A. RECENT DEVELOPMENTS IN THE SOUTH AFRICAN ECONOMY
1. Real economic activity
After a period of economic stagnation running from approximately 1982 to 1992, the South African economic performance improved gradually over the past three years. Six out of the eleven years preceding 1993 produced declines in total gross domestic production, and the few outshoots during this period, for example in 1984 and 1988, were short-lived because of balance of payments constraints at that time. South Africa could not afford any strong upsurge in imports in reaction to increases in domestic expenditure at a time when it was committed and forced by the international community to repay substantial amounts of foreign debt.
This situation changed dramatically over the past three years. The political and social reforms in South Africa brought with them the termination of international sanctions and trade boycotts, and the cessation of the disinvestment campaign and pressure for the withdrawal of foreign loans. South Africa, of course, welcomed the opportunity of being reintegrated in the world economy.
In this new environment, economic growth gradually rose to a higher level. The rate of change in gross domestic product switched from minus 2,2 per cent in 1992 to plus 1,3 per cent in 1993, before increasing to 2,7 per cent in 1994 and 3,3 per cent in 1995. Were it not for adverse climatic conditions and a substantial decline in gold mining production in 1995, the growth rate would have been even better -- growth in the secondary sectors of the economy last year exceeded 7 per cent, with a particularly strong contribution emanating from private sector manufacturing.
The expenditure or demand side of the economy showed even more resilience, and the rate of change in total gross domestic expenditure switched from minus 1,5 per cent in 1992 to plus 1,3 per cent in 1993, before accelerating to 6,7 per cent in 1994 and 5,6 per cent in 1995. It is clear that the South African economy at this stage needs but little demand stimulation -- the challenge remains to raise the production capacity to a higher level in order to meet the growing demand for goods and services.
It is therefore good to note that, on the demand side, a particularly strong increase in private sector fixed investment provided the main stimulus to the expansion. In 1994, total gross domestic fixed investment in real terms rose by almost 9 per cent, and in 1995 by a further 10 per cent. On the other hand, consumption expenditure by general government increased only modestly, with steady growth of between 3 and 5 per cent for private consumption expenditure.
It remains a major deficiency of the South African economy that not enough jobs are being created to provide employment for the growing labour force. Last year, however, saw the first year since 1989 that total employment increased, albeit by only 0,6 per cent compared with the level of employment in 1994. Despite the turn-around in the employment cycle during the course of 1995, it is estimated that nearly 280 000 people joined the ranks of the unemployed in the eighteen months up to the end of December 1995.
It is also encouraging to note that the rate of increase in the average nominal remuneration per worker in the non-agricultural sectors of the economy tapered off from 12,0 per cent in 1994 to 9,6 per cent in 1995. Adjusted for inflation, the average rate of increase in the real remuneration per worker last year was only 1,0 per cent. Because of the relatively good growth in particularly manufacturing production in 1995, the average productivity per worker increased by 3,2 per cent, with the result that there was an actual decline of 2,1 per cent in the unit labour costs per unit of production in the South African economy last year.
These important developments in the labour market deserve credit, not only because of the contribution they must make to enhance South Africa's competitiveness in the international markets, but also for the assistance they lend to the fight against inflation. If the unit labour cost per unit of production will continue to decline as it did last year, economic growth and total employment will be stimulated in the longer term. It will obviously also reduce the burden of monetary policy to maintain financial stability at all times.
One further aspect of real economic activity that continues to give reason for concern is the low level of saving in the national economy. The ratio of gross domestic saving to gross domestic product in 1995 was equal to only 16½ per cent. In view of the much needed increase in gross domestic fixed investment, the country had to rely to an increasing extent on foreign funds to finance the widening gap between domestic saving and investment.
It is not always understood that the economists' call for more saving is indeed a call for less consumption. In the national accounts analyses saving is but the difference between total production and total consumption. One of the reasons for the low rate of saving in South Africa is the excessive use of credit that enables the population to absorb tomorrow's production already in today's consumption. One of the many adverse macroeconomic results of over-consumption financed with credit creation is high interest rates, or alternatively, excessive money creation with an eventual higher inflation rate.
