1. The past

Developments over many years created a distorted economy in South Africa. The present economic structure reflects the effects of the unrealistic political ideologies of the past, unsustainable social tension over a long period of time, and globally supported international punitive actions applied against the country.

When the Government of National Unity was elected in April 1994, it had to contend not only with major political and social reforms, but also with reforming an economy that suffered from a long drawn out cyclical recession and various structural deficiencies. From 1982 up to and including 1992, the average annual rate of growth in gross domestic product was only ½ per cent, accompanied by an average decline of ½ per cent in total real gross domestic expenditure.

Furthermore, from 1985 up to 1993, persistent capital outflows to the rest of the world added up to an accumulated figure of R48 billion. In the process, the country's net gold and foreign exchange reserves were fully depleted. The capital outflows forced South Africa throughout this period to maintain large surpluses on the current account of the balance of payments which could, of course, only be accomplished by keeping the domestic economy depressed.

The difficult external situation, exacerbated by international sanctions, boycotts and disinvestment campaigns, provoked the South African Government into introducing and gradually extending exchange controls which by 1993 restricted outward capital transfers by both South African and foreign residents.

In its isolation, the South African financial sector had to cope with many stresses and strains, but also developed rapidly within the environment of a hothouse with a growing pool of funds trapped by exchange controls to remain within the country. In the longer run, the money and capital markets suffered from a lack of international competition and missed out on participating in the worldwide thrust towards multilateralism, globalisation and universal liberalisation.

Government itself had little difficulty in financing from internal sources a growing deficit in the budget. In the fiscal year 1993/94, the deficit in the budget of the central government exceeded 8 per cent of gross domestic product, and the borrowing requirement of the overall public sector exceeded 10 per cent of gross domestic product.

The most urgent economic challenge facing the Government of National Unity in April 1994 was the massive unemployment that accumulated in the country. With average economic growth of less than 1 per cent per annum over the preceding decade, and an addition of approximately 2-½ per cent to the total population every year, unemployment increased throughout the eighties and the early nineties. Only about 45 per cent of the economic active population found employment in the formal non-agricultural sectors of the economy, and best estimates of informal sector employment indicated total unemployment of approximately 30 per cent of the labour force at that stage.

Some of the other more basic economic structural deficiencies inherited from the past included:

A relatively skew distribution of income with about 20 per cent of the population earning just more than 60 per cent of total income. The Gini coefficient for South Africa gives a skewed distribution of about 0,58.

A relatively inefficient labour force with many undeveloped skills, lack of experience and insufficient training in the past.

A dire shortage of infrastructure in certain basic social services such as education, health care, and recreation facilities.

An over-protected domestic economy with high tariff-barriers and other protective measures that were deliberately introduced or developed by themselves as part of the international isolation programme.

A spatial maldistribution of population concentration, leading in the post-1994 election period to a massive movement of unemployed people from rural to urban areas.

A low propensity to save (or high propensity to consume), particularly with private individuals. Total gross domestic saving at this juncture is not sufficient to support economic growth on a sustainable basis at a level that will generate sufficient jobs to absorb the annual addition to the labour force, and reduce the huge backlog in employment that accumulated in the past.

On the other hand, the new government also inherited some important advantages which many other governments in a similar situation, especially on the African continent, were not able to benefit from. These included:

A well-developed first-world component of the economy that could serve as a basis for future development.

Many skills and highly-educated people who could continue to serve the country in its new economic development phase.

A well-developed and modern infrastructure that provides good communications, harbour and transport facilities, and highly sophisticated financial services.

When the Government of National Unity was elected to take control of the country in April 1994, it was therefore confronted with major challenges, also on the economic front, and with high expectations of the people of South Africa, particularly those that lived in poverty and were desperate for jobs and opportunities denied them in the past.

2. Economic developments over the past three years

The South African economy produced a laudable recovery over the past three years. Immediately after the new government took power in April 1994, international sanctions were repealed and the process of reintegrating South Africa in the world economy began. South Africa was reinstated as a full member of the United Nations, joined the Organisation for African Unity, was re-admitted as a member of the British Commonwealth of Nations, normalised its position in the International Monetary Fund and the World Bank Group, and entered into many new bilateral and multilateral international economic arrangements. One of the most promising in the longer term is the admission of South Africa as a full participating member of the Southern Africa Development Community (SADC). This group of twelve countries has a total population of about 130 million people, a natural affinity because of their geographical location in Southern Africa and a great potential for economic development because of the undeveloped stage of most of its members.

