of the rand against a basket of currencies of South Africa's major trading partners depreciated by 20 per cent. At this juncture, it continues to need coolheadedness from both policy makers and currency traders to restore stability to the foreign exchange market.

Not only the external economic relations of South Africa, but also domestic economic activity changed significantly from 1995 to the first half of 1996. Although the rate of overall real economic expansion has been retained at last year's level of about 3½ per cent, the primary sectors of production, and particularly agriculture and non-gold mining, have since replaced manufacturing and the services sectors as the prime movers of the economy.

The growth in overall expenditure, however, continues to outpace growth in total production with the result that large imports of goods and services are required to maintain equilibrium between overall demand and supply. The current account of the balance of payments therefore remains in deficit and, in light of the decline in the net capital inflow, it has now become a matter of concern from a macroeconomic policy point of view.

The maintenance of the expansion in domestic demand continues to depend heavily on the extension of more bank credit which not only contributes to an unacceptably high rate of increase in the money supply, but also leads the country towards an untenable debt position where an unduly high share of the current income of both government and households will be claimed for debt servicing. This dangerous prospect holds a serious warning for the banking sector to apply greater caution in their lending operations. It also dictates the need to continue with a restrictive overall monetary policy. Despite growing pressure from different sources for the relaxation of monetary policy, the Reserve Bank, in the interests of medium-term financial stability and longer-term sustainable economic growth and development, must persist on its current course of responsible monetary restraint.

RECENT ECONOMIC DEVELOPMENTS

The Reserve Bank's Annual Economic Report which was released this morning, contains a comprehensive review of economic developments during the past twelve months. A few of these developments of more direct importance for monetary policy will now be highlighted.

Continued but weaker economic expansion

In this, the fourth year of the current economic upswing, there are clear signals of a cyclical slow down in the rate of economic growth. Although the rate of expansion in the country's gross domestic product is still set on course to achieve about 3 per cent growth for 1996, the main impetus for growth is now being provided by a recovery in the agricultural sector, following the adverse climatic conditions during the 1994/95 season. At the same time, steady growth in the output of the non-gold mining industry continues to lend support to the overall growth rate. In contrast, the real value added by the manufacturing sector which expanded by nearly 11 per cent in the first half of 1995, increased by only 2 per cent in the second half of last year, before declining by about 1 per cent during the first half of 1996. The contribution of the services sector to growth has likewise slowed down with its total real value added increasing by less than 2 per cent in the first half of 1996, compared with 4½ per cent during the second half of last year.

Total domestic expenditure continued to show erratic changes from quarter to quarter, but generally it increased at a rate higher than the increase in total domestic production. After 5½ per cent growth in 1995, total real gross domestic expenditure increased at a lower average annualised rate of 3½ per cent in the first half of 1996. Some slow down in the rate of expansion of private consumption expenditure and smaller additions to inventories were partly offset by an acceleration in the rate of increase in consumption expenditure by general government, which rose by 3 per cent in the first half of 1996. Real gross domestic fixed investment did not maintain its relatively high rate of expansion of more than 10 per cent last year. Nevertheless, it still increased by 6 per cent in the first half of 1996.

Two major structural deficiencies of the South African economy were again tellingly exposed by the developments of the past year. Firstly, gross domestic saving continued to decline to a level of only 16½ per cent of gross domestic product. This was clearly not sufficient to finance in a non-inflationary way gross domestic investment equal to 19 per cent of gross domestic product, which in itself was still inadequate to sustain more rapid economic growth. The decline in the net inflow of foreign capital during the first half of 1996, which made less funds available for financing real investment, provided a strong reminder of the urgent need for a significant improvement in the propensity of the economy to save. Similarly, with domestic saving at a low level compared to many other countries at the same stage of economic development, the present deficit on the budget of the Government of about 5 per cent of gross domestic product also becomes unsustainable.