2. Balance of payments developments
As could have been predicted in the environment of large increases in domestic expenditure, and particularly in gross domestic fixed investment, South Africa's imports rose quite sharply over the past three years. The level of imports, measured in nominal values, almost doubled from 1992 to 1995. Total exports of merchandise also performed remarkably well, but could not match the rise in imports and, with but a small increase in the value of the net gold production over this period, the current account of the balance of payments switched from surpluses of about R5 billion in each of the years 1992 and 1993, to a deficit of R2,2 billion in 1994, and R12,7 billion in 1995. The deficit in 1995 was equal to 2,6 per cent of gross domestic product.
On this occasion, the growing current account deficit provided no serious funding problem, and placed no instant constraint on the expansion of domestic expenditure. This was, of course, thanks to the substantial inflow of capital from the rest of the world. After regular net outflows of capital of about R5 billion per annum from 1985 onwards, the capital account of the balance of payments showed a dramatic turn-around in the second half of 1994. Over the eighteen months from July 1994 to December 1995 a net amount of more than R30 billion flowed into the country from the rest of the world. This exceeded even the most optimistic expectations at the time of the election of the Government of National Unity in April 1994.
It is true that a substantial part of the net capital inflow over the past two years was either in the form of short-term funds, or portfolio investments entering the country through the Johannesburg Stock Exchange. A not insignificant amount of medium and longer term money was, however, also raised through international public issues by the South African Government and the parastatals, whilst South African private sector institutions made a number of international equity issues, particularly for the funding of their off-shore operations. A smaller amount of direct investment also flowed in.
The capital inflows in excess of the current account deficit enabled the Reserve Bank to replenish its foreign reserves. At the time of the election in April 1994, the Reserve Bank held, on a net basis, almost zero foreign reserves. By the end of 1995, the Bank's net foreign reserves holdings had risen to about R16 billion.
The overall favourable balance of payments situation also enabled the South African authorities to relax on the exchange controls. Over the past three years:
the debt standstill arrangements were terminated;
the financial rand system was abolished;
many South African corporates were enabled to acquire or establish international subsidiaries, branches or production units;
a programme for the gradual removal of restrictions on institutional investors to accomplish prudent international diversification of trust funds managed on behalf of the public was commenced with; and
some important liberalisation was introduced in the spot and forward foreign exchange markets.
Finally, as far as international financial relations are concerned, the exchange rate of the rand remained remarkably stable for a six year period from 1990 to 1995. Over this period, the average weighted value of the rand against a basket of the currencies of South Africa's major trading partners depreciated by 7 per cent per annum. In real terms, that is after adjustment for the inflation differential between South Africa and its major trading partners, the exchange rate of the rand depreciated by only 0,5 per cent per annum.
3. Domestic financial developments
Over the past few years, the Reserve Bank achieved mixed success in its efforts to keep the rate of growth in the money supply in check. After having risen by only 8 per cent in 1992 and 7 per cent in 1993, the M3 money supply increased at rates of 16 and 15 per cent, respectively, in 1994 and 1995. Excessive increases in the money supply may not be the only cause of inflation in the country, but remain an important precondition for sustainable inflation in the longer term. Although the influence on the money supply of the major social and political transformations in South Africa in recent years, and also the major technological advances in the financial sector with the introduction of electronic data processing and transfer systems, must be taken into account, the Reserve Bank remains concerned about the excessive rates of increase in the total, and in the various components, of the money supply. Recent rates of increases exceeded not only the real rate of growth in the economy, but also the nominal rate of growth in gross domestic production.
It is a matter of concern also that the major cause for the acceleration in the rate of increase in the money supply is an excessive rate of increase in bank lending to the private sector. Total bank credit extended to the private sector rose by 17 per cent during each of the past two years, compared with increases of only about 9 per cent per year in the preceding two years. Such increases not only raise the burden of debt servicing for the household sector, but can easily also lead to a deterioration of the quality of the loan book of banking institutions. It also, of course, exerts increasing upward pressure on the level of interest rates.
