1. The political reforms

It is not appropriate for a central banker to discuss political issues but the profound political reforms in South Africa in recent times transformed the economic prospects so decisively that one cannot but introduce a sensible discussion on the economy without also referring to the political changes.

After years of isolation and international rejection, which included trade sanctions, disinvestment campaigns and the systematic exclusion of South Africa from the world's financial and capital markets, the political reforms culminating in the election of a Government of National Unity in April 1994, led to the immediate withdrawal of these punitive actions. South Africa is now being reintegrated not only in the global political system, but also in the world economy.

The process of political reform met with great success so far, but has not yet been completed. The Government of National Unity has surprised many sceptics with sound macroeconomic management over the past year, and with a commitment to both monetary and fiscal disciplines that surpassed even the more optimistic expectations. At this stage, however, the country still has to face:

the first fully democratic election for local authorities scheduled to take place in early November this year;

a more clear definition of the political, economic and financial relationships between the central government and regional governments; and

the drafting of a final Constitution to replace the current Interim Constitution before the next general election can take place.

Major reforms and a restructuring of the public service are now in progress, and the Government is gradually building the necessary capacity to implement the many new programmes scheduled to change South Africa, for example the Reconstruction and Development Programme intended to provide more effectively in the basic needs of all South Africans, as well as to foster high and sustainable economic growth.

Over the past year, South Africa:

rejoined the United Nations Organisation and its affiliates;

rejoined the Commonwealth and participated in the last two meetings of the Ministers of Finance of this group;

became more active in GATT and joined its successor organisation, the World Trade Organisation as from 1995-01-01;

was reinstated as a full and participating member of the International Monetary Fund;

regained full rights and obligations associated with membership of the World Bank Group;

applied for full membership of the Africa Development Bank; and

joined the Southern African Development Community (SADC).

The focus of the global interest in South Africa is now shifting more and more to the economic performance of the country, and the ability of South Africans also to meet the expectations of its people for better living conditions. To achieve these goals, sustainable economic growth at a relatively high level will be essential.

2. Foreign capital returns to South Africa

The most significant economic change over the past year has been the dramatic reversal of the net capital outflows from the country over the preceding ten years. From 1985 up to the middle of 1994, the total net capital outflow from the country amounted to about R50 billion to give an average net capital outflow of about R5 billion per annum.

South Africa had to generate the necessary foreign exchange to make these capital transfers possible, or would have had no alternative but to default on its international commitments, including payments for imports. Over this extended period therefore the domestic economy had to remain depressed, and the average economic growth rate had to be restricted to less than one per cent per annum. In the process domestic demand was constrained, imports remained low and a maximum proportion of domestic production was released for exports. Surpluses on the current account of the balance of payments over this period, matched the persistent capital outflows and enabled South Africa to continue to honour all its international financial commitments.

Meeting these obligations, however, had a high social cost in terms of restricted economic growth, increasing unemployment and a declining average standard of life for the people of the country. Growing economic pressures undoubtedly made an important contribution to the political reforms of the last few years. It also left South Africa, at the time of the election of April 1994, with:

an economy that was fairly depressed and structurally distorted;

an intolerably high level of unemployment, estimated at a level of approximately 30 per cent of the economic active population;

almost zero official foreign reserves, completely exhausted by the net capital outflows; and

extensive exchange controls applicable to the outflow of capital owned by both residents and non- residents.

At the same time, expectations on what the new South Africa will deliver to improve the living conditions of the people, were extremely high and, in many respects, completely unrealistic. Spearheaded by a large net inflow of capital from the outside world, the political miracle of South Africa is beginning to affect also the economic situation of the country. Over the twelve months that ended in June 1995, a total net inflow of capital amounting to R18,6 billion occurred to assist a new upsurge in economic growth, some liberalisation of the foreign exchange market and a significant improvement in the official foreign reserves position.

The inflow of capital over the past eighteen months exceeded the most optimistic expectations of the pre- election period. Although an unduly large part of the inflows still represented short-term funds, the magnitude enabled the economy also to perform better than was expected. An analysis of the composition of the inflows indicates that foreign capital came into South Africa in various forms:-

South African banks borrowed a substantial amount of short-term funds from their counterparts in the rest of the world;

South African importers and exporters found easier access to foreign sources of finance and the rising imports were financed to an important extent with short- and medium-term foreign trade finance;

after the international sovereign credit ratings of investment grade were established, the SA Government, public sector institutions and private sector companies borrowed medium and longer term loans in the international capital markets;

a substantial amount of foreign funds were invested through the Johannesburg Stock Exchange and in new issues in South African private sector equities and in government and public sector bonds; and

a smaller amount flowed into the country in the form of direct investment in existing and in new subsidiaries, branches and joint ventures in South Africa owned by non-residents.