Secondly, despite the better economic growth performance over the past three years, very few additional job opportunities were created. In 1995 total employment in the formal non-agricultural sectors of the economy rose by only 0,6 per cent. Taking account of the growth in the labour force of more than 2½ per cent per annum, the total number of unemployed people increased by some 280 000 last year. Unemployment remains the most intractable economic problem of South Africa, and drastic measures are needed to raise the labour absorption capacity of the economy. This problem, reflecting a serious structural weakness, cannot be solved by means of normal periodic cyclical economic recoveries, nor by any artificial stimulation of the economic growth rate. The Government's recently announced macroeconomic policy strategy contains encouraging prospects to make some progress in containing the growing number of unemployed over time.

Foreign exchange market buffeted by exchange rate speculation

In 1994 and in 1995 the market for foreign exchange in South Africa was characterised by remarkably stable conditions. A sharp increase in imports accompanying the economic upswing caused a switch in the current account of the balance of payments from a surplus of R5,8 billion in 1993 to a deficit of R12,7 billion in 1995. A dramatic reversal of net capital movements from an outflow of R15 billion in 1993 to an inflow of almost R22 billion in 1995 provided not only sufficient foreign exchange to cover the current account deficit, but also enabled the Reserve Bank to repay all its outstanding short-term foreign loans, as well as increase the country's total official foreign reserves to a level of R19 billion by the end of January 1996.

At the same time, the real exchange rate of the rand also remained remarkably stable and, at times, even appreciated slightly, despite the relaxation of exchange controls, particularly on non-residents, as part of a policy of the gradual abolition of all exchange controls. The average nominal effective exchange rate of the rand depreciated by 9,3 per cent in 1994 and by 5,7 per cent in 1995, reflecting more or less the difference between the local rate of inflation and the average rate for South Africa's major trading partners.

Triggered by an unfortunate combination of certain changes in the international financial markets, particularly in the United States of America, and several economic and political developments in South Africa that were construed to be unfavourable, the market in foreign exchange displayed unexpected turmoil starting in February 1996. An initial depreciation in the weighted exchange rate of the rand of 9 per cent from 1996-02-13 up to the end of March 1996 could still be justified in terms of underlying economic fundamentals such as inflation differentials, purchasing power parity, a weakening of South Africa's competitiveness in the international markets, and the growing deficit in the current account of the balance of payments. The subsequent further depreciation of 11 per cent from the end of March 1996 up to the end of July, however, could hardly be explained or justified in terms of these basic economic fundamentals. Unfounded rumours, speculative transactions and negative views of the South African socio-political situation, forced the exchange rate of the rand to a value which now surely does not reflect the true economic potential of the country.

At the same time, the total net capital inflow subsided from an average of R11 billion during each of the two halves of 1995 to only R2,7 billion in the first six months of 1996. It is interesting to note, however, that further long-term capital flowed into the country during the first half of 1996 to the amount of R7,3 billion, or just slightly less than the R8,2 billion of the second half of 1995. This included a net inflow of R7,1 billion through the Johannesburg Stock Exchange and the Bond Exchange. Short-term capital, however, switched from a net inflow of R3 billion in the second half of last year to a net outflow of R4,6 billion in the first half of 1996. It was against the dangers of the volatility of these short-term capital movements that early warnings were sounded last year, not knowing at that time how hard South Africa would be hit six months later by the capriciousness of such short-term foreign financing.

The sudden slow down in the total net capital inflow brought the underlying deficit in the current account of the balance of payments prominently to the fore as a policy priority. In the circumstances, the Reserve Bank had to provide the necessary foreign exchange from its foreign reserves so as to enable importers to continue to meet their commitments. The new situation now focuses the attention on the need to gradually reduce the current account deficit by reducing imports and/or increasing exports -- a process that cannot be achieved overnight without extremely restrictive measures that will seriously disrupt the economic development process. During the necessary but slow transitional period it is expedient for the Reserve Bank to ease the stresses caused by the adjustment process by providing some assistance to the market. Accordingly, the country's official foreign reserves were permitted to decline from R19 billion at the end of January 1996 to R16,4 billion at the end of June. During July, the foreign reserves of the Reserve Bank declined by a further R0,9 billion.

