ADDRESS BY, DR C.L. STALS, GOVERNOR OF THE SOUTH AFRICAN RESERVE BANK, AT THE SEVENTY-SEVENTH ORDINARY GENERAL MEETING OF SHAREHOLDERS OF THE BANK IntroductionThe turbulences in the South African market for foreign exchange from February 1996, and the subsequent destabilisation of the balance of payments, contributed to a weakening of overall economic growth and to an upturn in inflation. The major task for monetary policy over the past year has accordingly been to restore both external equilibrium and domestic financial stability which are important preconditions for sustained investor confidence and economic growth.The process of restoring external economic equilibrium had to begin at home. Many adverse factors converged to contribute to the sudden exchange rate shock of February 1996. Some were of a non-economic nature while others were rooted in macroeconomic developments over the preceding two years. The problems caused by non-economic factors diminished as concern about the finalisation of the Constitution of the Republic of South Africa, the delay of local authority elections in certain provinces, and the political composition of the Government of National Unity, were fortunately allayed during the course of the past year. Equally important has been the fact that the Minister of Finance, newly appointed in April 1996, has stood the test of the markets with acclaim and soon established himself as an effective leader of the country&rsquos overall financial policy. Many of the disturbing economic problems which emerged last year were addressed by appropriate policy responses, while the private sector has on the whole endured the inevitable painful adjustments with much understanding. During both 1994 and 1995, growth in real domestic expenditure by far outpaced growth in real domestic production. This was clearly not a sustainable situation, and growth in domestic demand had to be curtailed to ensure a better balance in the overall economy. The untenable developments in domestic economic activity created a widening deficit in the current account of the balance of payments which was being financed by an inflow of volatile short-term foreign capital. When these short-term capital inflows switched into outflows after February 1996, however, a downward adjustment in the rate of growth in overall domestic expenditure, and therefore in the growing demand for imports, became imperative.The divergent rates of expansion in domestic production and expenditure, respectively, were also being financed to an increasing extent with domestic bank credit, or simply the creation of additional money. With insufficient domestic saving and a sudden decline in the inflow of foreign capital after February 1996, the pressure to accelerate the creation of more money increased even further. Assessed against this background, an untenable macroeconomic disequilibrium was rapidly being perceived to be developing at thethen level of the exchange rate of the rand. Large foreign capital inflows in 1995 as well as the early weeks of 1996 exerted upward pressure on the value of the rand. Within a floating exchange rate regime, the rand appreciated in real terms, despite heavy Reserve Bank intervention to absorb part of the excess supply of foreign exchange. The appreciation of the rand at the time was clearly irreconcilable with South Africa&rsquos otherwise weak position in a very competitive world economic environment. A stronger rand could not be sustained in the long term. Also instructive in this regard is that similar experiences by other emerging economies over the past year proved that alternative exchange rate systems, based on fixed or managed floating exchange rates, could also not cope with such divergent economic trends. In some of those countries, even more painful economic adjustments were required to restore financial stability than in the case of South Africa. The monetary policy approach adopted by the Reserve Bank under the circumstances was to let market forces take their course, with some short-term intervention by the Bank only