The domestic South African economy reacted swiftly to the new challenges. The most important change that took place was perhaps the almost dramatic switch-around in the net capital movements from the rest of the world. Almost to the day on which Mr Nelson Mandela was inaugurated as South Africa's new President, foreign funds started to flow back into South Africa. In the second half of 1994, a net capital inflow of R9 billion paved the way for a further net inflow of R21,7 billion in 1995. The 1995 inflow, however, included about R10 billion of speculative short-term capital that partly flowed out again in the first half of 1996. Over the past two years up to June 1996, the total net inflow of capital nevertheless amounted to about R34 billion.

The net capital inflow had a major impact on recent economic developments in the country. It firstly made it possible for the first time in a decade to tolerate a growing deficit in the current account of the balance of payments. From a surplus of R5,8 billion in 1993, the current account switched into a deficit of R2,2 billion in 1994 and R12,7 billion in 1995. This latter amount represented about 2-½ per cent of gross domestic product.

The capital inflows which exceeded the current account deficit up to the end of 1995, also enabled the Reserve Bank to start replenishing the country's depleted official foreign reserves. In April 1994, the Reserve Bank held about R8 billion in gross foreign reserves, but also carried about R8 billion in short-term foreign liabilities. By the end of 1995, the foreign reserves rose to R16 billion after the Reserve Bank had repaid all its foreign liabilities. This latter figure for foreign reserves provided more scope for monetary policy but was still regarded as insufficient. It provided cover for only about 7 weeks' imports. With the decline in the net capital inflow in the first half of 1996, the current account deficit was no longer covered by the total inflows and the official reserves declined by about R5 billion.

Thirdly, the inflow of foreign capital led to a relatively stable exchange rate of the rand. In 1995, the capital inflows indeed exerted some upward pressure on the exchange rate. Despite substantial intervention by the Reserve Bank to absorb part of the surplus amount of foreign exchange in the market, the exchange rate of the rand in real terms appreciated slightly over the year 1995 as a whole. In the first nine months of 1996, however, there was a strong reaction in the foreign exchange market when the capital inflow subsided. In nominal terms, the rand depreciated by about 18 per cent, and in real terms by about 13 per cent from December 1995 up to September 1996.

Fourthly, the surplus on the overall balance of payments over the past two years enabled the authorities to introduce major relaxations in the exchange controls. During this period:

the debt standstill arrangements introduced in 1985 were terminated early in 1994;

the financial rand or dual exchange rate system was abolished in March 1995;

restrictions on South African corporates were gradually eased to enable them to make foreign direct investments of more than R9 billion over the past three years;

a system was introduced in June 1995 to enable South African institutional investors to diversify up to 10 per cent of their total portfolios into foreign assets. Concessions were made so far for foreign investments of up to R19 billion in terms of this liberalisation programme;

restrictive limits on transfers for current account transactions were either removed or lifted to a level where they no longer provide any effective restrictions on current transfers. South Africa now complies fully with the requirements of Article VIII status within the IMF; and

important liberalisation actions were taken to make the spot and forward foreign exchange markets more competitive.

The switch-around in the net capital movements from abroad also had an important influence on the cyclical recovery in real economic activity. In 1993, the rate of change in total gross domestic product became positive again at 1-½ per cent, before it increased to 2-½ per cent in 1994 and 3-½ per cent in 1995. There are clear signals of a slowdown in the growth rate in real production in 1996, particularly in the secondary sectors of the economy, but overall growth of about 3 per cent is still predicted for the full calendar year.

Total production was stimulated by an even stronger recovery in total domestic expenditure which increased by 6-½ per cent in 1994 and 5-½ per cent in 1995. Growth was particularly strong in gross domestic fixed investment with increases of 8-½ per cent in 1994 and 10-½ per cent in 1995, concentrated mainly in private manufacturing. There were also substantial additions to inventories, whereas private consumption expenditure increased steadily to rise by about 5 per cent in 1995. Consumption expenditure by general government made but a small contribution to the increase in total demand. As in the case of domestic production, expenditure trends also showed signs of a slowdown in the rate of expansion in the first half of 1996.

Two disappointing elements of the economic development process of the past three years were, firstly, a further decline of gross domestic saving to a level of 16-½ per cent of gross domestic product, and the fact that no new jobs were created in the formal sectors of the economy. Taking account of the natural growth in the total population, unemployment increased further.

Inflation, however, remained relatively low and continued to decline. After almost two decades of double-digit inflation in South Africa, the rates of increase in both consumer and producer prices remained below 10 per cent over the past few years. Last year, the average rate of increase for consumer prices was 8,7 per cent and over the twelve months up to April 1996, it had declined to 5,5 per cent. Since then, mostly because of the depreciation of the rand in 1996, the rate of inflation rose again to 7,5 per cent over the twelve months ending in August 1996.

