1. Introduction

The importance of reducing inflation in South Africa to a lower level has increased over the past year. With South Africa's reintegration into the world economy, comparisons by potential investors of relative price changes in various countries more or less at the same stage of economic development and competing with each other for scarce funds, have become of greater importance. At the same time, the dedication to a programme of economic reconstruction and development in the country with the intention of improving the living conditions of the lower income groups of the South African population, has focused the attention on the adverse consequences for all South Africans of the continuous erosion in the value of money.

For many years, South Africans erroneously believed that inflation at the double-digit level is unavoidable, and that South Africa must ad infinitum live with prices rising at somewhere between 10 and 20 per cent per annum. This fallacy was embedded in the minds of people by a very poor track-record of more than twenty years of double-digit inflation. From 1972 to 1992, the average rate of inflation was indeed about 14 per cent, with annual rates ranging from 11 to 21 per cent over this period.

This bubble burst when inflation dipped to below 10 per cent in 1993, when the average rate of inflation for the year came to 9,7 per cent, to be followed by 9,0 per cent in 1994. Indications are that South Africa will have an average rate of inflation of below 10 per cent for the third year in succession in 1995. We may even have succeeded in establishing a new bench-mark for inflation at this lower level. We find increasingly that this lower level is now being accepted as a starting-point for wage negotiations, price adjustments, economic expansion programmes and projections of possible future economic developments.

There is a danger, however, that South Africans are again becoming complacent about the current level of inflation. The opportunity we now have to drive inflation to an even lower level can easily be lost again, unless we maintain a continuous vigil against the danger of rekindling inflation.

One reason for this misplaced complacency is often based on the argument that we need not be too sensitive about inflation as long as it stays below the level of 10 per cent, because at this low level it will not have any serious adverse effect on economic growth and development. It is sometimes argued that a little bit of inflation may even be good for growth, and may stimulate economic development. This argument is, however, fraught with danger. The biggest problem with this attitude is that a little bit of inflation never stays just a little bit -- inflation, if unchecked, feeds on itself and almost automatically moves to higher levels on a continuous basis. Without caution, it can easily run out of control and eventually destroy the total economy.

It is therefore in the interest of our economic objectives for the future that South Africa, and particularly the South African Reserve Bank, shall maintain its vigil against inflation. Indeed, there are good reason for doing our utmost best to bring inflation down to an even lower level than the current rate of about 9 per cent per annum.

2. South Africa's changing international economic relationships

Probably the most important economic changes in South Africa over the past year have been linked to the changing pattern of the country's international economic relations. These changes can have far-reaching implications for the growth potential of the economy, for the ability to create more jobs and to improve the living conditions of all the people of the country, provided we make the best use of the many newly-created opportunities.

Firstly, the harmful international sanctions, boycotts, disinvestment campaigns and the withdrawal of international loan funds from the country were removed and rolled-back much quicker than even the most optimistic predicted. It took but a few months after the election of the Government of National Unity for South Africa to be re-accepted into the global economy and for all international markets to become accessible again for South African importers, exporters and borrowers of short and long-term loan funds.

The normalisation of South Africa's international economic relations was nowhere better illustrated than the developments in the capital account of the balance of payments. After about ten years of successive net capital outflows, averaging about R5 billion per annum, there was a dramatic turn-around and over the twelve months ending in June 1995, South Africa experienced a net capital inflow of R18,6 billion.

Over this period, South African banks re-established old connections and expanded correspondence relationships with banking institutions in many countries; South African importers and exporters regained access to international trade financing facilities in almost unlimited amounts; foreign capital markets were re-opened for South African borrowers of long-term loan funds and the Government led the way with its global US dollar bond issue of $750 million in December 1994, and its Samurai issue in Japanese yen for ¥30 billion in May 1995; South African private sector institutions raised millions of rand in international equity issues, enabling them to make important investments in other countries; and foreign investors became major operators in both the equities and the bond sections of The Johannesburg Stock Exchange.

Secondly, South Africa re-established normal relationships with many multi-national international economic institutions. Relationships with the International Monetary Fund and with the World Bank were normalised; South Africa became a member of the Organisation for Africa Unity; joined the African Development Bank; became a participating member of the Southern Africa Development Community (SADC); entered into a number of double-taxation agreements with other countries; obtained international credit ratings from the Moody's, Standard and Poor's and Nippon Securities credit rating agencies; and resumed its activities as a fully respected member of the United Nations with its various Economic Commissions and Agencies.

Thirdly, South Africa began to play a new role on the African Continent, and particularly in the Southern African region. South Africa was given the responsibility for drafting and managing the Protocol for financial co-operation amongst the twelve member countries of the SADC; the South African trade with other African countries is increasing at a high rate; and a number of South African mining, manufacturing, trading and financial institutions extended their activities into other African countries by setting up branches, subsidiaries and joint ventures in these countries.

These extended international relationships are opening up new opportunities but also new challenges for South Africa. Now that the non-economic barriers on South Africa's trade with the rest of the world have been removed, the challenge is for us to be more competitive and to benefit from these new opportunities. This requires the rate of inflation, and therefore the pressures on the cost of production in South Africa, to remain in line with, or even better, to stay below, the rate of inflation in our major trading partners and competitors in the rest of the world.