It was fortunate that the depreciation of the rand occurred at a time when the Reserve Bank had no foreign liabilities outstanding, while it had also succeeded in reducing its net oversold foreign exchange position from over US $20 billion at one stage to only $8,1 billion at the end of February 1996. Thus, the net losses reflected in the forward foreign exchange position of the Bank were restricted to a smaller amount than would have been the case with a similar depreciation at any other stage during the past three years. This net oversold position has, however, increased again to over $15 billion as the Bank intervened in the forward foreign exchange market at the sliding exchange rate, mainly to enable importers to cover future commitments and to make use of available foreign financing facilities.

It is true that an increase in the net oversold foreign exchange position of the Reserve Bank inevitably increases the risk of possible losses from future exchange rate changes. Such losses will eventually become recoverable from taxpayers. This risk must, however, be measured against the costs to the taxpayers in general of a further fall in the exchange rate with accompanying higher interest and inflation rates. There is no costless way to adjust the economy downwards in a situation where the inflow of capital from abroad has fallen so abruptly as was the case in South Africa earlier this year.

Monetary expansion maintains strong momentum

The two most important aggregates for monetary policy purposes remain the M3 money supply and the total amount of bank credit extended to the private sector. Both these aggregates moved to relatively high rates of expansion during 1994 and prompted a more restrictive monetary policy stance. Throughout the greater part of 1995 and during the first half of 1996 the rate of increase in M3 fluctuated within a narrow band around the 15 per cent level, whereas the rate of increase in total bank credit extended to the private sector has been fluctuating around the 17 per cent per annum level for more than 20 months. Monetary policy has at best only succeeded in restraining the rates of increase in these aggregates, and prevented them from escalating to even higher levels.

On the one hand, the Reserve Bank has been criticised in some quarters for pursuing too lenient a monetary policy, and for underestimating the potential inflationary dangers of allowing the money supply to continue to rise well above the Bank's own predetermined guidelines for an acceptable rate of expansion. On the other hand, the Bank remains under severe pressure from certain other sections of the private sector to relax monetary policy, and particularly to engineer lower interest rates in the belief that this would support economic growth. In these circumstances, the Bank must remain objective. It must continue to apply its policies with the goal of maintaining overall financial stability over both the medium and longer term. This, after all, is the most important contribution monetary policy can make towards sustainable economic growth and development, including the creation of more jobs for the rapidly growing labour force of South Africa.

In assessing the relatively high rate of increase in the money supply over the past two years, sight must not be lost of important structural changes that are currently taking place in the South African economy. Firstly, the integration of South Africa in the global financial markets has opened up new sources of funds for South African banks, and has introduced volatile international capital movements that make control of the money supply more difficult. Secondly, within the South African context, the demand for money has been increased as more and more people are being absorbed in the market economy, and participate more actively in the regular exchange of goods and services against money, and vice versa. And, thirdly, the almost explosive increase in turnovers in the financial markets, such as the stock, equity, bond and foreign exchange markets, has also contributed to the increase in the demand for money. The unduly high rates of increase in the money supply witnessed over recent years may indeed have been partly due to these structural changes, and may therefore not warrant extraordinarily restrictive measures to force the money supply down, at least not at this stage. There must be no doubt, however, that once the effect of these structural adjustments have spent their force, the increase in the money supply will again have to be brought more in line with the anticipated rate of expansion in total economic activity.