The cyclical upswing in the economy over the past two years exerted some upward pressure on important monetary aggregates such as bank credit extension and the money supply. Total claims of the banking sector on the private sector rose by about 17 per cent in both 1994 and 1995 and the first half of 1996. The rate of increase in the M3 money supply accelerated to a level of about 15 per cent in 1994 and has remained at this level throughout 1995 and the first half of 1996.

The excessive rates of increase in the monetary aggregates may in part be due to structural changes that are taking place in the South African economy, but nevertheless call for a restrictive monetary policy at this stage. This is reflected in relatively high interest rates with the prime overdraft rate of banking institutions now at 19 per cent, or about 11 per cent above the current rate of inflation. The yield on long-term government bonds is now at a level of about 15 per cent.

Finally, as far as current economic developments are concerned, Government has succeeded in reducing the deficit on the budget from 7,9 per cent of gross domestic product in 1992/93 to 5,9 per cent in 1995/96. For the current fiscal year, the budget deficit has been estimated at 5,1 per cent, and government is now doing serious efforts to reduce it to about 4 per cent of gross domestic product in the next fiscal year.

These cyclical developments over the past three years were encouraging, albeit not spectacular. Current trends, and particularly the signals of a natural slowdown in the rate of economic expansion at this stage, is now focusing the attention even more than before on the need for a more comprehensive macroeconomic restructuring programme for the future.

3. A strategy for macroeconomic structural reforms

The Government recently responded to this further challenge by announcing a comprehensive and consistent programme for macroeconomic restructuring. The Macroeconomic Strategy for Growth, Employment and Redistribution adopted by Government in June 1996 provides inter alia, for:

an acceleration of the fiscal reform process;

the gradual further relaxation of exchange controls;

the maintenance of monetary policies consistent with continued inflation reduction;

a consolidation of trade and industrial policy reforms, incorporating tax incentives for a fixed period to stimulate investment;

the implementation of the public sector asset-restructuring programme;

a structured flexibility within the collective bargaining system to support a competitive and more labour intensive growth path; and

a social agreement to facilitate wage and price moderation, underpin accelerated investment and employment, and enhance public sector delivery.

The main objectives of this macroeconomic strategy are to increase the growth potential of the South African economy to 6 per cent per annum and to create 400 000 jobs per year by the year 2000.

A number of programmes were already initiated during the last three months to give effect to this strategy:

Exchange controls were relaxed further at the end of June 1996, particularly to increase facilities for institutional investors to make investments outside of South Africa;

Tax incentives legislation is currently being processed through Parliament providing inter alia for accelerated depreciation and a tax holiday for certain new investments;

The Government has appointed HSBC of London as an overall adviser for state asset restructuring, and a number of other advisers for the implementation of specific sectoral asset adjustment programmes; and

Targeted expenditure on certain infrastructural projects with an emphasis on employment and job creation are being increased. Most notably amongst these is the development of the Gauteng-Maputo corridor to link the industrial heartland of Gauteng with its nearest harbour in Maputo, Mozambique.

The Government has great determination to implement the Macroeconomic Strategy, despite some opposition against certain vital elements of the plan from certain sectors of the South African community. It is often difficult to convince people who already suffer from great poverty that more sacrifices must be made in the short-term in order to find a permanent cure for the ailments of

the economy. To them, the remedy may be perceived to be worse than the disease. The benefits of macroeconomic restructuring often accrue to the community only in the form of the J-curve -- there is initially a short downward phase during which the situation first worsens before it improves. After levelling out, benefits accrue to the country over a long period of time as the economy expands along the upward leg of the J-curve.

4. Summary

The cyclical upswing in the South African economy during the past three years provided evidence of a remaining vitality that is still present in this economy, despite having been battered for so long by internal strife and international punitive action. The normal course of the business cycle, however, also exposed some important weaknesses in the economy that needs urgent restructuring. These include the low level of saving, uncompetitiveness of local industries, a low labour-absorption capacity, a vulnerable balance of payments situation and the need for further economic, trade and financial liberalisation and effective asset restructuring programmes.

The Government's recently announced Macroeconomic Strategy for Growth, Employment and Redistribution duly acknowledges the need for more fundamental economic restructuring to eliminate the major deficiencies in the economy. In the end, the main objective of all macroeconomic policy must be to create more jobs in the country.

The contribution that monetary policy and the Reserve Bank must make towards the achievement of this overriding objective is to maintain overall financial stability in the economy, that is to keep inflation low. Overall financial stability may not be a guarantee for economic growth and development, but it definitely is and remain an essential prerequisite for growth and development.