South Africa welcomes the inflow of capital into the country but would like to see, in the year ahead, a change in the composition of the capital inflows. Deliberate efforts will be made to encourage the inflow of more long-term capital and it is hoped that foreign investments participating more directly in the domestic economic development process will increase.

3. Economic consequences of the net capital inflows

For many years, large net capital outflows depressed the domestic economy and restricted the growth potential of South Africa to less than one per cent per annum. The reversal of these capital outflows is now beginning to have the opposite effect on the economy, and is assisting South Africa in its serious efforts to meet at least some of the legitimate demands and expectations of its citizens.

The net capital inflow of about R20 billion over the past fifteen months enables the country to:-

finance a growing deficit on the current account of the balance of payments without recourse to the International Monetary Fund or other short-term official foreign borrowing;

increase the official foreign reserves held by the Reserve Bank and the commercial banks by more than R10 billion. This included a reduction in the short-term foreign borrowings of the Reserve Bank from R8,5 billion in May 1994 to about R1 billion at this stage;

abolish all exchange controls on non-residents and start dismantling the restrictions on the outflow of resident-owned investment funds; and

support a relatively stable exchange rate for the rand, with a small net depreciation in nominal terms of less than 4 per cent over the period from July 1994 to September 1995.

The inflows were indeed at times so substantial that they created new challenges for the protection of overall financial stability in the economy:

the banking sector found access to a new source of liquidity (i.e. foreign borrowings) to support a substantial increase in the amount of bank credit extended to the private sector;

there were at times upward pressure on the exchange rate of the rand for appreciation, which required active Reserve Bank intervention in the foreign exchange market; and

the inflows of capital contributed to an unduly large increase in the domestic money supply which required difficult neutralising monetary policy actions in order to prevent the re-emergence of undesirable new underlying inflationary pressures.

On balance, however, the net capital inflows were of great benefit to the South African economy and provided a major stimulus to the improvement of the economic growth rate. Despite adverse developments in the agricultural sector and in the gold mining industry, the overall rate of growth in gross domestic production accelerated from the unduly low rates of less than one per cent per annum over the preceding decade to about 3 per cent over the past eighteen months. Provided the net capital inflows will continue, the predictions are that the economy will continue to expand at this pace for at least the next eighteen months. For the time being, South Africa succeeded in finding the magic formula for sustainable growth, relatively low stable domestic financial conditions and reasonable equilibrium in the overall balance of payments.

4. The need for economic structural adjustment

A growth rate of 3 per cent per annum in the South African economy is not sufficient. This will barely enable the country to provide enough new jobs for the annual addition to the total labour force, and will hardly affect the huge backlog of unemployment estimated to be at least 25 per cent of the total labour force at this stage. It is obvious that the economic growth potential of South Africa must be lifted to a higher level should the country want to retain social and therefore, in the longer run, also political stability.

This is the big challenge now remaining for South Africa -- can the growth potential of the economy be lifted to a level high enough to create sufficient jobs, not only for the natural increase in the population, but also gradually to absorb the great number of unemployed workers inherited from the past?

For most countries, this will require a major macroeconomic restructuring programme, most probably assisted by multinational institutions such as the International Monetary Fund and The World Bank. So far, South Africa has preferred to go it alone. This does not mean that the country is not aware of the seriousness of the problem, or that it is not prepared to make the sacrifices necessary for structural readjustment. On the contrary, a number of important economic restructuring programmes is already in progress, and is beginning to show results, albeit on a modest scale. The following can be quoted as examples of this programme:

the Reconstruction and Development Programme intended to meet the basic needs of all South Africans, as well as fostering high and sustainable economic growth. The programme includes proposals for public works, land reform, the provision of affordable housing, the provision of access to clean water and sanitation, electrification, access to telecommunication facilities, the development of a social welfare programme and the establishment of a new health system;

the Human Resources Development Programme which encompasses programmes for education and training, arts and culture, sport and recreation and youth development;

restructuring of trade and industrial policies to realise a better growth and development performance, including the restructuring of the tariff structure, the provision of various export facilitating mechanisms, a new system for industrial training and technological development and the overhauling of the institutional structure for small and medium sized enterprises;

a liberalisation of the financial markets with a programme for the gradual relaxation of exchange controls, a restructuring of the capital market and an open invitation to foreign banks to participate more actively in the South African banking system; and

a programme for the restructuring of state-owned assets which is gradually beginning to gain more momentum.

Whilst all these programmes are being activated, it remains important to maintain overall financial stability in the South African economy. The recognition given by the new Government of National Unity to the independence of the South African Reserve Bank is making it possible for the Bank to commit itself unconditionally to this objective.

The challenge for South Africa therefore now remains to achieve an even better economic performance in future, with higher growth and reasonable overall financial stability. This will only be possible if South Africa will be able to attract a reasonable amount of foreign investment to supplement its own domestic savings.