For the present it is also relevant not to forget that the rate of inflation has declined dramatically during the past few years and equally important, that inflation has been below 10 per cent for three years in succession. Measured over twelve months, the rate of increase in the consumer price index declined to as low as 5,5 per cent in April 1996, before it reeled again under the influence of the depreciation of the rand and rose to 7,1 per cent by July 1996. There are, of course, extended time lags between changes in monetary policy and in the money supply, and also between changes in the money supply and in prices. An economy can often be inflation prone in terms of expectations long before the disease actually manifests itself. Monetary authorities must therefore always be on their guard, even in times when relatively low inflation is experienced.

There are also certain other factors at work in the economy which recently assisted monetary policy in bringing down inflation. These include the determined policy of Government to reduce tariffs and to abolish the surcharge on imported goods; the introduction of more foreign competition into South Africa's markets; the lower levels of inflation in the case of South Africa's major international suppliers of goods and services; and the decline in the real domestic labour costs per unit of production experienced last year.

The excessive rate of increase in bank credit extended to the private sector nevertheless remains a matter of concern, not only because of its effect on the money supply, but also because of the rising levels of indebtedness of private households. As pointed out in the Annual Economic Report, accumulated household debt has now risen to more than 66 per cent of personal disposable income. The stage has been reached where the average South African household has to earmark almost six weeks' of its annual income for the sole purpose of servicing the cost of its debt.

This situation also casts some doubt on the quality of the loan book of banking institutions. Controlling the amount of credit extension in an economy, when it has developed to the stage in which South Africa now finds itself, cannot entirely rely on interest rates. Many of the more recent participants in the market economy remain relatively insensitive to interest rate changes since they base their applications for loans almost entirely on disposable income. Borrowers and lenders must become more aware of the inherent dangers involved in the extension of credit beyond the capacity to service debt on a sustained basis. Many South African households have already moved beyond these limits and may be heading towards a debt trap.

For good reason, interest rates in South Africa remain high. The level of interest rates cannot be dictated by the needs of borrowers alone, just as they cannot be fixed solely by the demands of lenders. In the final analysis, interest rates must be determined by the underlying demand for and supply of loanable funds. The huge demand for funds emanating from general government, the business sector and private households, must be matched with the limited amount of domestic saving plus an amount of medium and longer-term foreign investment funds that can reasonably be expected to flow into the country. This simplified macroeconomic truism confirms that South Africa, with its low savings and high consumption propensities, cannot have low interest rates for any length of time without running the risk of persistent high inflation. The upward pressure on interest rates is further exacerbated by the present overall balance of payments deficit.

It will be recalled that with the onset of the current economic upswing, short-term interest rates moved up from a relatively low level of about 10 per cent early in 1994 -- when there was a low demand for funds -- to about 14 per cent by the middle of 1995. A few months of relatively stable conditions followed before the turmoil in the market for foreign exchange early in 1996 forced rates to even higher levels. The tender rate on 91-days Treasury bills, for example, that rose from 10,12 per cent in March 1994 to 14,07 per cent in June 1995, subsequently increased further to 16,21 per cent by May 1996. Taking account of the changed underlying market conditions, the Reserve Bank raised its Bank rate in four steps from 12 per cent in September 1994 to reach 16 per cent in April 1996.

It is essential that, in this volatile financial environment, financial markets remain flexible. Banking institutions in particular must be able to adjust their lending volumes and their interest rates at short notice in accordance with changes in the underlying flow of funds. In a rigid market situation the profitability of banks, and therefore their future capacity to grant loans, will be restrained.

Financial market developments reflect short-term volatility and long-term adjustments

Short-term developments in the financial markets have been reflecting the growing demand for credit as well as the volatility of international capital movements and exchange rate changes. The money market shortage increased from R3,2 billion at the end of July 1995 to R5,1 billion at the end of December 1995. The decline in the net foreign reserves since February 1996 has drained liquidity from the money market with the result that the shortage rose further to R11,0 billion at the end of April, only to recede to R8,6 billion at the end of July 1996. Reserve Bank accommodation can always provide temporary relief for acute liquidity shortages but, with the passage of time, banks must adjust their lending in accordance with the funds available in the market.