Against this background, and taking account of the low level of saving in the country, interest rates moved up quite strongly over the past three years. Short-term interest rates already started rising during the second quarter of 1994. The rate on 91-day Treasury bills, for example, was just over 10 per cent in early 1994, but then rose to 12,7 per cent at the end of 1994 and 14,2 per cent at the end of 1995. The Reserve Bank's discount rate rose from 12 per cent early in 1994 to its present level of 16 per cent.
Financial markets in South Africa in general almost exploded over the past few years. In 1992, the total value of shares traded on the Johannesburg Stock Exchange, for example, amounted to R22 billion, but then increased to R63 billion in 1995. The increase in the turnover in the bond market was even more spectacular, having risen from R496 billion in 1992 to R2 006 billion in 1995. The average price of all classes of shares listed on the Stock Exchange increased by 18,2 per cent per annum from 1992 to 1995. In the market for foreign exchange, the average daily turnover in the first five months of 1996 amounted to US $6,8 billion.
The rate of inflation in South Africa was gradually reduced from 15,3 per cent in 1991 to 8,7 per cent in 1995. After double-digit inflation from 1974 up to 1992, that is for a period of 19 years, the rate of change in the consumer price index finally broke through the magical 10 per cent barrier in 1993, and has now been in the single digit range for more than three years.
4. The budget of the central government
Government made an important contribution towards the encouragement of economic development within the private sector by constraining the rate of increase in total government expenditure, and reducing the deficit on the budget as a percentage of gross domestic product.
Over the past three fiscal years ending on 1996-03-31, total government expenditure as a percentage of gross domestic product stayed at the level of 31½ per cent, but with rising government revenue, the deficit before borrowing declined from 8,5 per cent of gross domestic product in 1993 to 6,2 per cent in 1996. For the current fiscal year, Government has budgeted for a deficit of only 5,5 per cent. Government has succeeded in meeting short-term demands for increased social and other essential economic upliftment expenditures mainly by reprioritising existing expenditure, and by rationalising in many government departments.
The deficit on the budget is, however, still large enough to exert undue upward pressure on total government debt which has risen from 44 per cent of gross domestic product in 1993 to 56 per cent in 1996. The growing amount of government debt, which will be inherited by the next generation, is still a worrying aspect of government finances and part of the reason why government regards it as essential to reduce the deficit as a percentage of gross domestic product even further during the next few years.
5. Prospects for 1996
The momentum of economic recovery was almost derailed in the first half of 1996 when a sudden outflow of foreign capital during the period February to April threatened financial stability. Following upon the large net inflows of capital since the middle of 1994, the inflow for a number of reasons suddenly petered out in the middle of February 1996. As a result of a large outflow of short-term funds and some disinvestment through Stock Exchange transactions, particularly during April, the rand came under tremendous pressure and the Reserve Bank's net foreign reserves declined by R6,6 billion from the end of January to the end of April 1996.
In the process, the exchange rate of the rand, which appreciated by 5½ per cent from the end of May 1995 up to the middle of February 1996, depreciated by more than 15 per cent in the subsequent 2½ months. The outflow of capital also drained liquidity from the domestic banking system and exerted substantial upward pressure on interest rates. The yield on long-term government stock, for example, rose from 13,77 per cent in January 1996 to 16,84 per cent on 1996-05-09. Short-term interest rates also moved up strongly. The rate on bankers' acceptances with a maturity of three months rose from 14,05 per cent at the end of February 1996 to 16,40 per cent at the end of April 1996. The Reserve Bank raised its discount rate from 15 to 16 per cent on 1996-04-29.
The events of February to April created major disruption in the South African financial markets and served to create undue pessimism about South Africa's economic potential, both within the local business community and amongst foreign investors. The situation, however, returned to more stable conditions towards the end of April, and the financial markets have been remarkably stable during May and June. After a net outflow of R1,9 billion through the Stock Exchange in April, there was a surprisingly large net inflow of funds of R2,6 billion in June. The Reserve Bank's net foreign reserves showed small increases in May and June, money market liquidity eased again, and some market interest rates declined.