Over the past year, the net inflow of foreign capital into South Africa exceeded R18 billion. About 25 per cent of this inflow represented investments in South African assets denominated in rand, for example non-resident investments in South African equities and bonds acquired through The Johannesburg Stock Exchange. If South Africa wants to remain attractive for the foreign investor, we shall have to keep our rate of inflation low. No investor is keen to commit his savings, or the funds he administers on behalf of clients, to a depreciating asset, particularly not if there are other alternatives available in many other countries of the world.

South Africa's membership of international institutions such as the International Monetary Fund, the World Bank and the African Development Bank exposes the country to regular scrutiny, and to periodic surveillance of our economic performances. The international public loan issues made by the Government over the past year require the international rating agencies from time to time to review South Africa's position, and compels South Africa to file regular reports, for example with the American Securities and Exchange Commission. In all these surveys, the rate of inflation is included as an important barometer of the successes or failures of our macro- economic management. Inflation in South Africa is no longer only of concern to South Africans, but many investors all over the world have a vested interest in financial stability in South Africa.

To enable the country to play its proper role on the African continent, we must set the example and lead the way in the fight against inflation. The other members of the SADC, for example, entrusted South Africa with the task of designing a framework for financial co-operation. They look to us for leadership and also for establishing a sound financial nucleus in support of the future economic development of the region. Other countries in Southern Africa will only be prepared to link their currencies to the rand provided the rand will be a stable currency.

As far as South Africa's expanding international economic relations are concerned, there are therefore many convincing reasons why low inflation must remain a priority of overall economic policy objectives. We can only reap maximum benefits from these new opportunities and challenges on condition that financial (and political and social) stability shall be maintained.

3. Domestic economic objectives

The political and social reforms of recent times have also had a major impact on the internal economic environment, and on the economic policy objectives. The reforms leading to the election of the Government of National Unity in April 1994 created many new expectations of better living conditions for the people of the country, and exposed more of the dire needs of the millions of people living below the poverty line, and looking for jobs.

The Government's economic initiatives are now concentrated on the Reconstruction and Development Programme which presents a comprehensive plan for the social upliftment of the South African people. This programme concentrates on the improvement of health care, the provision of better training and education facilities, the provision of more housing and better shelter for the many families in destitution, the development of small businesses, rural upliftment programmes and the creation of fair and equal opportunities for all the people of South Africa.

The attainment of all these objectives will, however, be complicated severely, if not made impossible, by an environment of high inflation. It is indeed regarded as a precondition for the attainment of these objectives that the Reserve Bank shall maintain overall financial stability, that is, shall keep the rate of inflation low. It is generally well understood in South Africa that inflation discriminates against the poor and the lower- income groups of the population. The rich can protect themselves better against inflation, whereas the poor and the low income groups of the population have no means to defend themselves against any persistent erosion in the value of money.

A second precondition for the attainment of the objectives of the Reconstruction and Development Programme is that the overall macro-economic growth rate shall be maintained at the maximum possible level. Over the eight years from 1985 to 1992 the average annual rate of increase in the gross domestic product was less than 1 per cent. Over the past 24 months, that is from the middle of 1993 to the middle of 1995, the growth rate increased to about 3 per cent per annum. This is not good enough for South Africa, but at least represents a major improvement from the previous position. In the longer term, South Africa needs persistent economic growth, and then also at levels even higher than what was attained over the past two years. To achieve this objective, overall financial stability will have to be protected. In particular, it will not be possible to sustain maximum economic growth for any lengthy period of time without keeping inflation low. South Africa needs higher economic growth with financial stability.

Reference is often made to the structural deficiencies in the South African economy which place a ceiling on the growth potential of the country. These include the continuing rise in real unit labour costs of production, the low multifactor productivity in general, the relatively large deficit in the public sector budget, intermittent depreciation of the rand, lack of more aggressive competition in domestic markets, the lack of sufficient savings (or the inclination to over-consumption) and a deeply embedded structural inflationary bias. Many of these deficiencies were cultivated by years of double digit inflation, and can only be cured by a determined and consistent programme of reducing inflation. Such an effort will need the support of Government, the business sector, the trade unions and, of course, the monetary policy of the Reserve Bank. The argument for lower inflation in South Africa is convincing enough. The new South Africa will not be able to reap maximum benefit from its new situation in the world, will not be able to achieve its laudable macro-economic objectives and will not be able to provide in the reasonable needs of its people, unless it will also maintain overall financial stability by keeping inflation under control.

4. Conclusion

The fight against inflation begins with monetary policy. The Reserve Bank has been tasked in the South African Reserve Bank Act and in the Constitution of the Republic of South Africa to use the monetary policy instruments at its disposal to protect the value of the currency.

It is no easy task for the central bank on its own to rid the economy of inflation. Theoretically it may be possible to stabilise the value of the currency by means of monetary policy alone. The more inflationary pressures are released elsewhere in the economy, for example by excessive wage increases, or by excessive increases in government expenditure, the more restrictive monetary policy will have to be to prevent inflation from getting out of control. In such a situation, monetary policy is often blamed for the decay of the total economy, and for increases in unemployment.

One of the remedies applied by the market economy to cure the system from excessive inflationary pressures, is for interest rates to rise. The central bank is often blamed for high or rising interest rates when underlying fundamentals of demand and supply create upward pressures because of unrealistic demands and expectations.

It is for these reasons that we in the Reserve Bank have to make the plea to all the participants in the economy to join in South Africa's efforts to bring inflation down to a more acceptable level. Such a joint effort will, in the end, achieve the goal of low inflation needed for sustainable economic development with less cost, less pain and less friction for the country as a whole.