Participation by non-residents in the secondary bond market illustrates the new volatile element introduced into this market by South Africa joining the global financial markets. After having been net buyers of bonds for a total value of R4,9 billion from July 1995 up to February 1996, non-residents were net sellers to the amount of R2,5 billion in March and April, only to become net buyers again to the amount of R2,6 billion in May and June 1996. In July, their interest in this market waned once more and their net purchases declined to only R0,7 billion.

Yields on long-term government bonds first declined from 16,40 per cent at the end of July 1995 to 13,64 per cent at the end of January 1996. During the subsequent six months, however, these rates moved up again to 16,01 per cent at the end of April and 15,74 per cent at the end of July 1996.

Major structural changes were introduced to the capital market during the past year. Bond dealing was separated from equity dealing when the Bond Exchange of South Africa was licensed on 1996-05-15 to operate as an independent bond market parallel to the Johannesburg Stock Exchange. The Johannesburg Stock Exchange also underwent major changes since November 1995 to provide, inter alia, for corporate membership, the participation of non-residents as well as local financial institutions as broking members, and automated trading. The traditional open outcry floor trading system finally ceased to exist on 1996-06-07.

A number of changes were also made in the formal derivatives market during the past year. Trade in commodities futures was added to the products of the South African Futures Exchange. In addition, the Johannesburg Stock Exchange revitalised the trading of options on equities. Volumes in respect of financial derivatives trading increased at a steady pace.

All these structural adjustments are intended to improve the efficiency of the South African markets and to bring them more in line with developments in international capital markets, thereby paving the way for the further integration of the South African markets with the global system.

Fiscal policy remains on course for gradual adjustment

The deficit in the main Budget, excluding extraordinary transfers, was reduced as a percentage of gross domestic product from 6,6 per cent in the fiscal year 1992/93 to 5,6 per cent in the fiscal year 1994/95. A substantial carry-over of R6,4 billion of unspent funds at the end of the fiscal year 1995/96 contributed to the reduction in the actual deficit to 5,1 per cent in that year. For the fiscal year 1996/97, the deficit was estimated at 5,1 per cent of gross domestic product. The actual outcome will, of course, be influenced by the government's ability to catch up on expenditure backlogs in respect of previously planned programmes which could lead to the spending of part of the funds carried forward to the current fiscal year.

For monetary policy purposes it is of the utmost importance that the fiscal deficit and dissaving by government be reduced further. This will alleviate the burden on monetary policy to maintain financial stability, and thereby also allow for lower interest rates.

MONETARY POLICY IN A COMPLEX MACROECONOMIC ENVIRONMENT

From the foregoing it is clear that the present macroeconomic environment in South Africa is a complex and uncertain one, reflecting not only the major political and social reforms that have been taking place in the country, but also the reintegration of South Africa within a changed global financial system that exposes the economy to greater volatility. Last year, large amounts of capital of a short-term nature flowed into the country, exerted upward pressure on the exchange rate of the rand, increased domestic liquidity and depressed interest rates when increases in the money supply and domestic bank credit extension tended to escalate out of control. The Reserve Bank partly neutralised these effects by intervening in the spot foreign exchange market as a net buyer, and by reducing its forward foreign exchange sales. In the domestic money market, excess liquidity was mopped up to some extent by selling government bonds from the Bank's monetary policy portfolio.

Since February 1996, the net level of foreign capital inflows diminished, and a shortage of foreign exchange developed in the market because of the large deficit in the current account of the balance of payments. The Reserve Bank has had to provide some foreign exchange from its reserves to maintain liquidity in the foreign exchange market, and more particularly to enable importers to continue to meet their commitments in respect of goods already ordered some months before. The new situation of an overall deficit in the balance of payments is now effectively draining liquidity from the domestic money and capital markets, and exerting upward pressure on interest rates.