The events did, however, leave one important scar, and that is an exchange rate that has depreciated by 15 per cent in nominal terms, partly to correct the fundamentals, and partly as an over-reaction to the market developments of the February/April period. In retrospect, although not everybody may agree, South Africa has weathered the storm reasonably well, has hopefully passed its first major test as a member of the volatile global financial market community, and is now proceeding again with its longer term programme of gradually raising the growth potential of the South African economy on a permanent basis to a higher level. The first challenge now is to ensure that the South African economy will indeed benefit from the depreciation of the rand, and that the potential advantages in depreciation will not be eroded by escalating inflation.
It is good to see confidence returning again to the South African business community. Despite the slippage of the past few months, the country can still look for economic growth in the region of 3 per cent in 1996; the chances have improved now of reducing the deficit on the current account of the balance of payments to below last year's level of about R12 billion; the chances are good that the exchange rate will for some time remain relatively stable at its new-found level; and the rate of inflation should remain below the 10 per cent level.
B. THE GOVERNMENT'S MACROECONOMIC STRATEGY FOR GROWTH, EMPLOYMENT AND REDISTRIBUTION
No survey of the current economic situation in South Africa can be complete without reference to the Govern-ment's recently released strategy for Growth, Employment and Redistribution. I have for some time been pleading for a marriage of the Reconstruction and Development Programme with a macroeconomic strategy that will provide a consistent programme for the elevation of the South African economic growth potential to a sustainable higher level. Without such a programme it would not have been possible to reach the laudable objectives of the Reconstruction and Development Programme. The Strategy Document presented to Parliament by the Minister of Finance on 1996-06-14 goes a long way towards meeting this request.
In the announced strategy, the Government included for South Africa the following macroeconomic goals that, I believe, provide distinct guidance for the implemen-tation of monetary policy over the next five years:
an acceleration of the fiscal reform process, including a tighter short-term fiscal stance to counter inflation,
an appropriate medium-term deficit target to eliminate government dissaving,
a further step in the gradual relaxation of exchange controls,
the maintenance of monetary policies consistent with inflation reduction,
exchange rate management to stabilise the real effective exchange rate at a competitive level,
a further lowering of tariffs to compensate for the real depreciation of the rand,
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 service delivery.
On inflation, one of the most important threats to the achievement of social and economic objectives in any developing or emerging economy, Government is equally unambiguous:
"To contain inflationary pressures requires concerted implementation of complementary stabilisation measures: accelerated tariff liberalisation, sharper deficit reduction, tight monetary policy, and above all, productivity- linked wage increases".
The Government also instructs the Reserve Bank as follows:
"The main objective of monetary policy will con-tinue to be the maintenance of financial stability and the reduction of the inflation rate. Positive real interest rates are a minimum condition for overall financial stability. Low inflation is an important requirement for higher economic growth, the creation of employment opportunities, and a more equitable distribution of income".
No central bank governor can ask for a more clear and more unequivocal mandate from his government. The role of monetary policy within the overall economic strategy of Government must be to lend support to the objectives set for the year 2000, and to do so as instructed:
"Responsible monetary policies anchor the com-petitiveness and stability of the economy in regard to both the domestic value of the rand and its foreign purchasing power and encourage domestic saving and investment. Finally, the fiscal containment in the package reduces the burden placed on monetary policy".
In answer to the many questions recently directed to the Reserve Bank, I would like to give an unmistakable reply:
Yes, if this strategy is diligently imple-mented, it will be possible to have a real Bank rate of not more than 3 per cent in the year 2000.
Yes, it is consistent within the strategy to assume that the annual rate of inflation will remain below 10 per cent and may even be lower than the 7,6 per cent envisaged for 2000.
Yes, economic growth at a rate of 6 per cent per annum can be reached, provided we all work to-gether in implementing the Strategy for Growth, Employment and Redistribution.
Needless to say, we in the Reserve Bank are enthusiastic about this programme and can only encourage all sectors of the economy to lend their full support to the realisation of the goals set by Government for the future economic development of South Africa.