In last year's situation of an overall balance of payments surplus, the Reserve Bank had to buy foreign exchange against the creation of rand, which it can of course do in unlimited amounts, provided, however, that the surplus domestic liquidity created in the process is neutralised through other macroeconomic policy actions. In the present situation, with an overall balance of payments deficit, the Bank must supply foreign exchange against rand but it is in this case restricted by the limited amount of foreign reserves at its disposal. The growing need to accelerate the restoration of greater equilibrium in the overall balance of payments through changes in the underlying fundamentals has therefore become self-evident.

Under current conditions, the monetary authorities must rely heavily on market forces to restore equilibrium. The disciplinary effects of these market forces are unfortunately not always perceived to be supportive of the near-term macroeconomic objectives of government and of the expectations of businesses, private households and trade unions. Furthermore, since the relevant market forces needed to remedy an overall balance of payments deficit invariably take time to show effect and are necessarily painful and costly, they understandably tend to be unpopular with the majority of the South African community. More particularly, a rise in interest rates at this stage, which forms one of the crucial elements in the market adjustment process, is widely regarded as unacceptable because of its adverse effect on domestic spending. This limited view, however, disregards the even more disastrous consequences for the economy of not correcting a non-sustainable deficit in the overall balance of payments.

As emphasised earlier on, the Reserve Bank is pursuing a policy which is partly intended to facilitate the arduous but inevitable adjustment process to restore a greater degree of overall balance of payments equilibrium. This means the economy must eventually adjust total domestic spending to a level that can be accommodated by the total of its production capacity plus imports. It must be possible, however, to finance total imports on a durable basis with export proceeds together with a consistent inflow of long-term foreign investment funds. In order to make the inescapable adjustment more palatable, the Reserve Bank is, in the first instance, supporting the process by selling some foreign exchange from its foreign reserves towards alleviating the market shortage. This policy action is being supplemented, also on a temporary basis, by allowing the Bank's net oversold forward book to increase again to a higher level. The Bank is at the same time deliberately allowing market forces to work towards the required adjustment as reflected in the depreciation of the exchange rate of the rand, the decline in the amount of liquidity available in the financial markets, and the recent rise in interest rates. It follows that without or with less Reserve Bank assistance, the market adjustment processes will have to be stepped up, and the unpleasant adaptation executed with more vigour.

The Reserve Bank more than any other institution is aware of the adverse implications of high interest rates for many sectors of the economy. As part of its policy of gradual adjustment the Bank has nevertheless over the past twelve months allowed interest rates to rise, not only in nominal terms, but even more so in real terms. Monetary policy has indeed effectively been tightened as inflation declined while nominal interest rates were not lowered. Given South Africa's complex macroeconomic situation, the choice for monetary policy, however, is not only between higher or lower interest rates, but rather between high interest rates now or high inflation in the future. In terms of its mandate, the Reserve Bank has no option but to protect the value of the currency. If the Bank were to fail in this its prime responsibility, many of the objectives of the Reconstruction and Development Programme, as recently incorporated in the Government's Macroeconomic Strategy for Growth, Employment and Redistribution, will not be attainable.

Monetary policy is consistently being pursued within the framework of the new Strategy for Growth, Employment and Redistribution, which is also fully supported by the Reserve Bank. The effective implementation of macroeconomic policies as outlined in the strategy, will indeed relieve monetary policy of much of the heavy burden that it must now carry to maintain overall financial stability. In particular, a successful reduction of the fiscal deficit to eliminate government dissaving; a further lowering in import tariffs; an effective promotion of exports; an aggressive public sector asset restructuring programme; and further improvements in the labour market aimed at achieving higher productivity, more competition and greater flexibility, together with progress towards establishing a lasting social accord to facilitate wage and price moderation, will reduce inflationary pressures in the economy, and lead to a lowering of interest rates in general.

In recent meetings between the Reserve Bank and representatives of organised commerce, business, manufacturing, mining and finance, general support was expressed for the Government's new macroeconomic strategy. All these groups, moreover, emphasised the urgency to implement the programme and to show results. This has meanwhile become more acute given the growing precariousness of South Africa's situation in international financial markets and the weak overall balance of payments position.

The Reserve Bank can be relied upon to lend its full support to the speedy implementation of the Government's programme for macroeconomic reform. Apart from adhering to monetary policies that are consistent with the directives of the strategy, the Bank will also continue to advise the Minister of Finance on a responsible programme to gradually phase out exchange controls. Good progress has already been made during the past two-and-a-half years on this front and further steps can be expected as and when justified by the successful implementation of the overall programme of economic restructuring.

INTERNAL ADMINISTRATION OF THE BANK

This year the South African Reserve Bank celebrated its seventy-fifth anniversary. It was an occasion not only to reflect on the past, but also to embrace the future. The changing South African political and social environment demands continuous adaptation from the Bank in respect of its structure, its functions and its staff composition.

As South Africa is extending its international political and economic relationships, the Reserve Bank is also getting more involved in new and extended financial relationships. During the past year, special attention was given to the development of closer co-operation among the central banks of the Southern African Development Community (SADC). The South African Reserve Bank is now taking a leading role in the Committee of Governors of Central Banks of SADC. The Economics Department of the Bank is in the process of compiling a comprehensive statistical data base and a central bank information system for the twelve participating member countries. Discussions are taking place on a regular basis to co-ordinate exchange controls and other monetary policies in the region.

The Bank has also been making some encouraging progress in transforming its total staff complement. This process is now gaining momentum and will receive even more attention in the year ahead. We are grateful for the meaningful contribution that new staff members are already making to the many important responsibilities of the Bank.

The essential function of training is being extended further and to this end the Reserve Bank's Training Institute has moved to new premises at the ABSA Training Centre outside of Pretoria. Apart from increasing the number of courses provided for the staff of the Bank, the Institute has also for the first time presented a specialised course in central banking for officials from central banks of countries in SADC.

South Africa's integration in the global financial system requires adherence to international standards for financial regulation and supervision. The Bank Supervision Department is giving special attention, inter alia, to closer co-operation with bank supervisors in other countries, the consolidated supervision of banking groups (including their international operations), the supervision of financial conglomerates, and the introduction of additional capital requirements for banks in respect of their exposures to market risk.

The Money and Capital Market Department participated actively in the establishment of the Bond Exchange of South Africa and the Central Depository for bonds. This formalisation of the bond market and the development of scrip immobilisation facilities have promoted greater participation by foreign investors in the bond market, and in this way have succeeded in creating a broader and more liquid market. The Bank, in conjunction with the Department of Finance, is now reviewing the Bank's roles as funding agent of the Government as well as market-maker in the secondary market for government bonds. The objective is to allow private sector institutions greater participation in these activities.

Developments in the foreign exchange market placed heavy demands on the International Banking Department over the past year. With an average daily turnover of more than $7 billion in the local market for foreign exchange, and with the Bank's intervention policies in the spot and forward markets for foreign exchange, total activities managed by this Department increased beyond expectations.

The Information Technology Department, in co-operation with the banks, finalised a national strategy for the reform of the South African payment system and in November 1995 the Reserve Bank and the Council of South African Banks (COSAB) formally endorsed this strategy. As one of the first steps in the implementation of the strategy, a Payments Association of South Africa (PASA) is being established, under the auspices of the Reserve Bank and COSAB, to act as a representative body which will be responsible for managing, controlling and governing all matters affecting inter-bank payments, payment clearing, and netting of inter-bank obligations within the new payment system. Particular attention is also given to the development of payment systems in SADC.

The phasing out of exchange controls has thus far had only limited effect on the total staff complement of the Exchange Control Department. Preparations are nevertheless being made for some of the staff members of this Department to assume new responsibilities in the proposed initiative of the Government to combat money laundering in South Africa's financial markets.

During the past year, a number of senior staff members left the Bank either on final retirement or to take up positions in the private sector. Dr J.H. Meijer retired as a Deputy Governor of the Bank on 1996-04-30. His successor has not yet been appointed by Government. Mr J.H. Postmus, Head of the Exchange Control Department, retired on 30 June this year after more than 42 years' service with the Bank. Mr E.J. Pike, former Head of the Administration Department, succeeded him. Dr D.C. Krogh retired on 31 July, after having served the Governors as Special Adviser for a period of almost six years. He was replaced by Dr E.J. van der Merwe, the former Head of the Economics Department.

The two vacancies for Government representatives which existed on the Board last year, were both filled recently. We welcome Dr B.D. Nomvete and Prof M. Padayachee to the Board. The Government also appointed Mr T.T. Thahane as a Deputy Governor of the Bank as from 1996-04-01. During the few months since his appointment, Mr Thahane has already made a very useful contribution to the activities of the Bank.

CONCLUDING REMARKS

The present situation reflects many of the traditional constraints experienced in the past when the South African economy was at a similar stage of the business cycle.

Firstly, after more than three years of economic expansion, the domestic economy is now losing some of its vigour as reflected in a slow down in the rate of expansion in manufacturing production as well as in the services sector, and also, as could have been expected, in most of the components of gross domestic expenditure.

Secondly, the overall balance of payments is in deficit because of large increases during the past two years in imports needed to supplement domestic production and to meet the requirements of large investments in both fixed capital and inventories, apart from the growing demand for consumer goods.

Thirdly, both bank credit extension and the money supply are increasing at excessive rates, and they lag behind the slow down in the growth of real economic activity. This may reflect some distress borrowing, but may also be due to structural changes in the South African economy. Over the medium term, however, the rates of increase in the monetary aggregates must be reduced and again brought more in line with the growth rate in nominal gross domestic product.

Fourthly, interest rates remain under upward pressure, and are placing an increasing burden on government, businesses and private households.

The balance of payments deficit at its present level is obviously not sustainable, particularly after the substantial decline in the net capital inflow since February 1996. The challenge for macroeconomic policy at present is to assess whether the current slow down in economic growth will be sufficient to correct the external imbalance, and whether the current monetary policy stance is restrictive enough to underpin this unavoidable adjustment process. In this assessment, account must also be taken of the expected effects of the depreciation of the rand on imports and exports, which will only work through with some considerable time lag.

The Reserve Bank's view is that, in the present situation, the Bank should provide some assistance to the market in foreign exchange by selling foreign currency from the official reserves, supplemented by available foreign credit facilities, if necessary. The Bank should also support the money market to assist banking institutions in bridging the period of transition to more stable conditions. In this way, the unavoidable but painful adjustments will become more tolerable. At the same time, macroeconomic corrective market forces must not be impeded, but deliberately encouraged, where necessary, to restore balance of payments equilibrium with a minimum of disruption. Exporters have an important part to play in this adjustment process by taking advantage of the current favourable exchange rate.

The need for a downward adjustment in the rate of expansion in total economic activity will, of course, be reduced considerably if more long-term foreign investment funds can be attracted. The effective implementation of the Government's Macroeconomic Strategy for Growth, Employment and Redistribution can make an important contribution towards creating a more friendly investment environment, for both foreign and South African investors. It also remains of crucial importance that the present wave of crime and violence be seen to be curtailed, and that greater confidence be gained in our determination as well as ability to achieve our longer-term economic goals in the interest of all the people of this country.

In conclusion, I would like to thank my colleagues on the Board for their commitment to the Bank, and for their support during the past year. I would also like to thank all the staff members of the Bank for continuing to make the South African Reserve Bank one of the most highly regarded central banks in the world.

I also thank shareholders present here today for your attendance at this, the seventy-sixth Ordinary General Meeting of the Bank. I look forward to seeing you all back here again next year.